Tax Rate of 131% ? - It Can Happen

Kevin L. Sherar, et ux. v. Commissioner, TC Summary Opinion 2011-44



I didn't know there was a way for somebody to be taxed 131% on income received, but Mrs. Sherar's attorney managed to find a way.  Linda Sherar was collecting workman's compensation insurance.  Her attorney advised her that she also qualified for Social Security disability payments.  She applied for them.  She received a check for $3,796.38.  Not a lot of money, but if it was laying on the street I would bend over to pick it up.  The reason that she didn't get much in Social Security disability is because her benefit was offset by the workman's compensation.  Here is where it gets ugly.  Workman's compensation payments are excluded from income.  Social Security payments are only partially excluded (85% included 15% excluded).  The 85% is applied to the entire benefit including the portion that was offset by workman's compensation.  So when the IRS looked at this they increased Mrs. Sherar's tax by $4,988.  The Court felt kind of bad for her, but couldn't do anything about it:

We acknowledge that Mrs. Sherar applied for Social Security benefits on the advice of counsel. We also acknowledge that if Mrs. Sherar had not applied for Social Security benefits, then her workers' compensation benefits would not have been subject to Federal income tax. See secs. 104(a)(1), 86(d)(3). Under the circumstances we can appreciate petitioners' dismay. Nevertheless, as the Supreme Court of the United States has instructed, we are duty bound to apply the law as written by Congress to the facts as they occurred and not as they might have occurred.

Freddie Stromatt, et ux. v. Commissioner, TC Summary Opinion 2011-42

I almost didn't bother with this one, but it is a fairly nice hobby loss case that was won by the taxpayers.  The IRS made an issue out of them putting that they were raising beef cattle on their Schedule F in the preliminary year when they just sold hay, but they did well on most of the factors.

In 1999 petitioners purchased an approximately 15-acre parcel of land near Dickson, Tennessee. Petitioner Edith Stromatt (Mrs. Stromatt) had retired before the land was purchased, and petitioner Freddie Stromatt (Mr. Stromatt) retired shortly thereafter.



In 2000 petitioners constructed a two-bedroom, one-bath house of approximately 792 square feet on the property. Mrs. Stromatt's father lived in the house from 2000 until his death in 2006. Petitioners did not live in the house or elsewhere on the property during the years at issue (2002-2004).

During 2000 and 2001 petitioners cleared the acreage, which had been untended for approximately 25 years and was overgrown with brush and trees, to prepare it for use as pasture, including the production of hay. Mr. Stromatt and Mrs. Stromatt's father operated the tractor and Bush Hog used for clearing the land, including pulling tree stumps. During 2001 and 2002 petitioners installed fencing and fertilized. This work was also performed by Mr. Stromatt and Mrs. Stromatt's father.


Petitioners harvested their first hay in 2001 and continued producing hay during the years at issue, harvesting it with rented equipment. Mr. Stromatt and Mrs. Stromatt's father performed this labor. Petitioners sold the hay, and these sales constituted the only income generated from the farming activity during the years at issue.

Petitioners first purchased cattle in 2005, acquiring six pregnant heifers. By the end of 2005 petitioners owned 17 head of cattle.


Mrs. Stromatt's father provided advice to petitioners on farming, including the number of cattle that could be supported on 15 acres of land.


Mrs. Stromatt's father was an experienced farmer, and Mrs. Stromatt grew up on a farm.

There were also substantiation issues which they probably should have settled at the agent level, but the Court was satisfied on that score also.

After weighing the regulatory factors and all other facts and circumstances, we conclude that petitioners engaged in their farming activity with an actual and honest profit objective. They and family members expended substantial amounts of physical labor to reclaim and fence land in an effort to establish a viable cattle operation. They did so at a pace that was not unreasonable in the circumstances, and they offset some losses by initially selling hay. They obtained knowledgeable advice. Their loss history was both brief (as of the close of the last year in issue) and not atypical for reclaiming land and establishing a cattle operation. The enterprise did not offer significant recreational opportunities


Jonathan C. Ladue, et ux. v. Commissioner, TC Summary Opinion 2011-41

This is about whether a deputy sheriff was subject to self-employment tax on pay that he received for "off duty services".  I've always heard this type of thing referred to as "pay details".  There is some support for the position that the deputy is functioning as an employee while on the assignment:

During 2007, petitioner was employed as a deputy sheriff by the Jacksonville Sheriff's Office (JSO). JSO permits deputies to provide off-duty services for entities other than JSO. JSO's General Order LIII. 10 (JSO General Order) contains detailed provisions that an officer must follow to obtain and maintain off-duty work.

Entities desiring to hire JSO deputies for off-duty services must submit an application to the Secondary Employment Unit of JSO. A JSO job scheduler acts as a liaison between JSO and the entity by completing the jobsite schedule for JSO employees working for a particular entity, “ensuring employee attendance is adhered to, and resolving employee/employer conflict when appropriate.” Entities that hire deputies for off-duty services are required to pay an administrative fee to JSO for each hour of off-duty service provided by each officer. Working while off duty is strictly voluntary; JSO deputies are not required to perform off-duty services.

The JSO General Order determines the off-duty minimum pay rate, limits the maximum monthly hours of off-duty work, and requires JSO deputies to wear their uniforms and monitor their police radios when providing off-duty law enforcement-related services. Deputies providing off-duty services are also subject to recall to regular duty by JSO. While working off duty, deputies are governed by all JSO policies, procedures, and directives, and the JSO Watch Commander may suspend a deputy's off-duty work if the work or the officer does not meet policy requirements

That was not enough for the Tax Court, though.

After considering these factors, as discussed below, we conclude that petitioner was not an employee of JSO but performed his off-duty services as an independent contractor.


First, petitioner's off-duty services were performed for, and were directly beneficial to, the third-party entity. See Milian v. Commissioner, supra (stating that performance of services by the employee for the employer is implicit in an employee relationship); March v. Commissioner, T.C. Memo. 1981-339 [¶81,339 PH Memo TC]. “Any benefit *** [the department] received by an increased police presence at petitioner's off-duty assignments was incidental and similar in nature to the benefit to a police department when officers increase the police presence in a community by driving their police cruisers home.”


A second factor of an employer-employee relationship is the ability to select and discharge at will. March v. Commissioner, supra. The mere approval from JSO to work off-duty jobs and the ability to suspend if department policies were not adhered to do not amount to the ability to hire and fire with regard to the off-duty positions.




Third, the source and method of payment may also help establish whether an employer-employee relationship exists. March v. Commissioner, supra. All of the third-party entities for which petitioner provided off-duty services operated separately from the city of Jacksonville and JSO; the third-party entities paid petitioner directly and treated him as an independent contractor, issuing him Forms 1099. The city of Jacksonville did not include off-duty pay in petitioner's Form W-2.


Slight changes in the way the pay details are structured would probably produce a different result.


CCA 201115022

If you think your joint account holder might be someone who is apt to be levied, it's time to get a separate account.

For purposes of determining ability to pay, ownership is presumed to be in equal shares unless the taxpayer demonstrates otherwise. See IRM 5.8.5.5. In the levy context, the Supreme Court held in the National Bank of Commerce case that where under state law the taxpayer has the unrestricted right to withdraw funds from a jointly held account a levy attaches to the entire account. The levy, however, is provisional and subject to a later claim by a codepositor that the money in fact belongs to him or her.

