                        T.C. Memo. 2011-42



                      UNITED STATES TAX COURT



          ROGER S. AND LISA G. CAMPBELL, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22750-05.              Filed February 17, 2011.



     Roger S. and Lisa G. Campbell, pro se.

     Robert V. Boeshaar, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes for the taxable years 1998,

1999, and 2001 of $13,530, $7,013, and $751, respectively, as
                              - 2 -

well as a $3,383 addition to tax under section 6651(a)(1)1 for

1998.

     After concessions,2 the issues for decision are:   (1)

Whether petitioners’ activity as Amway distributors was an

activity not engaged in for profit within the meaning of section

183 for taxable years 1998, 1999, 2000,3 and 2001; (2) whether

petitioners have substantiated claimed expenses from the Amway

activity for 1999 to the extent of gross profit from the

activity; (3) whether petitioners are entitled to deductions for

rental property expenses for 1998 and 1999; (4) whether

petitioners sustained a net operating loss in 2000 that may be

carried to one or more of the years in issue under section 172;

and (5) whether petitioners are liable for an addition to tax for

failure to timely file their 1998 Federal income tax return.




     1
      All section references are to the Internal Revenue Code of
1986, as in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
     2
      Petitioners concede that they are not entitled to deduct
$4,535 of expenses claimed with respect to their construction
business for 1998. Respondent concedes that petitioners are
entitled to a deduction for a wages expense of $2,699 for 1998.
Certain other adjustments are computational in nature.
     3
      Although respondent did not determine a deficiency for
2000, a determination under sec. 183 is necessary for 2000 in
order to determine the amount of any net operating loss
petitioners may carry back from that year.
                               - 3 -

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and they are so

found.   Petitioners resided in Washington when they filed the

petition.

     During the years in issue petitioners operated two

businesses in addition to the Amway activity.   Petitioner Lisa G.

Campbell (Mrs. Campbell) operated Preview Properties, a real

estate sales business.   Mrs. Campbell spent significant time,

including weekends, conducting the real estate business.   For

1998 and 1999 petitioners reported profits of $144,263 and

$43,189, respectively, from Preview Properties; they reported

losses from the business for 2000 and 2001 of $4,892 and $5,237,

respectively.

     Also during the years in issue petitioner Roger S. Campbell

(Mr. Campbell) operated RC Construction, a general construction

business, which he had operated since 1988.   Mr. Campbell spent

significant time during the years in issue managing his

construction business.   For 1998 and 2000 petitioners reported

losses of $11,188 and $4,224, respectively, from RC Construction,

while for 1999 and 2001 they reported profits of $20,000 and

$8,933, respectively.
                                - 4 -

Amway Activity

     Beginning in 1995 and during the years in issue petitioners

operated an Amway4 distributorship under the name RLC

Enterprises.    Amway is a supplier of household, cosmetic, and

nutritional products that are sold by individual distributors

through direct marketing.    Petitioners had not been involved with

a direct marketing activity before becoming involved with Amway.

They began their distributorship after being recruited by another

Amway distributor in 1995.

     An Amway distributor could generate revenue by selling Amway

merchandise directly to consumers at a retail markup or through

“performance bonuses” tied to the volume of products sold to

other Amway distributors he had recruited.    The individuals

recruited by an Amway distributor were referred to as the

recruiting distributor’s “downline” distributors; the recruiting

distributor was referred to as the “upline” or “sponsor”

distributor of the downline distributor.    A downline distributor

obtained his merchandise from his sponsor distributor, and the

sponsor distributor received performance bonuses from Amway based

on the volume of merchandise he sold to his downline

distributors.    These performance bonuses created an incentive for


     4
      The servicing corporation for petitioners’ distributorship
was Amway in 1998 and Quixtar, Inc., thereafter. For
convenience, we refer to petitioners’ distributorship as their
Amway activity and to the servicing corporation as Amway
throughout this opinion.
                              - 5 -

a sponsor distributor’s downline distributors to themselves

become sponsor distributors of additional downline distributors

in order to earn performance bonuses on the sales of distributors

who were downline to them--thus creating a pyramid of

distributors below a sponsor distributor that boosted the sponsor

distributor’s volume for purposes of performance bonuses.

Performance bonuses were computed as a percentage of sales volume

without regard to profitability.   The percentage increased as

sales volume exceeded certain thresholds.   Thus, Amway

distributors could maximize revenue by recruiting a large group

of downline distributors whom they in turn encouraged to sell or

distribute Amway merchandise and to make new recruits.

     Any Amway merchandise that an Amway distributor purchased

for personal use was also counted as a sale for purposes of

computing volume for performance bonuses.   Such merchandise could

be purchased by an Amway distributor at a discount below retail

price.

     Finally, certain Amway distributors were eligible to

purchase, for their own use or for sale to their downline

distributors, various “business support” materials including

books, magazines, other printed materials, audiotapes,

videotapes, software, and other electronic media to assist

distributors with training and motivation of themselves or
                                - 6 -

recruits.5   Petitioners purchased various business support

materials during the years in issue for their own use and for

resale to their downline distributors.

     Amway promoted the performance-bonus-generated pyramid

structure of its distributors through its independent business

ownership plan.   Petitioners focused on implementing the

independent business ownership plan and did not attempt to set up

a business plan of their own.

     Petitioners did not obtain any independent advice before

beginning to operate their Amway distributorship, with the

exception of that of their stockbroker, who counseled against it.

Petitioners instead relied on the advice of other Amway

distributors, particularly their upline distributors.

     Petitioners participated in Amway training functions

organized by Worldwide Group, L.L.C. (Worldwide Group).

Worldwide Group was operated by several Amway distributors

specifically to coordinate training and motivational seminars for

other Amway distributors.   Petitioners participated in perhaps

three out-of-town seminars organized by Worldwide Group each

year, as well as local sessions monthly.   The out-of-town

functions would generally take place over a weekend and would




     5
      According to Amway promotional materials, the purveyors of
these business support materials were independent of Amway or its
affiliates.
                                - 7 -

typically include lectures and workshops as well as social

functions.

