                  T.C. Summary Opinion 2006-47



                     UNITED STATES TAX COURT



       DAVID M. SEARS AND CAROL L. McCABE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7980-04S.                Filed April 3, 2006.



     David M. Sears and Carol L. McCabe, pro sese.

     Daniel J. Parent, for respondent.



     PANUTHOS, Chief Special Trial Judge:    This case was heard

pursuant to the provisions of section 7463 of the Internal

Revenue Code in effect at the time the petition was filed.      The

decision to be entered is not reviewable by any other court, and

this opinion should not be cited as authority.    Unless otherwise

indicated, subsequent section references are to the Internal
                                - 2 -

Revenue Code in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

     Respondent determined a deficiency in petitioners’ 2000

Federal income tax of $2,115.    After concessions by the parties,1

the issues for decision are:    (1) Whether petitioner David

Sears’s sales activity was engaged in for profit, and (2) if the

activity was engaged in for profit, to what extent petitioners

have substantiated the expense deductions claimed on their

Schedule C, Profit or Loss From Business.2

                           Background

     Some of the facts have been stipulated and are so found.

The stipulation of facts, supplemental stipulation of facts, and

the attached exhibits are incorporated herein by this reference.

Petitioners are married and resided in Oroville, California, at

the time they filed their petition.


     1
        Petitioners concede the following Schedule C, Profit or
Loss From Business, expenses: $100 of commissions and fees
expense, $1,322 of employee benefit programs expense, $31 of
other interest expense, and $12 of taxes and licenses expense.
They also concede that petitioner David Sears received $768 of
nonemployee compensation. Respondent concedes that petitioners
paid $10,149 of home mortgage interest and $1,115 of real estate
taxes.
     2
        Petitioners now claim additional expense deductions
beyond those claimed on their Schedule C. Based on our
resolution of the first issue in this case, infra, we need not
address whether they are entitled to deduct additional Schedule C
expenses. Respondent also adjusted petitioners’ Schedule A,
Itemized Deductions, for mortgage interest paid and property
taxes paid. These adjustments are computational; therefore, we
need not address them.
                                - 3 -

     In 1999, petitioners became associated with Renaissance, The

Tax People, Inc. (RTP), also known as Advantage International

Marketing.    RTP sold a product called “The Tax Relief System”

(the system), which was designed to generate Federal income tax

deductions.   RTP claimed that by establishing a “home-based

business” activity, a taxpayer could convert personal expenses

into business expenses.    The system consisted of various written

materials that RTP sold for $400.    RTP promised to refund the

purchase price if a taxpayer failed to generate at least $5,000

of Federal income tax deductions during the first 12 months of

using the system.

     RTP also sold a related service called “Platinum Tax

Advantage” (the platinum service)3 that was available to

customers who purchased the system.     For $100 a month, platinum

service members could contact RTP and receive tax and financial

planning advice.    RTP also claimed it would prepare customers’

tax returns and represent them before the Internal Revenue

Service (IRS) in the case of an audit.

     RTP sold the system and the platinum service by means of

“multi-level marketing” or “network marketing”.    A “downline”

distributor was recruited by an “upline” distributor.    An upline

distributor earned a $30 commission for every sale he made of the

system and an additional $3 commission for each month a downline

     3
        The parties also referred to the platinum service as
“Prepaid Tax Advantage.”
                                 - 4 -

distributor purchased the platinum service.4    Thus, if an upline

distributor sold the system and a year’s subscription to the

platinum service, he earned commissions totaling $66.     An upline

distributor also earned commissions based on a downline

distributor’s sales and on the downline distributor’s success in

developing his own downline distribution network.     See Elliott v.

Commissioner, 90 T.C. 960 (1988), affd. without published opinion

899 F.2d 18 (9th Cir. 1990), for a general discussion of multi-

level marketing.

     Petitioner David Sears (Mr. Sears) was recruited as a

downline distributor in August 1999.     He also purchased the

platinum service, which he maintained until he discontinued his

involvement with RTP in 2001.5    To generate sales and recruit

downline distributors of his own, he frequently went to coffee

shops or doughnut shops and initiated conversations with other

patrons about taxes.   Mr. Sears would mention the RTP system “as

an alternative to just complaining” about taxes.     He also invited

acquaintances to dinner to discuss the system.    During this time,

     4
        The upline distributor did not provide the tax advice and
other services to downline distributors. RTP provided such
services directly.
     5
        Petitioner Carol McCabe (Ms. McCabe) also purchased the
system and the platinum service; however, petitioners do not
claim that Ms. McCabe’s RTP activity was a trade or business for
Federal income tax purposes. They testified that only one person
was covered by the $100 platinum service fee. Thus, in order for
Ms. McCabe to receive tax and financial planning advice of her
own, she had to purchase separately the system and the platinum
service.
                                 - 5 -

Mr. Sears maintained a full-time job at a computer software

company, where he earned $46,081.60 in the taxable year 2000.