Selling Soap as a Hobby - Amway IBO's in Tax Court

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42




The Amway distributorship system is well known to respondent and this Court
Friscia Construction, Inc., et al. v. Commissioner, TC Memo 2000-192

I included the Campbell case in one of my group posts.  It concerned someone whose Amway activities were considered a hobby by the Tax Court denying them deductions for losses.  That portion of the post was picked up by someone who calls himself Joecool and posted on his blog under the title "Do IBO's have a clue about business?".  I found that there are quite a few blogs dedicated to pointing out the downside of the Amway experience including Married To An Ambot by Anna Banana :

My story of what its like to be married to an Amway cult follower. I expose the lies that our upline told and what happens at Amway meetings and functions. I leave the explanations of why Amway is a poor business opportunity or the tool scam to other bloggers. This blog mainly exists to curse out my former upline, aka the cult leaders, and to let everyone know what kind of idiots I had to put up with. Feel free to join in or live vicariously.

Come on Anna, stop holding back. Tell us how you really feel.

 So I got motivated to look at what was in the database I prowl for my little tax jewels had on Amway.  As the above quote from Friscia Construction indicates, there is quite a bit.  "The Court" is the Tax Court.  "Respondent" is the IRS (In all Tax Court cases the taxpayer is "The Petitioner" and IRS is "The Respondent").  Friscia Construction is unusual among the cases I found.  It is about the IRS challenging  the deductions of a profitable Amway distributor.

Although originally focused on soap, Amway sells a variety of household products through its multi-level marketing system.  In case you have never been invited to an Amway presentation or, more likely, didn't go when you were invited, the emphasis is not so much on the products or even selling the products.  It's about getting other people to sell the product, who in turn get other people and so on with you sitting at the top of your pyramid (only they make it real clear its not a pyramid). 

Bloggers like Joecool and Anna Banana claim that there are very few people who make money at it.  Those that do probably don't make as much as they claim, since those in the "upline" need to paint a glowing picture to motivate the "downline" IBO's (Independent Business Owners).  Further, the bloggers claim that most of the soap and other stuff is actually bought by the IBO's themselves.  Finally, the "upline Diamonds" make most of their money from selling "tools" (i.e. motivational tapes and the like) to the downline.

The other attraction of Amway to some people is that it might allow them to deduct as business expenses things like cars, part of their home or entertainment that they would have spent anyway.  That's probably the aspect of Amway that the IRS finds most interesting.  Joecool did a post on how some IBO's think of their income tax refunds (generated by Amway losses sheltering other income) as profit.

To me the most interesting thing that I found in my search is this excerpt from the Internal Revenue Manual for examiners who are doing information requests:

.4.4.3.39 — Amway Corporation
[Last Revised: 12-10-2007]
(1) Amway Corporation has waived the hand delivery requirements of 26 USC §7603 and will accept summonses by personal service, mail, or overnight service at Amway Corporation, 7575 E. Fulton, Ada, MI 49355, Attn.: Director, Legal Division. Direct distributors who further qualify for profit sharing bonuses receive the non-cash part of that bonus through a mutual fund account administered by Amway Mutual Fund, Inc., 7575 E. Fulton, Ada, MI 49355, which requires a separate summons

Now I am subject to the AICPA Statements of Standards on Tax Practice, which among other things forbids me from giving clients advice based on what I believe the audit selection process of a taxing authority is.  I wouldn't do it anyway, because I think most people who give that type of advice are guessing.  Even if you happen to be one of my clients, I'm speaking to you purely as a reader here when I give you this advice:

                                                You don't tug on Superman's cape
                                                You don't spit into the wind
                                                You don't pull the mask off that old Lone Ranger

And you don't take no Schedule C losses from an arrangement with a company that IRS examiners have on speed-dial.

I found 23 cases of IBO's who fought the IRS in Court.  (A couple appealed, but I only counted them once)They pretty much all lost.  In these type of cases there are really three ways you are denied deductions.  The first is substantiation.  You didn't prove it.  Next is that the expenses are not really ordinary and necessary expenses of the business.  When you are talking about cars and business use of the home, those two issues can get blurred together.  The third is that there really isn't any business there.  Taxpayers fight the IRS and win on that issue frequently even a Vietnamese couple whose "business" was playing slot machines using the principles of Feng Shui.  Amway IBO's who take on the IRS on the Section 183 "hobby loss" issue almost always lose.

One of the most common themes is that IBO's seek advice generally only from their "uplines", who of course are not disinterested.  They also do not seem to put any energy into trying to control their expenses.  I'm going to give you a little snippet from each of the cases and comment a bit on some of them.

LOPEZ v. COMM., Cite as 94 AFTR 2d 2004-7075 
Jorge N. Lopez, et ux. v. Commissioner , TC Memo 2003-142

Tax Court properly determined that engineer and wife weren't entitled to business deduction for expenses incurred in connection with their Amway products distribution activity because they didn't engage in activity for profit: although taxpayers showed proof of profit motive, such wasn't sufficient to override govt.'s evidence that included their failure to keep businesslike records, their failure to alter unprofitable methods, their non-dependence on activity income, and their use of activity to socialize with friends and family.
 
In their own Amway activities, which began in 1996, the Lopezes sold products at cost to both their downline distributors and their customers, which practice eliminated retail sales as a source of gross income. They chose instead to focus their efforts on developing a network of downline distributors to generate performance bonuses.  Relying on Amway brochures, the Lopezes concluded that they would need to achieve and maintain a monthly point value of 4,000 for their Amway activities to be profitable. In 1998 and 1999, the Lopezes' point value did not exceed 372 points in any month.


The only advice they sought for their Amway activities was from upline distributors, and when they received unsolicited advice from their accountant, they disregarded it. During the years in question, Mr. Lopez was employed full-time as a petroleum engineer, and Mrs. Lopez was a homemaker.

The tax court ultimately was not persuaded that the Lopezes' primary motive for conducting their Amway activities was for income or profit. It found that the conduct of their Amway activity “virtually precluded any possibility of realizing a profit.” The Lopezes' lack of a business plan for recouping losses and achieving profitable levels of activity indicated the absence of a profit motive. In the face of four consecutive years of losses, the Lopezes still did not change their approach to increase the likelihood of earning a profit. The tax court further found that the Lopezes did not conduct market research to help them assess the potential profitability of their activities. It also noted that, although the Lopezes had no prior business experience, they accepted the advice of upline distributors rather than seeking advice from unbiased, independent business sources.

Since the Mr and Mrs Lopez appealed, they got to lose twice.

OGDEN v. COMM., Cite as 87 AFTR 2d 2001-1299
Michael A. Ogden, et ux. v. Commissioner, TC Memo 1999-397
 Contrary to the Ogdens' contention, evidence of profit is not determinative of whether a profit motive exists. See id. at 876 (no single tax regulation factor, nor the existence of a majority of factors, is determinative of whether a profit motive exists). There is overwhelming evidence in the record that, if believed, supports a conclusion that the Ogdens maintained their Amway activity for deductions, personal pleasure and to offset wages. The tax court did not abuse its discretion in denying the motion for reconsideration.

Amway does not have a quota for sales, its products do not have to be sold above cost, and its distributors are not required to sponsor downline distributors. An Amway brochure, The Amway Business Review, states that the potential for earning income increases as the number of distributors in a sponsor's group grows and as sales increase. Distributors devote as little or as much of their time to Amway activities as they desire. The eight page Amway Business Review in large blocks on four of its pages highlights the fact that “The Average Monthly Gross Income for “Active” Distributors was $88.”

We believe Amway distributors may be biased when discussing Amway because they have a natural desire to advance the organization and/or obtain income from a downliner.