     Petitioners concentrated on recruiting downline distributors

and marketing Amway merchandise to them, expending significant

time and effort for those purposes.     In this connection,

petitioners would make presentations at which they provided free

samples of some of the Amway products and/or business support

materials.   The distribution of the Amway products petitioners

sold to their downline distributors was time consuming,

consisting of taking and submitting distributors’ weekly orders,

collecting and remitting payments to petitioners’ upline

distributor, and distributing the merchandise to their downline

distributors.    Each week Mrs. Campbell would also ship or deliver

any products she had sold directly to retail customers.

     Petitioners also purchased Amway products for personal use;

as distributors, their purchases were often at a discount.    Mr.

Campbell purchased a truck at a discount through a program

affiliated with Amway, and petitioners also purchased appliances,

electronics, clothing, office supplies, and nutritional products

through Amway.   Petitioners also purchased Amway products for use

in their other businesses.   Amway was a substantial source of

materials and supplies for Mr. Campbell’s construction business.

Petitioners’ records show that in 1999 $14,418 worth of their

Amway purchases was used in Mr. Campbell’s construction business.
                               - 8 -

Mrs. Campbell used Amway products to furnish model houses in her

real estate business and for gift baskets for clients.   While

some of the products petitioners purchased for personal use or

use in their other businesses were not eligible for discounts,

the purchases nonetheless augmented petitioners’ sales volume so

as to increase their performance bonuses.

     Mrs. Campbell kept voluminous notes on petitioners’ Amway

activity, but petitioners made no written projections for profit,

loss, or break-even scenarios with regard to the Amway activity.

Petitioners would learn the extent of their profit or loss from

the Amway activity for any given year when they prepared the

year’s tax return.   Their returns for 1998 and 2000 were filed

approximately 22 months after the close of the respective years;

their 1999 and 2001 returns were filed approximately 10 months

after the close of the respective years.    Thus, petitioners were

generally not aware of the profitability of their Amway activity

for any given period until much later.

     Petitioners experienced losses from their Amway activity in

every year from its inception through the years in issue.   For

the years in issue and 2000, petitioners reported the following

gross receipts and claimed the following costs of goods sold,

expenses, and losses attributable to their Amway activity on

their Schedules C, Profit or Loss From Business:
                                   - 9 -

             Gross       Cost of        Gross
Year       Receipts    Goods Sold      Profit    Expenses    Net Profit

1998       $19,984      $44,745      ($24,761)   $13,761     ($38,522)
                        1
1999        52,620        57,145       (4,525)    19,960      (24,485)
2000        74,690        83,372       (8,682)    16,795      (25,477)
2001       103,266      108,272        (5,006)    14,974      (19,980)

       1
        Petitioners now contend this figure is $54,999.

       Respondent contends that petitioners had the following

amounts of gross receipts, costs of goods sold, expenses, and

losses attributable to their Amway activity:

             Gross       Cost of        Gross
Year       Receipts    Goods Sold      Profit    Expenses    Net Profit

1998        $19,984    $21,345        ($1,361)   $11,095     ($12,456)
1999         52,620     38,311         14,309        9,941      4,368
2000         74,690       N/A            N/A       18,528       N/A
                                                  1
2001        103,266    108,272         (5,006)      14,243    (19,249)

       1
      The notice of deficiency determined that petitioners had
substantiated $18,139 of expenses for 2001. Of this $5,884 was
attributable to a claimed expense for commissions and fees which
the parties now agree was already included in petitioners’ cost
of goods sold.

       To summarize, respondent has allowed amounts for costs of

goods sold for both 1998 and 2001 that exceed petitioners’ gross

receipts from the Amway activity.      Respondent also concedes that

petitioners have substantiated operating expenses that further

increase the losses generated by the Amway activity.         However,

with respect to 1999, respondent’s disallowance of approximately

one-third of petitioners’ claimed cost of goods sold and one-half

of petitioners’ claimed operating expenses results in gross and
                               - 10 -

net profits of $14,309 and $4,368, respectively, from the Amway

activity for that year.

     At the time of trial petitioners continued to be involved in

the Amway activity and they had no intention of discontinuing it.

Rental Property Expenses

     During the years at issue petitioners owned an unfinished

house in Montana, which was on land they leased from Mrs.

Campbell’s parents for $100 per year.   In 1997 Mrs. Campbell and

her parents executed a document labeled a “purchase agreement”

which provided that Mrs. Campbell would purchase a horse from her

parents for $9,500.    The document further provided that in lieu

of any cash payment for the horse, the unfinished house would be

rented to Mrs. Campbell’s parents for $500 annually, $300 of

which was to be credited against the purchase price of the horse

and $200 of which was for Mrs. Campbell’s parents’ care of the

horse.

     With respect to the house, petitioners reported $500 in

rental income for both 1998 and 1999 on Schedules E, Supplemental

Income and Loss, and claimed thereon $4,299 and $4,481,

respectively, for rental property expenses.

Notice of Deficiency

     After conducting an examination of petitioners’ 1998-2001

returns, respondent issued them a notice of deficiency.   The

notice determined that petitioners did not engage in their Amway
                                - 11 -

activity with a profit objective for 1998-2001 and made

adjustments for all 4 years, including 2000, but it did not

determine a deficiency for 2000 because the adjustments for that

year resulted in a loss.

     The adjustments for 2000 included disallowance of the

$25,477 loss petitioners claimed with respect to their Amway

activity.   However, respondent made no adjustment to the $4,892

loss petitioners claimed with respect to Mrs. Campbell’s real

estate business.     With respect to the $4,224 loss petitioners

claimed from Mr. Campbell’s construction business, the notice

allowed an additional $3,614 depreciation expense, increasing the

loss by that amount.    The aggregate result of the adjustments to

petitioners’ 2000 return was to reduce their claimed loss for the

year from $60,464 to $38,601.

                                OPINION

I. Burden of Proof

     The Commissioner’s determinations in the notice of

deficiency are presumed correct, and the taxpayer generally bears

the burden of proving that the determinations are in error.     See

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

However, under section 7491(a), the burden of proof on any

factual issue relevant to a taxpayer’s liability for tax shifts

to the Commissioner if the taxpayer has introduced credible

evidence with respect to that issue and has satisfied certain
                              - 12 -

other conditions, including compliance with the Internal Revenue

Code’s substantiation requirements.     Sec. 7491(a)(1) and (2).   As

discussed infra, petitioners have failed to provide

substantiation for required items.     Accordingly, they are not

entitled to a shift in the burden of proof under 7491(a).