     Following one of the tax-reduction strategies advocated by

RTP, Mr. Sears established a “Medical Expense Reimbursement Plan”

(the reimbursement plan) to cover employees of his RTP activity.

He testified that petitioner Carol McCabe (Ms. McCabe) became an

employee of the activity in April 2000 and elected to participate

in the reimbursement plan.   The record does not indicate what

duties Ms. McCabe performed, but Mr. Sears testified she worked 2

hours a week for $6 an hour.   Mr. Sears filed Forms 941,

Employer’s Quarterly Federal Tax Return, for the second, third,

and fourth quarters of 2000, reporting total wages paid of $468.

At least two of the Forms 941 were filed late.

     Petitioners initially reported that Ms. McCabe incurred

$2,777 of reimbursable medical costs.    They deducted that amount

as employee benefit programs expense on their Schedule C for the

activity.6   Petitioners later conceded, however, that $1,322 of

those expenses were nondeductible because they were paid before

Ms. McCabe became an employee.    Mr. Sears also admitted that he

did not make reimbursement payments to Ms. McCabe.   Instead, Ms.

McCabe paid her medical bills, and petitioners claimed a


     6
        Petitioners attached a second Schedule C to their joint
2000 Federal income tax return for a business described as
“Consulting - Health care insurance” that Ms. McCabe operated.
Respondent made no adjustments to this Schedule C, and it is not
in dispute.
                               - 6 -

corresponding amount of employee benefit programs expense.     Mr.

Sears believed it was unnecessary to reimburse Ms. McCabe because

“The money [to pay the medical bills] was coming from the same

place.”   He described this practice as a “Poor job of accounting,

maybe.”

     On October 25, 2000, a Kansas State court entered a

Temporary Restraining Order (TRO) against RTP, its founder, and

other related parties, enjoining them from marketing products and

services to new customers and imposing restrictions on their

business activities with existing customers.    The court found

that RTP and the other defendants “committed numerous acts which

are deceptive and unconscionable acts and practices” in violation

of the Kansas Consumer Protection Act, sec. 50-683 (1994).     The

court later permanently enjoined the defendants from conducting

any business activity in or from the State of Kansas.

     Petitioners continued to use the RTP system and purchase the

platinum service after learning of the TRO, but they did not

attempt to recruit new downline distributors.    Petitioners

believed that RTP was a legitimate business, although Mr. Sears

acknowledged “there were some things going on that were not good
                               - 7 -

* * * apparently even illegal things going on by some of the

people who were connected with the company.”7

     Petitioners filed their joint 2000 Federal income tax return

on or about August 13, 2001.   They reported gross income of

$2,713 and expenses of $17,464 from the RTP activity, for a loss

of $14,751.   Petitioners did not have RTP prepare the return,

according to Mr. Sears, because RTP had been “shut down” before

that time.

     Respondent determined that the RTP activity was not a trade

or business for Federal income tax purposes because it was not

engaged in for profit.   Respondent disallowed petitioners’

claimed expense deductions, except to the extent of gross income

from the activity.   As an alternative position, respondent

disallowed certain claimed expense deductions for lack of

substantiation.

                            Discussion

     In general, the Commissioner’s determinations set forth in a

notice of deficiency are presumed correct, and the taxpayer bears

the burden of showing that the determinations are in error.      Rule

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

to section 7491, the burden of proof as to factual matters shifts


     7
        The stipulation of facts states that three people pleaded
guilty to crimes related to their involvement with RTP. The
crimes include conspiracy to commit mail and wire fraud;
assisting, counseling, and advising in the preparation of a false
and fraudulent tax return; and defrauding the IRS.
                               - 8 -

to respondent under certain circumstances.   Petitioners have

neither alleged that section 7491(a) applies nor established

their compliance with the requirements of section 7491(a)(2)(A)

and (B) to substantiate items, maintain records, and cooperate

fully with respondent’s reasonable requests.   Petitioners

therefore bear the burden of proof.

     Section 162 provides that a taxpayer who is carrying on a

“trade or business” may deduct ordinary and necessary expenses

incurred in connection with the operation of the business.     To be

engaged in a trade or business within the meaning of section 162,

“the taxpayer’s primary purpose for engaging in the activity must

be for income or profit.”   Commissioner v. Groetzinger, 480 U.S.

23, 35 (1987).   Profit means economic profit, independent of tax

savings.   Surloff v. Commissioner, 81 T.C. 210, 233 (1983).    If

the taxpayer is not engaged in a trade or business under section

162, the taxpayer generally may deduct the expenses related to an

activity “not engaged in for profit” only to the extent of the

gross income derived from the activity for the taxable year.