ELLIOTT v. COMMISSIONER, 90 TC 960

Deductions denied for business expenses and depreciation connected with Amway distributorship. Activities were conducted in unbusinesslike manner, taxpayers maintained full-time jobs, and little distinction was made between Amway activities and personal social activities. Also, IRS properly imposed penalties for failure to timely file and negligent or intentional disregard of rules.

A further indication of the unbusinesslike fashion in which petitioners conducted their Amway activity was the thin line dividing business activities from personal and [pg. 973]recreational activities. Petitioners offered scant evidence that their Amway activity required them to do anything other than to maintain an active social life. Although they occasionally attended seminars, most of their activity involved giving parties and taking people out to restaurants. While there is no requirement that profit-oriented work be onerous and unpleasant, the evidence presented by petitioners does not indicate activity motivated by a profit objective. On the contrary, the evidence shows that petitioners made some small modifications in their routine social life, kept cursory notes about their activities, and claimed deductions for the cost of nearly everything they owned or did. On this record, we find as a fact that petitioners' activities were motivated by a desire to avoid tax rather than a desire to generate income.

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42

Activities not for profit—profit objective—distributorship and direct marketing activities. Code Sec. 183 deduction limits applied to expenses pro se married real estate and construction business operators claimed in connection with Amway distributorship activity that they engaged in without requisite profit objective. Lack of profit objective was shown by facts that taxpayers commingled expenses, had no idea if they were making profit for any given year until they filed that year's return, didn't keep complete records, and otherwise didn't conduct activity in businesslike manner. It was also telling that taxpayers didn't have experience in this type of activity, didn't seek out independent advice, used activity losses to offset their real estate and construction business income, and stated that they would continue with activity regardless of whether it ever turned profit. Countervailing facts that they spent significant time on activity and increased gross receipts during years at issue weren't dispositive considering overall record.

Kenneth J. Nissley, et ux. v. Commissioner, TC Memo 2000-178

Activities not for profit—Amway distributorship. Husband and wife/CPAs didn't engage in Amway distributorship activity for profit: taxpayers incurred substantial losses for 8 consecutive years; and didn't conduct activity in business-like manner where they kept separate bank account and records to “guarantee” deductions


Kenneth C. Theisen, et ux. v. Commissioner, TC Memo 1997-539

 Full-time IRS agent and travel agent-wife didn't operate Amway distributorship for profit, so weren't entitled to deductions from activity: taxpayers didn't conduct activity in business-like manner where they didn't have business plan, perform break-even analysis or have budget; admitted that benefits included ability to buy discounted products for personal use; testified that distributorship was for financial gain and personal purchases were more than purchases acquired for resale; reported losses for 5 consecutive years; couldn't explain how or when distributorship would become profitable or why auto and telephone expenses increased without corresponding revenue increase; kept income and expense ledger for substantiation purposes only; and intentionally excluded cost of motivational tapes from costs of goods sold to avoid disclosing negative gross income on returns

Generally, no. The way the plan is written is, you're taught to purchase things from yourself for yourself, and you get other people — say, Look. Just change your buying habits. Don't go to HEB. Don't go to Eckerd's. Don't go to Sam's. You get access to all these products. Change your buying habits. Buy things for yourself

Petitioner also conceded that petitioners' personal purchases were more than the purchases they acquired for resale to other customers or downline distributors. Specifically, petitioner admitted that in 1992 he bought $4,500 of products for personal use and $3,262 of products for other purposes. For 1993, he conceded he bought $10,729 of products for personal use and $4,991 of products for other purposes.



Bryan J. Brennan, et ux. v. Commissioner, TC Memo 1997-60

1. Litigation costs—substantial justification for IRS position—distributorship conducted for profit. Taxpayers were denied litigation costs with respect to underlying case challenging IRS's disallowance of their business deductions: IRS was substantially justified in its position that taxpayer didn't conduct household product distributorship with requisite profit objective under Code Sec. 183 . Taxpayers had losses for 7 consecutive years, yet earned substantial income from other sources for 2 of those years, and didn't provide IRS with business plan or profit projection; and similar distributorship-related activities had been found to contain elements of personal pleasure. Also, IRS's concession of the issue within 5 months of filing answer and 2 months of receiving additional information was reasonable.

This is a case of the taxpayer actually settling favorably with the IRS.  They were, however, not able to recoup attorneys fees.

William B. Hart, et ux. v. Commissioner, TC Memo 1995-55

Taxpayers weren't entitled to deduct business loss related to Amway distributorship: taxpayers didn't engage in activity for profit. Expenses of distributorship activity related mainly to social functions: taxpayers attended seminars in Colorado and California, and monthly dinners with their “network”; taxpayer-husband took guest who was interested in finding out more about distributorship on fishing trip; and “supplies” expense included groceries bought while taxpayers were away delivering products or visiting clients. Court rejected argument that activity was conducted in businesslike manner because taxpayers kept records, sought expert counseling, and devoted time and effort to distributorship: they didn't utilize records in way to help them make profit; they didn't seek advice on how to cut back on expenses; many of expenses claimed had significant elements of personal pleasure; and due to distributorship's low receipts it appeared that taxpayers used their time spending money on entertainment rather than focusing on earning profit.

Negligence penalty was upheld: despite Tax Court's warning in prior case that taxpayers couldn't translate their Amway business into deduction for personal aspects of their lives, taxpayers again attempted to deduct clearly personal expenses in guise of distributorship activity, which they had failed to show was being operated for profit. But taxpayers weren't liable for penalty for filing late return: recent death of taxpayers' son was reasonable cause for delay in filing return; and there was no willful neglect.

Petitioners do not appear to have heeded our warning, and respondent was not as charitable this time. Again petitioners have attempted to deduct clearly personal expenses in the guise of an Amway activity that they failed to show was being operated for a profit. We sustain respondent on this issue.



Thomas P. Poast, TC Memo 1994-399

IRS proved that taxpayers, full-time automobile workers, lacked requisite profit objective in carrying on their Amway distributorship activity. Taxpayers failed to conduct activity in businesslike manner: taxpayers maintained incomplete sales records, used solely to help to substantiate claimed deductions; they failed to isolate business expenses from personal expenses; and taxpayers kept no realistic and reasonable budget despite incurring substantial net losses in all prior years. Further, taxpayers' claim that they sought expert counseling regarding business techniques was rejected: taxpayers abandoned "ineffective" techniques without performing cost/benefit analysis of techniques; and techniques received from "upliners" (who had financial stake in taxpayers' sales) were never seriously utilized. Also, much of the time taxpayers spent on Amway activity involved substantial pleasurable personal aspects.



Shortly before becoming involved with their Amway activity, petitioners attended a seminar conducted by an insurance agent, Donald Fletcher, who conducted similar seminars nationwide. Fletcher promoted his life insurance product, while suggesting to the participants of the seminars that the premiums be funded by tax savings generated by deducting largely personal expenses through a home based business like Amway.  Fletcher offered to prepare participants' tax returns and provide representation in audits for a cost of $125.


We find not only that the techniques were not seriously utilized, but also that, for the most part, petitioners' advisers were not experts as much as they were upliners with a financial stake in petitioners' retail and downline sales. Neither petitioners nor their advisers appeared to be even vaguely interested in the importance of cutting back their expenses.

Gerald Eugene Swaffar, TC Memo 1992-180

IRS failed to prove that taxpayer's Amway activities weren't carried on for profit. Deductions for expenses related to Amway activities were allowed only to extent conceded by IRS: taxpayers failed to substantiate expenses in excess of that amount. Penalties for negligence and substantial understatement were imposed

At trial, respondent contended for the first time that petitioner's Amway activities were not engaged in with the requisite profit objective under section 183. Such new matter requires that the burden of proof be placed on respondent. See Rule 142(a). Respondent further contends that, assuming the Amway activity was entered into with a bona fide profit objective, petitioner has failed to establish that the above expenditures were incurred and were ordinary and necessary in carrying on a trade or business, pursuant to section 1.