II. Applicability of Section 183 to Petitioners’ Amway Activity

     A.   In General

     Under section 183(a), if an activity is not engaged in for

profit, then no deduction attributable to that activity is

allowed except to the extent provided by section 183(b).     In

pertinent part, section 183(b) allows those deductions that would

have been allowable had the activity been engaged in for profit

only to the extent of gross income derived from the activity

(reduced by deductions attributable to the activity that are

allowable without regard to whether the activity was engaged in

for profit).

     Section 183(c) defines an activity not engaged in for profit

as “any activity other than one with respect to which deductions

are allowable for the taxable year under section 162 or under

paragraph (1) or (2) of section 212.”     Deductions are allowable

under section 162 or under section 212(1) or (2) if the taxpayer

is engaged in the activity with the “actual and honest objective

of making a profit”.   Dreicer v. Commissioner, 78 T.C. 642, 645

(1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir.
                               - 13 -

1983); Golanty v. Commissioner, 72 T.C. 411, 426-427 (1979),

affd. without published opinion 647 F.2d 170 (9th Cir. 1981).

The taxpayer need not, however, establish that his or her

expectation of profit was reasonable.   See Dreicer v.

Commissioner, supra at 644-645; sec. 1.183-2(a), Income Tax Regs.

     The existence of the requisite profit objective is a

question of fact that must be decided on the basis of the entire

record.   Elliott v. Commissioner, 84 T.C. 227, 236 (1985), affd.

without published opinion 782 F.2d 1027 (3d Cir. 1986); Dreicer

v. Commissioner, supra at 645; sec. 1.183-2(b), Income Tax Regs.

In resolving this factual question, greater weight is given to

objective facts than to a taxpayer’s statement of intent.   See

Westbrook v. Commissioner, 68 F.3d 868, 875-876 (5th Cir. 1995),

affg. T.C. Memo. 1993-634; sec. 1.183-2(a), Income Tax Regs.

     The regulations set forth a nonexhaustive list of factors

that may be considered in deciding whether a profit objective

exists.   These factors are:   (1) The manner in which the taxpayer

carries on the activity; (2) the expertise of the taxpayer or his

advisers; (3) the time and effort expended by the taxpayer in

carrying on the activity; (4) the expectation that the assets

used in the activity may appreciate in value; (5) the success of

the taxpayer in carrying on other similar or dissimilar

activities; (6) the taxpayer’s history of income or losses with

respect to the activity; (7) the amount of occasional profits, if
                                - 14 -

any, which are earned; (8) the financial status of the taxpayer;

and (9) any elements indicating personal pleasure or recreation.

Sec. 1.183-2(b), Income Tax Regs.

     No single factor, nor even the existence of a majority of

factors supporting or rebutting the existence of a profit

objective, is controlling.     Id.   Rather, all facts and

circumstances with respect to the activity are to be taken into

account.     Id.

     The parties agree that the appreciation of assets has no

meaningful application as a factor with respect to determining

petitioners’ profit motivation in pursuing their Amway activity.

The parties disagree whether the other regulatory factors are

indicative of a profit objective.

     B.      Manner in Which Petitioners Carried On the Amway
             Activity

     If a taxpayer carries on the activity in a businesslike

manner and maintains complete and accurate books and records, it

may indicate a profit objective.     Sec. 1.183-2(b)(1), Income Tax

Regs.     However, if there is a lack of evidence that the

taxpayer’s records were used to improve the performance of a

losing operation, such records generally do not indicate a profit

objective.     Golanty v. Commissioner, supra at 430; see also

Sullivan v. Commissioner, T.C. Memo. 1998-367, affd. without

published opinion 202 F.3d 264 (5th Cir. 1999).     In particular,

keeping records that are used only for purposes of preparing tax
                              - 15 -

returns is not indicative of a profit objective.   See Rowden v.

Commissioner, T.C. Memo. 2009-41; Kinney v. Commissioner, T.C.

Memo. 2008-287.

     Petitioners did not conduct the Amway activity in a

businesslike manner.   Although they maintained a separate bank

account for the activity and maintained records for certain

aspects of it, petitioners never used these records as an

analytical tool for improving profitability.   Mrs. Campbell

testified that she did not know whether the Amway activity was

profitable in any given year until she completed petitioners’ tax

return for that year which, for 2 of the taxable years in issue,

did not occur until almost 2 years later.   It is a fair inference

that petitioners’ recordkeeping was directed more towards

substantiating deductions on a tax return than assessing the

profitability of the Amway activity.

     Moreover, petitioners’ Amway records were incomplete and

unreliable.   Petitioners’ recordkeeping made it impossible to

distinguish between Amway product purchases that were properly

includible in costs of goods sold and those that were withdrawn

from the business for personal consumption, leading respondent to

disallow a substantial portion of petitioners’ claimed costs of

goods sold.   At the examination the revenue agent determined that

she needed to reconstruct petitioners’ costs of goods sold for

1998 and 1999 to ascertain the extent to which the Amway products
                             - 16 -

purchased by petitioners and included by them in costs of goods

sold had in fact not been resold to downline distributors.       The

revenue agent compared petitioners’ total Amway product purchases

with the deposits into their Amway account of checks written to

them by individuals, treating all such checks as payments for

Amway products from downline distributors.       The revenue agent

treated the difference between the total Amway products purchased

and the amounts received from downline distributors as

representing the value of Amway products that had been withdrawn

from inventory by petitioners for personal use.       The computation

made by the revenue agent was as follows:

                                       1998        1999

Purchases                             $58,402     $72,384
Less payments from distributors       (19,665)    (38,311)
                                       38,737      34,073
Less inventory at end of year          (2,732)     (4,220)
Personal use items1                    36,005      29,853
     1
      The revenue agent’s calculation did not take into account
petitioners’ opening inventory in each year, thus understating
her computation of petitioners’ personal use items by $1,680 and
$2,732 for 1998 and 1999, respectively.