Sec. 183(a) and (b)(2); Elliott v. Commissioner, 90 T.C. at 973.

     We consider all of the facts and circumstances in deciding

whether a taxpayer entered into the activity for a profit,

placing greater weight upon objective facts than the taxpayer’s

statements of intent.   Dreicer v. Commissioner, 78 T.C. 642, 645

(1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983).

The following nine nonexclusive factors are relevant in making
                                 - 9 -

our decision:    (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 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 any, which are

earned; (8) the financial status of the taxpayer; and (9) the

elements of personal pleasure or recreation.    Sec. 1.183-2(b),

Income Tax Regs.

      Not all of the factors listed above are applicable to

the facts of this case.    We focus on only those factors

that are relevant.

1.   The Manner in Which the Taxpayer Carries On the Activity

     The fact that the taxpayer carries on the activity in a

businesslike manner may indicate that the activity is engaged in

for profit.     Elliott v. Commissioner, supra at 972; Engdahl v.

Commissioner, 72 T.C. 659, 666 (1979); sec. 1.183-2(b)(1), Income

Tax Regs.   Relevant indicators include maintaining complete and

accurate books and records, obtaining a business license,

maintaining a separate business bank account, developing a

written business plan, having a plausible strategy for earning a

profit, and attempting changes in order to improve profitability.

See Morley v. Commissioner, T.C. Memo. 1998-312; Holowinski v.
                                 - 10 -

Commissioner, T.C. Memo. 1997-168; Ellis v. Commissioner, T.C.

Memo. 1984-50; sec. 1.183-2(b)(1), Income Tax Regs.

     Mr. Sears admitted that he “had some pretty weak business

practices”.   Indeed, there is no indication he prepared a budget

or instituted an accounting system to track revenue and expenses.

Nor does it appear that he maintained a separate bank account or

credit card for the activity.8    Mr. Sears also reflected poor

recordkeeping practices by failing to timely file at least two

Forms 941, including one that was filed more than 2 years late,

and by deducting employee benefit programs expense for costs paid

before Ms. McCabe was covered by the reimbursement plan.

Furthermore, his failure to reimburse Ms. McCabe for medical

expenses indicates he viewed his family’s funds and those of the

activity as interchangeable.

     Mr. Sears did apply for a business license from the City of

Oroville under the name “American Tax Savers” and registered the

Internet domain name “americantaxsavers.com”, although he never

established an Internet Web site for the activity.     Mr. Sears

also had a written business plan.     However, the business plan

consisted of a 25-page, preprinted package from RTP and a 1-page

document titled “Explanation of profit potential” signed by Mr.


     8
        Petitioners maintained at least two credit cards,
including a “Quicken Visa Business Card” in both of their names.
However, it is not clear from either the account statements or
the remainder of the record whether either credit card was used
exclusively for the activity.
                               - 11 -

Sears.   The RTP package does not discuss the size of the market

in Oroville, the median income level of its inhabitants, or any

other information specific to Mr. Sears’s circumstances.

Instead, it contains vague statements such as “Our [RTP]

marketing strategy is to aggressively promote the Tax Relief

System, our products, and our overall business opportunity on a

nationwide basis”.

     The 1-page document signed by Mr. Sears is equally devoid of

meaningful content.    It states that Mr. Sears intends to make 18

sales per month, eventually creating a downline distribution

network of 3,000 people and “residual monthly income in excess of

$9,000.00”.   It does not discuss the segments of the market he

intends to target, the types or amounts of expenses he expects to

incur, or how he will overcome the time constraints imposed by

his full-time job.    In sum, any positive inference we might draw

from the written business plan is outweighed by the absence of a

plausible strategy for earning a profit.

     Finally, there is no indication that Mr. Sears attempted

changes to improve the activity’s profitability.    Mr. Sears

testified that he performed a break-even analysis, concluding

that he would need “a substantial number” of downline

distributors to break even.    Nevertheless, it does not appear

that he tried to reduce his expenses or develop new recruiting

methods.   This factor does not support petitioners’ claim of a

profit objective.    See sec. 1.183-2(b)(1), Income Tax Regs.
                              - 12 -

2.   The Expertise of the Taxpayer or His Advisers

      Preparation for an activity by extensive study of its

accepted business, economic, and scientific practices, or

consultation with those who are expert therein, may indicate a

profit objective.   Engdahl v. Commissioner, supra at 668; sec.

1.183-2(b)(2), Income Tax Regs.   Efforts to gain experience and a

willingness to follow expert advice may also indicate a profit

objective.   Dworshak v. Commissioner, T.C. Memo. 2004-249;

Lundquist v. Commissioner, T.C. Memo. 1999-83, affd. 211 F.3d 600

(11th Cir. 2000).