An analysis of petitioner's Amway activities requires this Court to conclude, without analyzing in depth all nine factors, that respondent has not carried her burden of showing that petitioner did not engage in the Amway activity with an actual and honest objective to make a profit. We emphasize that we do not affirmatively conclude that petitioners had a profit objective, but only that respondent has failed to prove that petitioners lacked such an objective.


Sometimes it is better to be lucky than good.  If in its deficiency notice the IRS asserts that you didn't have a profit motive, it is up to you to prove that you did.  In this case, the IRS raised the issue later, which shifted the burden of proof.  The IRS couldn't prove that they didn't have a profit motive. 

Gerald W. Jordan, TC Memo 1991-50

Amway distributor was allowed to deduct expenses for travel, incentive prizes, and seminars: expenses were ordinary and necessary. Deductions were allowed in part for meal and car expenses, and were denied for gift expenses, because taxpayer didn't fully substantiate claims.

Another win for an IBO.  Hooray.  Too bad they didn't do a better job on substantiation.

Joseph M. Ransom, TC Memo 1990-381


Taxpayer wasn't engaged in Amway distribution activity with profit objective. Factors tending to indicate lack of profit motive were: absence of separate checking account; failure to cut costs or recruit new distributors; and substantial income from other sources (with attempted Amway deductions that would have almost eliminated tax he would otherwise owe on that income).


Peter S. Rubin, TC Memo 1989-290

Deductions attributable to Amway distributorship activities were disallowed to extent they exceeded gross income from those activities, which weren't engaged in for profit: taxpayers kept records in cursory and sloppy manner, and they engaged in distributorship activities to claim tax deductions for personal expenditures and to purchase Amway products at sizeable discounts for their own use.

Dewitt Talmadge Ferrell, Jr., TC Memo 1987-102

Losses claimed by airline pilot and housewife were limited where their business activities, involving selling of Amway products, sundials, and posters, weren't engaged in with profit objective, but rather were conducted primarily to generate tax deductions and credits for personal expenses. Revenues were of secondary importance to taxpayers who had no sales expertise and made no effort to obtain any, didn't maintain reliable records, and devoted little effort to sales. Burden of proof was on taxpayers since they didn't show that business ever reported profit before years in issue; Sec. 183(d) presumption didn't apply.



J.H. Schroeder, TC Memo 1986-583


As to the Amway distributorship fee, petitioner failed to show that he conducted his Amway affairs in connection with a trade or business or an activity engaged in for profit. Petitioner made no sales of Amway products and had no income from his Amway operations during 1981. He failed to possess the requisite profit objective, since he admittedly became a distributor solely for the purpose of being able to purchase items at discount prices by virtue of his status as a "dealer". See section 183.



Harry Mitchell Goldstein, TC Memo 1986-339

Taxpayers' Amway activities weren't trade or business and weren't engaged in for profit but were undertaken primarily to obtain tax deductions and credits; business expenses, investment credit, and child care credit denied. Taxpayers' (husband and wife) activities weren't carried on in businesslike manner, they both had full-time jobs, and they had very little success in obtaining other distributors or selling products. Taxpayers had become Amway distributors and claimed losses based on business deductions and credits.

Q. How many sales did you make in 1980?
A. Sales—1980—Probably not even $5 worth, because we did not get any new people coming in, you see. We just mostly went in for ourselves and then get the other people coming in with us.
Q. So it is your testimony that your total income from Amway in 1979 and 1980 was less than $5?
A. Yes.
Q. Are you still in the Amway business?
A. Yes. We like the products and you can't get them any other way.

John Alcala, TC Memo 1984-664

On this record, there arises the strong suspicion that petitioners became Amway distributors primarily for the purpose of providing themselves with Amway merchandise which they could not otherwise obtain, while, at the same time, providing themselves with considerable tax deductions. Compare Barcus v. Commissioner, T.C. Memo. 1973-138 We make no such finding herein, but we do hold that petitioners have failed to carry their necessary burden of proof to establish that they entered into a bona fide business enterprise with the intention and objective of making a profit. McCormick v. Commissioner, T.C. Memo. 1969-261

Randall B. Ollett, et ux. v. Commissioner, TC Summary Opinion 2004-103

In addition to the travel-related expenses, petitioners also had expenses of $3,571 in 1999 and $710 in 2000 for professional books and other materials that were part of Amway's “training program”. These books were recommended by petitioners' upline network and may be described as general self-motivation books. Petitioners also purchased various audio tapes that included stories told by other Amway distributors of how they built successful networks.


As noted above, petitioners' revenue from the Amway activity for the years in issue was minimal, and even that amount was attributable in part to petitioners' purchases of household goods for their own personal use. When asked about how they intended to turn their losses into profits, Mr. Ollett responded: “The only way I can solve it is to talk to more people. And there, in essence, is the challenge that I have, which is finding those people”.

Petitioners did not have any sales experience prior to becoming Amway distributors. Petitioners relied exclusively on their upline distributors, who stood to benefit from petitioners' participation, for advice and training. They did not seek independent business advice at the beginning of their Amway activity to assess their potential for success, and they did not seek independent business advice for turning around years of operating losses. Petitioners' failure to seek independent business advice strongly suggests that petitioners did not carry on the Amway distributorship in a businesslike manner.

Joe Guadagno, et ux. v. Commissioner, TC Summary Opinion 2003-88

Included with petitioners' timely filed return for each year is a Schedule C, Profit or Loss From Business. Each return was prepared by a certified public account who also was an Amway distributor. Petitioners' Schedules C for 1996 and 1997 list their principal business as “Amway”. For 1998, petitioners' Schedule C lists their principal business as “DistConsumerProduct”. Petitioners reported net losses of $26,264, $24,047, and $19,810 on their Schedules C for 1996, 1997, and 1998, respectively.



Before becoming Amway distributors, petitioners had neither experience with Amway nor experience in running a business. Nevertheless, they did not seek independent business advice at the outset, and they did not seek independent business advice afterwards even though losses were sustained year after year. Instead, they relied upon other Amway distributors whose advice is more accurately characterized as personal motivational advice than strategic business advice.

Larry Minnick, et ux. v. Commissioner, TC Summary Opinion 2002-147

As previously stated, more weight must be given to objective facts indicating a profit objective than to petitioners' statement of intent. Dreicer v. Commissioner, supra. After considering the objective factors detailed above, we find especially relevant the manner in which petitioners carried on the Amway activity and petitioners' history of losses and lack of profits. We find from these and the other objective facts in the record that petitioners did not have an actual and honest intent to profit from the Amway activity in 1996 and 1997.

Broadrick R. Moore, et al. v. Commissioner, TC Summary Opinion 2001-173



Considering the record in its entirety, we are satisfied that petitioners did not have the actual, honest, and bona fide objective of making a profit. It appears that they became Amway distributors simply to deduct expenses for items of a personal nature

Karl Meyer, et ux. v. Commissioner, TC Summary Opinion 2001-157


The Amway “pyramid” incentive system is promoted by Amway in the form of the “9-4-2 plan”.  Under the “9-4-2 plan”, each Amway distributor is encouraged to personally recruit 9 “downline” distributors, each of whom in turn is encouraged to recruit at least 4 “downline” distributors, each of whom in turn is encouraged to recruit at least 2 “downline” distributors (for a total of 117 “downline” distributors in the initial distributor's organization). The “9-4-2 plan” is promoted as the theoretical break-even point for a distributorship, assuming that (1) the distributor and each “downline” distributor within the distributor's organization purchases $200 of Amway products per month and that (2) the distributor does not have expenses exceeding $2,000 per month. At least in theory, the potential for profit is enhanced as each of the 117 “downline” distributors in the distributor's network successfully implements the “9-4-2 plan”.