The revenue agent then determined the appropriate costs of goods

sold by making the following computation:
                             - 17 -

                                       1998      1999

Beginning inventory                   $1,680     $2,732
Purchases less withdrawals            22,397     42,531
                                      24,077     45,263
Less end of year inventory            (2,732)    (4,220)
Cost of goods sold1                   21,345     41,043
     1
      The revenue agent’s failure to account for opening
inventory in the calculation of items withdrawn for personal use
carried over onto her computation of costs of goods sold, causing
the figure to be overstated by $1,680 and $2,732 in 1998 and
1999, respectively.

     As a result of the examination respondent determined that

petitioners had substantially overstated the costs of goods on

their Amway Schedules C for 1998 and 1999.      Respondent’s

examination revealed that, of the $44,745 claimed as cost of

goods sold for 1998, only $21,345 could be traced to the

generation of receipts from the resale of Amway products, leaving

$23,400 in Amway product purchases claimed as cost of goods sold

for which there was no record of any proceeds from resale.      For

1999, of petitioners’ claimed cost of good sold of $57,145, only

$41,043 could be traced to the generation of resale receipts,

leaving $16,102 in claimed cost of goods sold for which there was

no record of any proceeds from resale.6   After a painstaking


     6
      As noted, the revenue agent’s computations actually
understated the value of items withdrawn for personal use in 1998
and 1999. On brief, respondent makes a correction for the
revenue agent’s corresponding overstatement of cost of goods sold
for 1999 (from $41,043 to $38,311) but he does not do so for
                                                   (continued...)
                               - 18 -

review of petitioners’ records, including additional

substantiation we permitted petitioners to submit after trial, we

agree with respondent’s position that petitioners substantially

overstated costs of goods sold for each year.

     Petitioners’ response appears to be that the $23,400 and

$16,102 in 1998 and 1999, respectively, of their Amway product

purchases for which there are no corresponding resale proceeds

represent Amway products that were given away for promotional or

training purposes; i.e., as free samples or as “business support”

(motivational) materials for their downline distributor recruits,

prospective recruits, and/or retail customers.    Petitioners also

accounted for personal use by excluding $14,800 and $14,418 in

1998 and 1999, respectively, of Amway product purchases from

their computation of costs of goods sold, as reflected in the

posttrial substantiation they submitted.

     We are not persuaded by petitioners’ explanation.    First, we

note that the exclusion of $14,800 for 1998 and $14,418 for 1999

of personal products that petitioners document in their posttrial

substantiation is already accounted for in the revenue agent’s

computation.    The revenue agent’s starting figures for Amway

purchases, $58,402 for 1998 and $72,384 for 1999, closely

approximate the results petitioners show in their posttrial



     6
        (...continued)
1998.
                              - 19 -

substantiation for Amway product purchases before exclusion of

personal use products, $59,063 for 1998 and $71,024 for 1999.

Recognizing the foregoing, we find it difficult to believe that

petitioners gave away Amway products totaling $23,400 in 1998 and

$16,102 in 1999 (i.e., each year’s Amway product purchases that

could not be traced to a resale).   Accepting petitioners’

explanation requires the Court to believe, for example, that they

gave away Amway products in excess of gross receipts in 1998.

Second, petitioners introduced expense summaries (Exhibit 23-P)

indicating that substantial amounts of Amway “business support”

materials were sold to their downline distributors, not given

away (i.e., $4,680 in 1998 and $14,197 in 1999).   Third, Mrs.

Campbell admitted in her testimony that she used Amway products

in her real estate business to stock model homes and to give in

gift baskets to clients, yet the only non-Amway use of Amway

product purchases in 1999 that is reflected in petitioners’

posttrial substantiation is use in Mr. Campbell’s construction

business.   In sum, while we are persuaded that some portion of

the Amway product purchases for which there are no corresponding

resale proceeds were given away for promotional or training

purposes during the years at issue,7 we believe such use fell


     7
      We account for promotional expenses in 1999 by allowing as
a promotional expense $4,000 of petitioners’ claimed “supplies”
expense (which they also explain as attributable to the giveaway
of Amway products as free samples or promotional materials for
                                                   (continued...)
                              - 20 -

considerably short of $23,400 and $16,102 in 1998 and 1999,

respectively.

     Considering all the facts and circumstances, including

especially the confusing state of petitioners’ Amway records, we

conclude that a substantial portion of the costs of goods sold

respondent disallowed for 1998 and 1999 represents Amway

purchases that petitioners withdrew from inventory for personal

use or use in their other businesses.   This commingling of the

Amway merchandise, resulting in substantial inaccuracies in

reported costs of good sold, is further evidence that

petitioners’ Amway activity was not conducted in a businesslike

fashion.   It also resulted in petitioners’ claiming business

deductions for personal expenditures.

     Finally, in the face of reporting consistent losses from

their Amway activity, petitioners did little to change how they

operated the business--except, apparently, reducing the size of

free samples given to prospective downline distributors and

attempting to increase retail sales.    Petitioners had no business

plan other than the plan Amway provided.   While it is true that

petitioners’ reported gross receipts grew dramatically during the

years at issue, suggesting success in recruiting downline


     7
      (...continued)
existing or prospective distributors). We note in this regard
that “selling expenses” are accounted for in the regulations as
business expenses rather than as cost of goods sold. Sec. 1.162-
1(a), Income Tax Regs.
                              - 21 -

distributors,8 this trend had no significant impact on

profitability.   Petitioners’ reported gross receipts almost

doubled between 1999 and 2001, yet their reported losses remained

around $20,000 annually.   See Ogden v. Commissioner, T.C. Memo.

1999-397 (annual increases in gross income from Amway activity

not indicative of businesslike conduct of activity where exceeded

by claimed deductions), affd. 244 F.3d 970 (5th Cir. 2001).    Mr.

Campbell testified that petitioners would stick with the Amway

activity even if it never returned a profit.   Under these

circumstances, it is clear that petitioners did not operate their

Amway activity in a businesslike manner.   Accordingly, this

factor weighs heavily against petitioners.

     C.   Expertise of Petitioners or Their Advisers

     Preparation for the activity by extensive study of its

accepted business practices, or consultation with those who are

expert therein, may indicate a profit objective where the

taxpayer carries on the activity in accordance with such

practices.   Sec. 1.183-2(b)(2), Income Tax Regs.