      Petitioners attended numerous RTP seminars and conventions.

Mr. Sears testified that attendees sometimes discussed revenue

rulings or other aspects of the tax law, but that “conventions in

network marketing are more for training in doing the business”

and to help “build enthusiasm” for the activity.     Mr. Sears did

not explain what he meant by “training in doing the business”.

Although petitioners may have gained expertise relevant to the

activity from the RTP-sponsored events they attended, the

substance of the seminars and conventions is unclear.    Without

more information, this factor neither supports nor undercuts the
                              - 13 -

claim that petitioners entered into the activity with a profit

objective.   See sec. 1.183-2(b)(2), Income Tax Regs.

3.   The Time and Effort Expended by the Taxpayer in Carrying On
     the Activity

      The fact that the taxpayer devotes much of his personal time

and effort to carrying on an activity may indicate an objective

to derive a profit, particularly if the activity does not have

substantial personal or recreational aspects.     The taxpayer's

withdrawal from another occupation to devote most of his energies

to the activity may also be evidence that the activity is engaged

in for profit.   Sec. 1.183-2(b)(3), Income Tax Regs.

      Mr. Sears maintained a separate full-time job in 2000 but

“set up a pretty regular schedule” for his recruiting efforts,

often meeting with potential recruits before he went to work.      We

have found that maintaining a full-time job in addition to

conducting a purported business activity can be “a positive

factor reflecting * * * [the taxpayer’s] motivation.”     Dickson v.

Commissioner, T.C. Memo. 1986-182.     Mr. Sears’s recruiting

efforts, however, often involved dining out or meeting “an old

family friend” to discuss RTP.   Because of the substantial

recreational aspects of the activity, this factor is neutral.

See sec. 1.183-2(b)(3), Income Tax Regs.
                                - 14 -

4.   The Success of the Taxpayer in Carrying On Other Similar or
     Dissimilar Activities

      The fact that the taxpayer has engaged in similar activities

in the past and converted them to profitable enterprises may

indicate that he engaged in the present activity for profit.

Sec. 1.183-2(b)(5), Income Tax Regs.     The taxpayer’s success in

other business activities may also indicate a profit objective.

Hoyle v. Commissioner, T.C. Memo. 1994-592.

      Petitioners testified they had experience with other network

marketing businesses.    The record contains little information

about any of these activities.    Mr. Sears did describe a network

marketing activity involving “Cell Tech,” which he said sold

digestive aids and various natural supplements.    This may be the

activity described in a 1999 Schedule C as “Sales - Nutritional

Products.”    In any event, the Schedule C reported a $4,691 loss

and thus does not indicate success in a similar or dissimilar

activity.    Because there is no indication that any of

petitioners’ other activities were profitable, this factor is

neutral.    See sec. 1.183-2(b)(5), Income Tax Regs.

5.   The Taxpayer’s History of Income or Losses With Respect to
     the Activity

      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.   Petitioners began the RTP activity in 1999, reporting a

loss of $8,372.    In 2000, they reported a loss of $14,751.
                                - 15 -

Because these losses occurred during the initial or startup stage

of the activity, however, this factor is neutral.     See id.

6.   The Financial Status of the Taxpayer

      A profit objective may be indicated where the taxpayer does

not have substantial income or capital from sources other than

the activity.     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, especially if there are personal or

recreational elements involved.     Sec. 1.183-2(b)(8), Income Tax

Regs.

      Petitioners’ reported gross income of $47,959 in 2000 is not

insignificant.     Given that personal and recreational elements

were involved in the RTP activity, and that the RTP system was

geared towards generating income tax deductions, this factor does

not support a profit objective.     See id.

7.   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.

        Petitioners testified that they hoped to make a profit from

the RTP activity.     As discussed above, however, the activity

involved personal and recreational elements, such as dining out

and meeting friends.     This factor does not support a profit
                                - 16 -

objective.     See id.

     None of the above factors supports petitioners’ claim of an

economic profit objective independent of tax savings.    See

Surloff v. Commissioner, 81 T.C. at 233.    We therefore conclude

that petitioners did not enter into the RTP activity with a

profit objective.    Given our conclusion, we need not decide

whether petitioners substantiated their claimed Schedule C

deductions.9    We also need not address section 183(b)(2) because

respondent allowed expenses related to the activity to the extent

of the activity’s gross income.    See sec. 183(a) and (b)(2).

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.




     9
        Under sec. 213(a), medical expenses paid and not
compensated for by insurance are deductible to the extent they
exceed 7.5 percent of adjusted gross income (AGI). Even if
petitioners could substantiate their claimed medical expenses,
such expenses would not exceed the AGI threshold.