The Amway “9-4-2 plan” does not provide meaningful guidance to distributors regarding how expenses incurred in pursuing an Amway activity may be reduced

Despite their lack of experience with either Amway or an Amway type activity, petitioners never sought meaningful counsel from disinterested third parties. Rather, petitioners relied principally on advice from “upline” distributors and other interested Amway individuals

James R. Landrum, et ux. v. Commissioner, TC Summary Opinion 2001-112



Prior to the years in issue, petitioners had three separate experiences with Amway, beginning in 1974. Mr. Landrum was a corporal in the Marine Corps and was stationed in Hawaii in 1974. His Amway activity consisted of purchasing cases of wax from an Amway distributor at wholesale, selling “a case or two a month to [his] friends,” and keeping the difference between the wholesale and retail prices. He ceased his activities with Amway in 1976 when he was transferred from Hawaii and then released from active duty with the Marine Corps. After their marriage in 1977, petitioners participated in an Amway distributorship. Their experience with Amway was unprofitable, and they terminated it after 2 years. Petitioners became involved with Amway a third time in 1985, while Mr. Landrum was employed at Goodyear. Although petitioners had about 50 persons reporting to them, directly or indirectly, in the pyramid structure of Amway, there were insufficient sales for profit. Petitioners' third Amway venture lasted approximately 2 years, and again, petitioners terminated the activity for lack of profit. In late 1995, petitioners were introduced to Amway a fourth time by friends of Mrs. Landrum. This fourth Amway experience is the subject of the present controversy.

Mr. Landrum estimated that the person who established a successful 6-4-2 grouping would receive $1,800 to $2,200 in monthly commissions and then might proceed to gain even greater benefits as a “direct distributor” who might then triple his organization and receive an “Emerald bonus” and then expand to have six legs and a “Diamond organization”. According to Mr. Landrum, Amway distributors with an emerald organization make $75,000 to $100,000 annually, and those with a diamond organization make $125,000 to $250,000 yearly, “And it goes up from there” as he put it.

Conclusion:

23 cases on the same issue is a goodly number, but of course they are over a long period of time.  It's clearly not a random sample.  If you are say the 20th case like this either you didn't do your homework or you are really stubborn.  The other thing that biases this is that the IRS picks the worst cases to contest.  Before you get a "90 day letter", which is what allows you to go to Tax Court, you can have an independent appeal in the IRS.  Once you file to go to Tax Court, the case will get kicked back to appeals to see if they can settle. At that point appeals can consider "hazards of litigation". So there are probably many people who got decent settlements from the IRS. Of course there are also many who just wrote a check to close out the audit.  All in all, though, if the reason you want to start a business is so that you can deduct money you spend anyway (Something I advise you not to do), Amway is probably one of the worst things that you could pick.  It's worse than horse breeding, which the IRS seems to have a particular antipathy for, but the Tax Court often allows.

Interestingly, I did not find any cases of people who were using other types of tax shelters to shelter their Amway income.  Also, if the Amway dream is really true, you would think I would find a case like that of Peter Morton, who was being challenged on deducting his jet expenses, only with the taxpayer being a Quintuple Diamond Super Duper Amway guy.  At the Amway meeting I went to they said that they were glad not everybody took advantage of the Amway opportunity, since they needed pilots for their planes and the like.

All in all, I would say that while not determinative, the record in the tax court is supportive of Joecool and Anna Bannana.  At least, there are some more stories for them.

If You Kill Your Parents It's Your Own Fault You are an Orphan

Here are a few items that I didn't quite get to in tax season.

CCA 201106015

The law firm provides one of its attorneys to perform legal services for a municipality. It's usually the same attorney every time. The firm sends an invoice to the municipality, and the municipality pays the firm. The municipality does not issue a Form 1099. The attorney is paid by the law firm. Small municipalities essentially contract out for these services when they can't afford their own full time city attorney.


The question is whether the IRS should assert that the attorney is an employee of the municipality, rather than an employee (or partner) of the law firm for purposes of the services provided to the municipality.


My answer is no. The attorney is not an employee of the municipality. ———————————

It is nice to know that sometimes national office will restrain the overzealous.  What they would be accomplishing other than creating aggravation for the small municipality is beyond me.

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42

There were a couple of issues in this case around substatntiation, but the main thing was a hobby loss question on Amway activities.  I remember going to some Amway presentations and it is really shocking to me that people can actually lose money on something that sounds like such a good deal.

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.


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.


Although petitioners have prior entrepreneurial experience and both operated other businesses concurrently, they had no 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.

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.

In the presentations it was always about you recruiting people who recruit people and so on. It always seemed that somebody somewhere had to be selling an awful lot of soap for the thing to work.

U.S. v. THOMAS, Cite as 107 AFTR 2d 2011-1599

This was a protester who was complaining about having to file all his delinquent returns as a condition of his supervised release.  He figures the IRS already did substitute returns and that it was going to be hard to dig up records from that long ago.  The Court had no sympathy as they cited one of my favorite jokes.

We hold that the district court correctly calculated the applicable sentencing range and did not abuse its discretion in imposing an obligation to file all unfiled tax returns and pay all outstanding tax arrears as a condition of supervised release.

We note that any difficulties that may arise from the age of the necessary documents or the passage of time are entirely self-inflicted; had he complied with his duty to file the returns when they were initially due, there would be no such troubles. His contention on appeal that this state of affairs amounts to a “burden” imposed by the district court is absurd, like killing your parents and complaining of being an orphan.



Jeffrey S. Charlton, et ux., et al. v. Commissioner, TC Memo 2011-51

This was a statute of limitations case.  The underlying plan was clearly a loser:

During 1998, Jeffrey and Timothy formed Graphic Connections Group, LLC; Wealth Builders International, LLC; and Golf Links Display Group, LLC (collectively, the partnerships). Pursuant to the partnerships' operating agreements, Jeffrey and Timothy each had a 1-percent interest, and the domestic trusts had a 98- percent interest, in each of the partnerships. The domestic trusts paid the personal expenses of Jeffrey's and Timothy's families and distributed income to the Belize trusts. Jeffrey and Timothy used foreign bank accounts in Belize and Antigua to access the income. On August 1, 1999, Token Trust purchased Titan Trust's and Timothy's interests in the partnerships.

One of my rules is to not get involved in any plan that includes a place I can't easily point out on the map. (Belize is in Central America by the way.  You probably already knew that.)  As it turned out though the Tax Court believed that Mr. Charlton was gullible rather than fraudulent:

Jeffrey, who undoubtedly had a penchant for fast and easy money, foolhardily followed the Aegis system (i.e., structuring the transactions and resisting the IRS audit). See Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Gajewski v. Commissioner, supra. Nevertheless, Jeffrey maintained adequate records and made all pertinent information available to Mr. Moore, his longtime trusted, yet imprudent, CPA. See Niedringhaus v. Commissioner, supra at 211. To his detriment, Jeffrey relied on the professional judgment of Mr. Moore, who inexplicably believed in and acquiesced to an elaborate scheme designed by con artists. See Estate of Temple v. Commissioner, 67 T.C. 143, 162 (1976) (holding that reliance upon an accountant to prepare accurate returns may negate fraudulent intent if the accountant was supplied with all the information necessary to prepare the returns); Marinzulich v. Commissioner, 31 T.C. 487, 490 (1958) (holding that a taxpayer's reliance upon his accountant to prepare an accurate return may indicate an absence of fraudulent intent).