     Although petitioners have prior entrepreneurial experience

and both operated other businesses concurrently, they had no



     8
      Some of the growth in gross receipts may also be
attributable to the fact that petitioners processed through their
Amway activity the purchase of supplies and materials for Mr.
Campbell’s construction business and Mrs. Campbell’s real estate
business. For example, in 1999 petitioners purchased at least
$14,418 of Amway products for the construction business alone.
                               - 22 -

experience with operating a direct marketing distributorship

before they were recruited as Amway distributors.   Petitioners

obtained advice only from their upline distributors and other

interested Amway individuals, persons who had a direct financial

interest in the maximization of petitioners’ sales volume,

without regard to petitioners’ profitability.   See Ogden v.

Commissioner, supra (Amway upline distributors’ advice biased in

view of financial interest in downline distributor’s sales

volume).   The only disinterested third party with whom

petitioners consulted was their stockbroker, who advised them not

to become involved in Amway.   This factor weighs against

petitioners.

     D.    The Time and Effort Expended by Petitioners in Carrying
           On the Activity

     The fact that the taxpayer devotes much of his personal time

and effort to carry on an activity may indicate an intention to

derive a profit.   Sec. 1.183-2(b)(3), Income Tax Regs.

     Both petitioners spent extensive time and effort carrying on

the Amway activity.   Petitioners went to Amway training

functions, participated in counseling sessions with upline

distributors, and expended substantial time attempting to recruit

new downline distributors.   Mrs. Campbell credibly testified that

she spent approximately 25 hours on average per week taking and

organizing orders from her retail customers and downline
                                - 23 -

distributors, placing these orders, and distributing the

merchandise.

     This factor favors petitioners.

     E.    Petitioners’ Success in Carrying Out Other Similar or
           Dissimilar Activities

     The fact that the taxpayer has engaged in similar activities

in the past and converted them from unprofitable to profitable

enterprises may indicate that he is engaged in the present

activity for profit, even though the activity is presently

unprofitable.   Sec. 1.183-2(b)(5), Income Tax Regs.

     Petitioners had no prior history of engaging in a direct

marketing distributorship.   However, both petitioners

successfully operated other businesses.    During the years in

issue, both Mr. Campbell’s construction business and Mrs.

Campbell’s real estate business had profitable years and loss

years.    While the real estate and construction businesses are not

similar to an Amway distributorship, we conclude that

petitioners’ record of at least moderate success in other

business activities makes this factor favor petitioners.

     F.    Petitioners’ History of Income or Loss

     A series of losses during the initial or startup stage of an

activity may not necessarily be an indication that the activity

is not engaged in for profit.    Sec. 1.183-2(b)(6), Income Tax

Regs.; see Golanty v. Commissioner, 72 T.C. at 427.      However,

where losses continue to be sustained beyond the period which
                              - 24 -

customarily is necessary to bring the operation to profitable

status, such continued losses, if not explainable, may be

indicative that the activity is not engaged in for profit.    Sec.

1.183-2(b)(6), Income Tax Regs.   The “goal must be to realize a

profit on the entire operation, which presupposes not only future

net earnings but also sufficient net earnings to recoup the

losses which have meanwhile been sustained in the intervening

years.”   Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965),

affd. 379 F.2d 252 (2d Cir. 1967); see also Nissley v.

Commissioner, T.C. Memo. 2000-178.

     Petitioners’ gross receipts from their Amway activity

increased significantly each year in issue, from $19,984 in 1998

to $103,266 in 2001.   Nonetheless, if we use petitioners’

reported results, their cost of goods sold always exceeded their

gross receipts, and after accounting for operating expenses,

petitioners’ Amway activity generated annual losses that

generally exceeded $20,000, notwithstanding the growth in gross

receipts.9   Petitioners in this respect are similar to the


     9
      Petitioners claimed that they had a small profit from their
Amway activity in 2002, and they submitted a copy of a Federal
income tax return they had submitted to respondent for that year.
Because the return was filed late and close to the time of trial,
respondent had not yet processed the return. The return was
prepared during the pendency of this proceeding. We are
therefore mindful that petitioners had an incentive to show a
profit from Amway for that year in order to bolster their
position in this proceeding. Nothing in the record, other than
petitioners’ testimony, enables us to determine whether
                                                   (continued...)
                               - 25 -

taxpayers in Ogden v. Commissioner, T.C. Memo. 1999-397.      In

Ogden, the taxpayers’ Amway activity showed substantial and

increasing gross revenue for a period of 3 consecutive years and,

in contrast to petitioners’ activity, generated small amounts of

gross profit (i.e., gross revenue less cost of goods sold).

After the Ogden taxpayers’ claimed expenses, however, their Amway

activity produced losses each year of approximately $20,000, a

magnitude similar to petitioners’ claimed losses.    We concluded

in Ogden that the growth in gross receipts did not support a

finding of a profit objective in view of the sustained pattern of

losses.   We reach the same conclusion here.   Petitioners’

sustained period of losses favors respondent.

     Moreover, some of the growth in petitioners’ gross receipts

is illusory.   Petitioners’ Amway gross receipts included their

bonus payments, which were boosted by product sales that

reflected petitioners’ purchase of Amway products for use in

their other businesses.10   Thus, some of petitioners’ increase in

gross receipts was due not to their efforts at building their




     9
      (...continued)
petitioners’ claimed profit in 2002 is genuine or whether it is a
result of their decision to claim fewer expenses. We therefore
decline to make any finding that petitioners’ Amway activity was
profitable in 2002.
     10
      As noted, petitioners recorded $14,418 of Amway purchases
for Mr. Campbell’s construction business in 1999.
                                - 26 -

Amway activity but to their decision to use Amway as a supplier

of the construction business.

     G.     Petitioners’ Financial Status

     The fact that the taxpayer does not have substantial income

or capital from sources other than the activity may indicate that

an activity is engaged in for profit.    Sec. 1.183-2(b)(8), Income

Tax Regs.    Substantial income from sources other than the

activity, particularly if the losses from the activity generate

substantial tax benefits, may indicate that the activity is not

engaged in for profit.    Id.