If you are using Mr. Charlton as a guide to your future plans, I would point out that if you go shopping for a CPA who is as gullible as you are, you might not be able to rely on who ever you end up with.  If you talk to two of them and neither one will drink the Kool-Aid with you, give it up.

A Wrinkled Return

Shawn C. Blanchette, et vir. v. Commissioner, TC Summary Opinion 2011-15

Tax court decisions bring us into many dimensions of human experience - lactation, mercenaries, underwear and "gentlemen's clubs" to name but a few.  I wouldn't have thought that I'd ever get to mention tessaracts, but there you have it.  Ms. Blanchette called her science fiction memorabilia business A Wrinkle in Time, no doubt in honor of Madeleine L'Engle's novel in which the existence of extra spatial dimensions beyond the three we are familiar with plays an important role.  Just as a cube is what you get when you expand the concept of a square into the third dimension, a tessaract is what you get when you expand a cube into the fourth dimension.  You can probably get a better notion of this from reading Sphereland, the sequel to Flatland, which you should probably read first.  They are both great.  "A Wrinkle in Time" is pretty good too although it doesn't stack up to a truly great science fiction work like Acts of the Apostles by John Sundman.  (You would cause a great deal of offense if you counted the better selling work with the same title science fiction).

Because of my professional bias I usually root for the taxpayer when I am reading the case unless they are being really lame.  The clever title for her business made me really pull for Ms. Blanchette as I was reading along.  I guess I didn't root hard enough to cause a reversal in the flow of time so even after I was done reading the case, she had still lost.  It was a hobby loss case and I think it is a fairly instructive one.  Here's the story:

In 1992 Ms. Blanchette formed and operated a proprietorship under the name A Wrinkle in Time (AWIT). From 1992 through 1995 Ms. Blanchette operated AWIT as a retail store in Santa Clara, California, leasing space and obtaining a business license to do so. Ms. Blanchette was the primary business owner and was intimately involved with all aspects of the business. On average, she worked at her store 14 hours per day, 7 days a week. Ms. Blanchette aggressively promoted AWIT locally with newspaper advertisements and regionally at science fiction conventions. Although Ms. Blanchette adopted a business plan in 1993 to transform AWIT into a partnership that could further penetrate the science fiction memorabilia market, she never executed that plan. Despite Ms. Blanchette's efforts, her collectibles activity generated losses from 1992 through 1995.

In 1996 Ms. Blanchette relocated to Sunnyvale, California, where she operated AWIT as a retail store in leased space until 2001. During that time, Ms. Blanchette developed a Web site to sell her collection to online customers. Although she adopted a second business plan in 2000 to rebrand AWIT's online image, Ms. Blanchette did not bring that plan to fruition. She continued to incur losses from 1996 through 2001.

In 2001 Ms. Blanchette relocated to Las Vegas, Nevada. From 2002 through 2005 Ms. Blanchette sold science fiction memorabilia mostly online and at conventions. During that time Ms. Blanchette rented warehouse space to store her collection; and although the warehouse was generally not open to the public, she would sometimes show that collection to potential customers. Ms. Blanchette incurred losses from 2002 through 2005.

Not surprisingly the business also had losses in 2006 and 2007.  Enough being enough, the Service disallowed losses from 2005 to 2007 for a total deficiency of slightly less than 10 grand.  The Court referred to the nine factors that should be considered in a hobby loss (Section 183) case:

 (1) The manner in which the taxpayer carries on the activity;
 (2) the expertise of the taxpayer in carrying on the activity;
 (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 loss with respect to the activity;
 (7) the amount of occasional profits, if any, which are earned by the taxpayer;
 (8) the financial status of the taxpayer;
 (9) elements of personal pleasure or recreation.

1.  Although Ms. Blanchette separated her personal finances from the business and kept thorough records the court noted that she did not use those records to generate business intelligence to move her toward profitability:

Petitioners contend that the online expansion of Ms. Blanchette's collectibles activity demonstrates that she sought to improve the profitability of her activity during the subject years. We disagree. The adaptation of Ms. Blanchette's collectibles activity online occurred some time between 1996 and 2000. Since she moved her collectibles activity online, we have found no significant undertakings on the part of Ms. Blanchette to improve her overall profitability. To the contrary, she continued to add to her inventory without due regard for the losses she repeatedly incurred.

Score one for the IRS.

2. The court called the "expertise" factor a push, unfairly I think:

Ms. Blanchette testified that she consulted with other science fiction memorabilia collectors about her activity. However, she never consulted with accountants, lawyers, or business advisers about her activity. The failure to procure objective business advice is a negative factor while her consultation with other collectors is a positive consideration. This factor is neutral.

I doubt that there are many accountants and lawyers who can tell you a lot about how to make money in the collectibles business.

3.  They also called the time and effort factor a push, which I thought was very unfair.

4. The court did not give Ms. Blanchette the benefit of the doubt on the expectation that her collection would appreciate.  Part of their analysis was way off:

..........even though a portion of Ms. Blanchette's collection was worthless, she did not liquidate those items and reinvest the proceeds in other collectibles with potential for real appreciation.
You do not get very much to reinvest from selling things that are worthless.  Presumably you score big in collectibles from keeping things that are presently perceived as worthless that subsequently become valuable.

Their next point though is one in which Ms. Blanchette could have really helped herself if she had had a detailed list of every item with its cost and estimated fair market value.

Also the court held it against her that she did not insure her collection.  Whether to insure or self insure is a business decision that might be reasonable either way, but it would not have been that difficult for her to get a quote on the cost of insuring her collection.

Factors 5 through 8 were not good either.  Essentially the losses from the science fiction business have been funded by her husbands salary.  It was the ninth factor that was particularly hurtful:

Ms. Blanchette is passionate about science fiction, and she derives great pleasure from her collectibles activity. This enjoyment, however, cannot overcome the complete disregard for profit objective with which she has conducted her activity. Given the small profit potential and significant satisfaction derived from the collectibles activity, we are confident that it is Ms. Blanchette's quest for personal gratification that keeps her going and not any bona fide profit objective.

The IRS really seems to hate horse breeding as a business.  Taxpayers seem to be able to win horse cases in tax court though.  Reading those cases, I always get the impression that the taxpayers somehow convince the judges that they don't particularly like horses.  Consider this from Richard A. Frimml, et ux. v. Commissioner, TC Summary Opinion 2010-176:

This factor favors respondent. Petitioners made many business decisions regarding the purchase, care and sale of a number of Paint horses for their horse activity. Petitioners paid extensive amounts to care for Special when he was injured. On the other hand, petitioners decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.

You can check out my post on it to find out what was so special about Special (has to do with fluids).

I do have to admit that I would have a lot more fun fooling around with light sabers and phasers and reading great works of science fiction like Cheap Complex Devices by John Sundman than trying to manage animals that are considerably larger than I am that seem to defecate a lot so maybe Ms. Blanchette deserved to lose.  I don't care I was rooting for her anywhere.


Full disclosure and celebrity name dropping:

John Sundman and I were in the same high school graduating class.  The Xavier High School class of 1970 also included noted science fiction author Bradley Ferguson author of Flag Full of Stars.