     Although the profitability of Mr. Campbell’s construction

business and Mrs. Campbell’s real estate business fluctuated,

petitioners reported combined profits from the two businesses of

$133,075, $63,189, and $3,696 for 1998, 1999, and 2001,

respectively, and a combined reported loss of $9,116 for 2000.11

Petitioners were able to use the reported losses from the Amway

activity to offset 29 percent, 38 percent, and 100 percent of

their combined income from the real estate and construction

businesses in 1998, 1999, and 2001, respectively.   Thus, the tax

benefits generated from their reported Amway losses were

substantial.   Petitioners’ financial status enabled them to



     11
      As discussed infra, in the notice of deficiency respondent
allowed additional depreciation expense for petitioners’
construction business for 2000, increasing the combined loss from
the construction and real estate businesses to $12,730.
                               - 27 -

exploit significant tax benefits from the losses generated by the

Amway activity.   Therefore, this factor favors respondent.

     H.     Elements of Personal Pleasure or Recreation

     The presence of personal motives in carrying on an activity

may indicate that the activity is not engaged in for profit,

especially where there are recreational or personal elements

involved.    Sec. 1.183-2(b)(9), Income Tax Regs.

     This Court has observed that “there are significant elements

of personal pleasure attached to the activities of an Amway

distributorship” and that “an Amway distributorship presents

taxpayers with opportunities to generate business deductions for

essentially personal expenditures.”     Brennan v. Commissioner,

T.C. Memo. 1997-60.    We accept petitioners’ testimony that they

did not engage in the Amway activity for its social aspects or

because their Amway activities afforded them recreational

opportunities.    Nonetheless, petitioners used their Amway

distributorship as a means to generate business deductions for

essentially personal expenditures and as a source of discounts on

items for personal consumption or use in their other businesses,

as illustrated by the extensive disallowances of their claimed

deductions, many of which they now concede.    For 1999

petitioners’ proffered substantiation shows that they deducted,

as “legal and professional” expenses of the Amway activity, hay

and shoes for their horses.    Petitioners concede that the meals
                              - 28 -

and entertainment expenses they claimed with respect to the Amway

activity were overstated by $602 and $803 for 1998 and 1999,

respectively.   We have discussed previously the inadequate

bookkeeping that resulted in petitioners’ claiming cost of goods

sold for Amway products used for personal consumption or in

petitioners’ other businesses.

     Petitioners’ Amway activity enabled them to obtain an

extensive range of consumer products for personal use (or other

business use) at a discount, including a truck and household

appliances.   Petitioners were entitled to discounts at several

national chain retailers through Amway, including Barnes & Noble,

OfficeMax, Craftsman Tools, Circuit City, and Sur La Table.

Petitioners’ own recordkeeping reflects that $14,800 and $14,418

of Amway products in 1998 and 1999, respectively, was purchased

for personal use or use in their other businesses, and we have

concluded that additional amounts were used for this purpose and

improperly reported as costs of goods sold in those years.

Petitioners obtained a further effective discount on these

purchases because they boosted petitioners’ Amway sales volume

for the year, generating additional bonuses.   The availability of

consumer product discounts for personal use merchandise is a

factor supporting the conclusion that Amway distributors lacked a

profit objective.   See Nissley v. Commissioner, T.C. Memo. 2000-

178; Ogden v. Commissioner, T.C. Memo. 1999-397.
                               - 29 -

     These personal aspects are further underscored by Mr.

Campbell’s testimony that petitioners expected to continue their

Amway activity, even if it never returned a profit.    See Nissley

v. Commissioner, supra (personal dimensions of Amway activity

underscored by admission that taxpayers had no intention of

getting out of Amway even if it did not turn profitable).

     Accordingly, we find that petitioners derived substantial

personal benefits from their Amway activity.    This factor favors

respondent.

     I.     Conclusion

     Petitioners spent significant time carrying on their Amway

activity.    Furthermore, petitioners achieved substantial

increases in gross receipts from the Amway activity during the

years in issue, reflecting some success in recruiting downline

distributors, though some of the increase was illusory because it

was attributable to their acquisition of Amway products for use

in their other businesses and for personal consumption.

     However, petitioners did not conduct their Amway activity in

a businesslike manner.   They usually had no notion of whether the

Amway activity had been profitable for a given year until they

completed their tax return for that year many months later.   They

also deducted personal expenses as Amway business expenses.

Their recordkeeping commingled costs of Amway products used for

personal purposes and in their other businesses with those of
                              - 30 -

products used in their Amway distributorship to such an extent

that their cost of goods sold for each year, and operational

results, for the Amway activity were substantially misstated.

     Petitioners’ substantial use of discounted Amway products in

their other businesses and for personal consumption persuades us

that the discounts were a principal motivation for petitioners’

involvement in the Amway activity.     We are likewise persuaded

that petitioners’ substantial use of the discounts and their

commingling of the Amway merchandise in their records indicates

that they were largely indifferent to whether the Amway activity,

standing alone, produced a profit.     We conclude that the benefits

of the discounts to their other businesses and of the reduction

in their effective tax burden from the Amway losses made

petitioners willing to accept losses from the Amway activity

indefinitely (as Mr. Campbell testified).     In view of the

foregoing, petitioners have failed to prove that they carried on

their Amway activity with the requisite objective of making a

profit.   Consequently, their deductions arising from the Amway

activity are limited by section 183.

III. Substantiation of Petitioners’ Amway Expenses

     A. In General

     The parties dispute whether petitioners have substantiated

many of the expenses claimed for the Amway activity, including

cost of goods sold.
                              - 31 -

     For 1998 and 2001 respondent concedes that petitioners have

substantiated expenses that exceed their gross income derived

from the Amway activity.   We therefore need not address whether

petitioners have substantiated any expenses beyond those

respondent conceded for those years, because our holding that

petitioners’ Amway activity was not engaged in for profit

precludes any such deductions in excess of gross income derived

from the Amway activity.   However, petitioners’ claimed Amway

expenses that respondent concedes for 1999 are less than

petitioners’ gross income from Amway in that year.    Accordingly,

we must decide whether petitioners have substantiated any Amway

expenses for 1999 beyond those respondent conceded.

     Petitioners and respondent agree that petitioners had

$52,620 of gross receipts from their Amway activity in 1999.