OK 2010 This is Really Goodbye

In  a previous post,  I explained the need for occasional purges of material that does not transform itself into a full length post.  Now I'll explain the Amazon ads.  All hope of them being a means of monetizing has vanished.  They are purely decorative.  The only thing my readers, who apparently now number in the scores (If you have trouble remembering what a score is here is a little trick.  Remember "Four score and seven years ago".  Now subtract the year of the Declaration of Independence from the year of the Battle of Gettysburg.  Then subtract seven.  Then divide by four.  Piece of cake.). do is come to the site.  I have a little gadget next to where I type the blog and I can search Amazon and then click to move the link and image into the blog.  I thought I would see what I got with Goodbye and up comes one of my favorite books.  It's very short and I read it from time to time to cheer myself up. 

As the title indicates this is the last of the 2010 material.  I would have gotten it in sooner, but it got pushed aside by two much more interesting recent developments.  One was about mercenaries and the other was about breasts.  So how was blog housekeeping going to compete? With no further fanfare here is the last of 2010:

Private Letter Ruling 201051024

This was a ruling on exempt status.  Exempt status ruling are a fairly rich source of tax humor, although it will be a while before somebody tops Free Fertility Foundation.  I'm not inclined to mock this particular effort, although it does provide a slighly heightened reading on my bs detector.

You were incorporated under the nonprofit laws of the state of M on x. According to your Articles of Incorporation your purpose is to advance the religious beliefs, cultural traditions and lifestyles of four N churches (the "churches") by providing loans and other assistance for real estate purchases and other farm and business related purchases to members of the churches; to encourage savings and thrift and continue to be committed to Christian principles of operation by providing investment and borrowing opportunities to enhance economic social and spiritual well being of the N Brotherhood; and to operate exclusively for charitable, religious or educational purposes.

Investors are limited to residents of M who are members of the churches. Eligible individuals meeting the minimum-investment requirement ($10,000), up to a maximum of 25 new investors annually (to comply with the requirements for exemption from the security laws of the state of M), will be accepted on a first-come, first-serve basis. 



You state that both your lending and borrowing activities will support your exempt purpose of advancing your religious beliefs, cultural traditions and lifestyles of the churches. You represent that central to your religious doctrine is a belief (i) in Biblical financial truths, including brotherly financial aid, responsibility for stability in family finances, the collective responsibility for all members of the church for each other's well being and personal stewardship and (ii) that deacons of your churches are called by God to oversee and, where applicable, alleviate the financial hardship of their church's members. You state that all of these principles lead to the rejection of laws that permit or facilitate the avoidance of responsibility, such as bankruptcy and insolvency laws.

Although you were initially funded by contributions from founding board members and received a church offering from each of the churches, you do not plan to engage in further fundraising activities. Your primary method of raising capital will be interest bearing loans from investors. Your sole source of income will be interest charged to borrowers. You plan to use the spread between the interest rates paid to investors and those charged to borrowers to pay all necessary future expenses.

The organization did not qualify for exempt status.

Articles 4(a) and (b) of your Articles of Incorporation states that you were formed to provide investment and borrowing opportunities. Providing investment and borrowing opportunities to members is not an exempt purpose described in section 501(c)(3).



Your primary purpose is to operate a trade or business, a lending institution which directly competes with commercial lending institutions. Your business practices are consistent with those of the industry in general. You will be funded by capital from investors. Your method of determining fees is similar to the method used by commercial lending institutions.

The minor mystery in this is what the organization expected to gain by its exempt status since it was planning on just breaking even and would not be getting charitable contributions.  It may be there was some state law benefit.  In my recent post on exempt organizations I note one that was trying to qualify so it could get a liquor license.  Presumably that was not the plan with this one.

I'm not much of a scriptural scholar, but I'd like to know where the stuff about bankruptcy comes from.  I think there is more in there about forgiving debts.

Humphrey E. Igberaese v. Commissioner, TC Memo 2010-284

This is really a run of the mill substantiation case. It concerns a host of deductions including charity.

Cash Charitable Contributions Igberaese asserts that he contributed $200 to his church in cash every week of the year, for a total of $10,400. He said that when he was in town, he would attend church and would personally donate the $200 to the church. He said that when he would be out of town, he would provide the cash to other church members in sealed envelopes to take to the church for him. He said he did not recall, even approximately, how often he provided the cash to other church members to donate for him. Nor did he remember the names of any of these members. He presented a printout of a computer spreadsheet consisting of the name of the church, the date of each contribution (each Sunday of the year), the amount of each contribution ($200), and the yearly total ($10,400). He testified that he made each entry around the time of that week's contribution.

Putting aside the formal substantiation requirements for charitable contributions, I'd advise people like Mr.Igberaeseke to work on their stories a little better.  I don't have personal acquaintance with tax court judges, but I believe I've learned a bit about them from reading their opinions for the last thirty years.  Among the things that I have surmised is that they are not idiots and that they live in the same world that I do.  Some of them probably go to church and will therefore know that people who drop cash in the collection plate mostly still think that George Washington is our holiest president.  If the ushers know who's face is on a C note, it is not from experience gained counting the collection

We do not find the evidence Igberaese introduced to be credible. As we discuss in connection with each deduction, Igberaese presented little beyond his own unpersuasive testimony and self-created documentation to corroborate his series of implausible deductions. Several of his explanations for the absence of further corroboration were also implausible.

We are similarly skeptical of Igberaese's documentary evidence, which shows little more than that he has written down his implausible assertions

Trout Ranch, LLC, et al. v. Commissioner, TC Memo 2010-283

This was a dueling expert case.  The Trout Ranch had donated a conservation easement.  The partnerships expert indicated that it was worth 2.1 million.  He based the valuation on other easements sold in the area. The Tax Court was not greatly impressed :

 In essence, in all three cases the conservation easements all but eliminated residential development. In stark contrast, the Trout Ranch CE restricted development from at least 40 residential lots to 22 lots (a reduction in potential development of 45 percent). We are simply not convinced that the value of a conservation easement that restricts development to at most one residential lot sheds any light on the value of a conservation easement that allows as many as 22 residential lots.

The Service had originally wanted to allow $485,000, but when it came to trial they decided to reduce that to 0.  I mean, what the heck, why not say the property was worth more with the easement and have them pick up income ?  The switch led to some fancy burden of proof discussion, which the Court indicated didn't matter because they were able to determine the true value.

The Tax Court came in at $560,000.  We know that is the right answer, because its what the Tax Court said.  The case is worth reading if you are interested in valuation issues.  It's not great for my purposes as I couldn't find any good quotes.

Richard A. Frimml, et ux. v. Commissioner, TC Summary Opinion 2010-176


My tentative title for this was "Paint Your Horses".  It is a hobby loss (Section 183) case.  The IRS seems to be firmly convinced that people take care of animals much larger than themselves that appear to defecate copiously for fun.  Go figure.  The couple was raising American Paint Horses.  The Tax Court ruled that they were in fact trying to make money.

Petitioners' knowledge at trial was extensive as it related to breeding and artificially inseminating Paint horses. Their knowledge included the genetics, the mechanics and the financial aspects of breeding.  Even the horses aren't having any fun.

The worst thing about people who win hobby loss cases around horse breeding is that the Tax Court gives them extra points for heartlessness.

Petitioners made many business decisions regarding the purchase, care and sale of a number of Paint horses for their horse activity. Petitioners paid extensive amounts to care for Special when he was injured. On the other hand, petitioners decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.

In case you are wondering what was so special about "Special".

They have identified semen production by Special as a potential future source of revenue.

This case is similar to that of Johnny L. Dennis TCM 2010-216 which I gave a brief mention.  Besides doing a cost benefit analysis on the vet bills, the other thing that they have in common was not riding the horses themselves.