Petitioners claimed a total of $86,662 in cost of goods sold and

operating expenses for their Amway activity for 1999,12 but

respondent has disallowed $38,410 of the total.   Respondent’s

disallowances, if sustained in full, would cause petitioners’

gross income from their Amway activity to exceed the expenses

respondent allowed by $4,368 ($52,620 gross receipts less $48,252

in cost of goods sold and expenses allowed by respondent).    We



     12
      As compared to the amounts petitioners claimed on their
1999 return, petitioners at trial conceded $2,146 in cost of
goods sold and claimed an additional $1,759 and $9,944 in office
and supply expenses, respectively.
                              - 32 -

must therefore decide whether petitioners are entitled to any

Amway expenses for 1999 in excess of those respondent allowed.

As discussed below, we find that petitioners are entitled to

$1,000 in office expense and at least $4,000 in promotional or

marketing expense deductions for 1999.   We therefore need not

address the other disputed items.

     Generally, a taxpayer must keep records sufficient to

establish the amounts of the items reported on his Federal income

tax return.   Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.    In

the event that a taxpayer establishes that a deductible expense

has been paid but is unable to substantiate the precise amount,

we generally may estimate the amount of the deductible expense,

bearing heavily against the taxpayer whose inexactitude in

substantiating the amount of the expense is of his own making.

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).

     B.   Office Expenses

     For 1999 petitioners claimed $4,048 of office expenses,

$2,289 on their return and an additional $1,759 at trial.

Respondent determined that no office expenses were allowable for

that year.

     Petitioners have offered substantiation of approximately

$2,074 of office expenses.   They have introduced an exhibit

titled “1999 New + original office expense additional”, which

consists of a handwritten ledger and a summary spreadsheet
                               - 33 -

purporting to record their Amway office expenses for 1999.

Petitioners provided no invoices for any of the listed entries.

Consequently, we find petitioners’ proffered substantiation

insufficient.

     Nonetheless, we are persuaded by petitioners’ testimony and

the record as a whole that their Amway activities, including

especially Mrs. Campbell’s distribution tasks, were extensive.

We are further persuaded that petitioners necessarily incurred

office expenses to execute these tasks in 1999.    Given the extent

of petitioners’ distribution network and sales volume, we find a

reasonable estimate of their office expenses for 1999 to be

$1,000 (approximately $83 per month), and we accordingly allow

$1,000 of office expenses for 1999.

     C.     Promotional Expenses

     Petitioners claimed $9,944 of expenses attributable to

“supplies” for their Amway activity, all of which respondent

disputes.    Petitioners contend that the supplies expense

represents free samples and “business support” materials given to

their existing or prospective downline distributors.

     Petitioners’ proffered substantiation of the supplies

expense consists of handwritten and computer-generated ledgers

purporting to record $6,040 and $3,898, respectively, of Amway

products, including training and motivational books, audiotapes,

and videotapes, given away as promotional or training materials
                               - 34 -

in 1999.   In many instances, these ledgers record multiple

purchases of the same item (which tends to rebut the notion that

the items were for personal use).   In these circumstances, we

find credible petitioners’ claim that they gave away at least

some significant portion of the items on these ledgers in an

effort to recruit downline distributors and encourage existing

downline distributors to purchase products and engage in further

recruiting.   Moreover, respondent has conceded that $16,688 of

Amway products was purchased by petitioners in 1999 but not

resold.    While we have previously concluded that some portion of

this $16,688 in Amway products purchased in 1999 represents

personal use, we are persuaded that petitioners also gave away a

portion for promotional purposes.   Considering that petitioners

generated $52,620 of Amway gross receipts for 1999, we find that

at least $4,000 (approximately 7.5 percent of 1999 gross

receipts) constitutes a reasonable estimate of petitioners’

promotional expenses for the Amway activity for 1999.

      As a consequence of the office and promotional expenses we

are persuaded petitioners incurred in their Amway activity for

1999, they have substantiated expenses that are at least equal to

their gross income from Amway in that year.

IV.   Deductions for Rental Expenses in 1998 and 1999

      Petitioners claimed deductions for Schedule E rental

expenses of $4,299 and $4,481 for 1998 and 1999, respectively,
                               - 35 -

for expenses purportedly incurred in renting their unfinished

Montana house to Mrs. Campbell’s parents.

     Section 212 allows a deduction for ordinary and necessary

business expenses paid for the production of income or for the

management or maintenance of property held for the production of

income.   An expense is ordinary if it is customary or usual

within a particular trade business, or industry.    Deputy v. du

Pont, 308 U.S. 488, 495 (1940).    It is necessary if it is

appropriate and helpful for the business.    Commissioner v.

Heininger, 320 U.S. 467, 471 (1943).

     Petitioners reported $500 of annual rental income in 1998

and 1999 from the Montana house.    Petitioners allowed Mrs.

Campbell’s parents to use the house for various purposes.

Petitioners claim that their rental expenses consisted of

cleaning and maintenance of the house, depreciation, and property

taxes paid on the house.

     Petitioners are not entitled to the claimed deductions.

Petitioners provided no documentary evidence to substantiate

their claimed expenses.    There is no evidence of their basis in

the house to support a depreciation deduction, no evidence of a

local tax bill, and no invoice for maintenance or cleaning.

Respondent’s disallowance of petitioners’ claimed rental expense

for 1998 and 1999 is sustained.
                               - 36 -

V.   Net Operating Loss Deduction

     Section 172(a) authorizes a net operating loss (NOL)

deduction.    An NOL is defined as the excess of allowable

deductions over gross income, with specified modifications.    Sec.

172(c) and (d).    The modifications for purposes of computing an

NOL include an exclusion of personal exemptions and nonbusiness

deductions of taxpayers other than corporations (except to the

extent of income that is not derived from a trade or business).

Sec. 172(d)(3) and (4).    Section 172(a) allows an NOL deduction

for the aggregate of NOL carrybacks and carryovers to the taxable

year.   Section 172(b)(1)(A) generally provides that the period

for a carryback is 2 years and that the period for a carryover is

20 years.    A taxpayer may elect to waive the carryback period,

but only if he files an election to do so by the due date

(including extensions) of the return for the year in which the

carryback NOL is generated.    Sec. 172(b)(3).   Otherwise, the NOL

must be carried to the earliest of the taxable years to which it

may be carried, and it offsets taxable income for that year.

Sec. 172(b)(2).

     In general, the taxpayer bears the burden of establishing

both the actual existence of an NOL in another year and the

amount of that NOL that may be carried to the years in issue.

Keith v. Commissioner, 115 T.C. 605, 621 (2000).     We have

jurisdiction to consider such facts related to years not in issue
                               - 37 -

as may be necessary for redetermination of the tax liability for

any period before the Court.   See sec. 6214(b).

     In the notice of deficiency respondent made a series of

determinations concerning petitioners’ 2000 taxable year, the

result of which was a loss for that year of $38,601, rather than

the $60,464 claimed on the return.      The notice determined that,

pursuant to section 183, the losses arising from petitioners’

Amway activity in excess of the gross income derived therefrom

were not allowable, resulting in the elimination of a $25,477

loss claimed.   The notice made no adjustment, however, to the

$4,892 loss petitioners claimed with respect to Mrs. Campbell’s

real estate business.   With respect to Mr. Campbell’s

construction business, the notice determined that petitioners’

claimed loss of $4,224 should be increased by an additional

$3,614 depreciation expense that was not claimed on the return.

Respondent made no other adjustments, accepting petitioners’

claimed itemized deductions and personal exemptions.

     The adjustments respondent made in the notice of deficiency

concerning petitioners’ 2000 taxable year, wherein respondent

concedes a $38,601 loss for the year, indicate that petitioners’

2000 taxable year may give rise to an NOL carryback or

carryforward to one or more of the years at issue.     Neither party

has addressed this issue on brief.      In view of petitioners’ pro

se status, however, we conclude that it is appropriate, and is a
                                - 38 -

necessary part of our jurisdiction to redetermine the

deficiencies for the years before us, to resolve whether

petitioners are entitled to an NOL deduction for any year at

issue.   We will accordingly direct the parties to address

petitioners’ entitlement to any NOL from 2000 as part of their

Rule 155 computations.

     For purposes of the Rule 155 computations, we sustain

respondent’s determination that the loss petitioners claimed for

2000 from the Amway activity is limited by section 183.    For the

same reasons discussed in relation to the other years at issue,

we conclude that petitioners did not engage in their Amway

activity in 2000 with the requisite profit objective and that

their deductions are therefore limited to their gross income

derived from the activity.   Since respondent concedes that

petitioners had $83,372 of cost of goods sold in 2000, which

exceeded their gross income in that year, it follows that

petitioners are not entitled to the $25,477 loss they claimed for

2000 arising from the Amway activity.

     In making no adjustment to petitioners’ claimed $4,892 loss

from Mrs. Campbell’s real estate business, and in allowing an

additional depreciation deduction of $3,614 on top of the $4,224

loss claimed for Mr. Campbell’s construction business, respondent

appears to have conceded that petitioners had aggregate Schedule

C losses of $12,730 for 2000.    Similarly, respondent appears to
                              - 39 -

have conceded that petitioners had itemized deductions of $20,303

and personal exemptions of $5,600 for 2000.   Together, the

foregoing would generate a loss totaling $38,601 for 2000, before

the necessary adjustments under section 172(d).

VI.   Section 6651(a)(1) Addition to Tax

      Respondent determined that petitioners are liable for an

addition to tax for failure to timely file their 1998 return.

Under section 7491(c), the Commissioner has the burden of

production with respect to a taxpayer’s liability for the section

6651(a)(1) addition to tax.   In order to meet that burden, the

Commissioner must offer sufficient evidence to indicate that it

is appropriate to impose the relevant penalty.    Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).    Once the Commissioner

meets his burden of production, the taxpayer bears the burden of

proving error in the determination, including evidence of

reasonable cause or other exculpatory factors.    Id. at 446-447.

      Section 6651(a)(1) provides for an addition to tax for a

taxpayer’s failure to file a required return on or before the due

date, including extensions.   The addition to tax may be avoided

if the failure to file was due to reasonable cause and not

willful neglect.   United States v. Boyle, 469 U.S. 241, 245-246

(1985).   Reasonable cause exists for late filing if the taxpayer

exercised ordinary care and prudence but was nevertheless unable

to file on time.   Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.
                              - 40 -

Illness or incapacity may constitute reasonable cause if the

illness causes an inability to file.   Joseph v. Commissioner,

T.C. Memo. 2003-19.   However, illness or incapacity does not

constitute reasonable cause where the taxpayer has the capacity

to attend to other responsibilities.   Wright v. Commissioner,

T.C. Memo. 1998-224 (“‘selective inability’ to file tax returns

while attending to other responsibilities does not demonstrate

reasonable cause”), affd. without published opinion 173 F.3d 848

(2d Cir. 1999).

     Petitioners concede that they filed their 1998 return on

October 18, 2000.   Accordingly, respondent has met his burden of

production, and in order to avoid the addition to tax,

petitioners must show that reasonable cause existed for their

failure to timely file their return.   Petitioners argue that they

had reasonable cause because their daughter was extremely ill and

was giving birth to a child at the time the 1998 return was due.

They contend that their care for their daughter was so time

consuming that it was reasonable for petitioners not to file

their 1998 return when due.

     Petitioners did not testify as to the length of their

daughter’s illness and did not provide medical records.   However,

even accepting that petitioners’ daughter was severely ill and

that petitioners had to care for her, petitioners have not

established that their daughter’s illness provided reasonable
                               - 41 -

cause for not timely filing the 1998 return.    During 1999, the

year in which petitioners’ 1998 return was due, they generated

significant income from their construction business and their

real estate business.   Concurrently, they spent significant time

in their Amway activity.    Because petitioners were able, despite

their daughter’s illness, to carry on extensive business

activities with significant success, petitioners’ contention that

they simply did not have time to file their 1998 returns is

implausible.   See Coury v. Commissioner, T.C. Memo. 2010-132; see

also Wright v. Commissioner, supra; Bear v. Commissioner, T.C.

Memo. 1992-690, affd. without published opinion 19 F.3d 26 (9th

Cir. 1994).    We accordingly conclude that petitioners did not

have reasonable cause for the failure to timely file their 1998

return.   The addition to tax under section 6651(a)(1) determined

by respondent is sustained.

     To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.