U.S. v. RUTH, JR., Cite as 106 AFTR 2d 2010-7443

The decision itself is about criminal procedural issues which are not of great interest to me.  If you have an interest in such things check out Jack Townsend's blog.  I read cases like this because the story behind the story is often interesting.

The conduct at issue began while Ruth and Pilkey were incarcerated at the Federal Correctional Institution in Fort Dix, New Jersey. The defendants submitted tax returns to the IRS claiming refunds in the names of fellow inmates for wages never earned and giving addresses where the inmates never lived. These inmates fell into three groups: (1) those who were aware of the fraud, (2) those who were not aware of the fraud and had instead provided their personal information in order to receive legal assistance from Ruth and Pilkey, and (3) those who testified they did not know the defendants. Ruth and Pilkey were able to avoid having to submit W-2 forms by misrepresenting that fellow prisoners were working at companies that had gone bankrupt. As part of the scheme, defendants obtained employer identification numbers for these bankrupt companies. To avoid detection by prison authorities, defendants enclosed envelopes addressed to the IRS within large envelopes sent to collaborators outside of prison. Defendants had the tax returns sent to mail-forwarding services who would then deliver the returns to their collaborators.

I became interested in accounting in part from reading stories about epic frauds.  I doubt anybody will ever top Alfredo Reis.  Read the book about him if you don't believe me.  He convinced the British bank note printing company that printed the money issued by the Bank of Portugal that he worked for the bank and got them to print money for him.  He used the money to buy stock in the Bank of Portugal which was the only entity that could prosecute counterfeiting.  These fellow aren't in the same league, but given the adverse conditions they were working under (being in prison and all), they really achieved a lot.  Of course you might expect that the IRS computers would catch them eventually.  That's not exactly the way it turned out.

Defendants' scheme resulted in the IRS issuing refunds of tens of thousands of dollars. Eventually the IRS became suspicious of returns filed by persons in federal custody using the same type of form and listing the same employers and addresses. In May 2004, an inmate came forward who informed prison officials about the fraudulent tax scheme. Based on this information, prison officials searched the lockers of several inmates, including Ruth and Pilkey, and recovered records and material used to file the fraudulent tax returns.

So that is it for 2010.  Goodbye 2010.

Auxilliary Legion of Super Posts

One of the more obscure pieces of DC trivia I recall is the legion of superheroes having an auxiliary.   It consisted of people who's super powers were too lame for admittance to the regular legion.  Among them were Bouncing Boy and Night Girl. Of course they let Batman in with no super powers, but what of it.  Anyway these people with lame super powers got together and they would save the regular legion from disaster without the regular legion realizing it.  I'm working on pure memory here so I may have the details wrong.  Doesn't really matter.  My memory of the auxiliary legion is what I am invoking.

I look at a lot of material to find things that I feel are blog worthy.  Generally I am looking for things that are not noticed by a lot of other people that are either of practical importance or kind of interesting or maybe funny.  I look at all federal court tax decisions and a multitude of IRS pronouncements which are a veritable alphabet soup.  If something is time sensitive I might put it up right away as a bonus post, but generally I stick with a MWF schedule.  If I have the next three complete and scheduled I feel pretty good.  Usually I'll have about 20 or so in some stage on incubation.  If they go much more than a month without getting completed, they are probably never going to make it, but I hate to consign them to the abyss without a chance, so here are a couple of developments that will never be complete posts unless I get some comments.  Yes, you the reader can promote any member of this sad group of auxiliaries into full membership in the Legion of Super Posts.

Johnny L. Dennis, et ux. v. Commissioner, TC Memo 2010-216

The tentative title was "Not Just Horsing Around".  It is a hobby loss case.  Raising horses is probably the poster boy for hobby losses.  This couple though was seriously trying to make a living raising horses.  Probably the most disturbing part of the case is that the Tax Court thought it was a plus that he did a cost benefit analysis on calling the vet when his horses had colic and determined it was not worth paying for the treatment.  They also got credit for not riding the horses that much. 

Rick Mahlum, et ux. v. Commissioner, TC Memo 2010-212

This is a collection due process case.  The taxpayers owed about $15,000.  They claimed the IRS abused its discretion in not considering their alternative.  They did not submit financial data or get in current compliance.  Their proposal was for the IRS to put their account in non-collectible status.  Reading some of these collection cases, I sometimes think Congress created a monster with the Taxpayer Bill of Rights.  Once it is determined that you owe the tax you are entitled to a hearing on any collection action the Service makes and you can then appeal the results of that hearing to the Tax Court.  I don't comment on tax policy though, except when I do.  Mr. Mahlum lost.


State Farm Mutual Automobile Insurance Company and Subsidiaries v. Commissioner, 135 T.C. 26

Tentative title was "Good Hands".  This concerned section 832.  Section 832 falls in Subchapter L, which is the Subchapter I know the least about.  The taxation of insurance companies is a field unto itself.  It was actually the story behind the tax controversy that was interesting.  One of State Farm's customers was in an accident and found liable.  The judgement against them was $185,849 and the limit on the policy was $50,000.  State Farm appealed.  The customer who had been found liable on the accident then teamed up with the other side, agreeing to give them 90% of his settlement, and sued State Farm for bad faith.  They won $1,000,000 in compensatory damages and $145,000,000 in punitive damages.  Ultimately State Farm ended up being out a little over $16,000,000.  The tax controversy was about what had gone into reserves in one of the years while this was being appealed.  Apparently you can't reserve against punitive damages.  It was more the whole business issue that fascinated me about this.  Not wanting to cut a check for $50,000 ending up costing them $16,000,000 plus whatever legal fees they spent and their exposure had been much higher.

Phu M. Au, et ux. v. Commissioner, TC Memo 2010-247

Title was "Gambling on Software".  I thought this was pretty interesting, but a couple of other bloggers picked it up first.  The first time I read about it, after identifying it myself, was in Rubin on Tax in a post titled Turbotax Defense Rejected.  I think I was pointed there, by Robert Flach, who of course delights in more proof of the unreliability of tax software.  The taxpayers had deducted gambling losses without having gambling winnings and blamed their software.  It reminded me of the time my brother generated himself a return with a large refund that he asked me to review.  I was sorry to have to point out that he had entered miles into his software in a field that called for dollars (That would less than double the deduction this year, but this event was quite a while ago.)  Now that I think about it that was probably the last time my brother had me check his return.  It also reminded me of a case I wrote about in August about taxpayers who were allowed an ordinary deduction for slot machine losses, because they were in the business of gambling.

CICCOLINI v. U.S., Cite as 106 AFTR 2d 2010-7081

Title was "Bless Me Father".  This is another one where the underlying story is more interesting than the tax issue which is pretty mundane.  It concerns a Catholic priest who apparently was embezzling from a charity that he ran :

The conduct underlying the charged offenses occurred during 2003 and 2004. From April 2003 to June 2003, the Defendant deposited $1,038,680 in cash into his bank accounts in 139 separate transactions of less than $10,000. The Defendant admitted that he structured the transactions to evade bank reporting requirements. 31 U.S.C. § 5324(a)(3). When asked where the money came from, the Defendant claims that he held more than a million dollars in cash in his room at the Immaculate Conception Church Rectory and that he only decided to deposit this money in 2003 because he was worried that changes to the appearance of U.S. currency would somehow diminish the value of his cash savings. Ciccolini also does not explain why he kept over $1 million in cash in his room during a time when he had other bank and investment accounts with millions of dollars. Nor could the Defendant explain why he structured the transactions to avoid the reporting requirements. Similarly, the Defendant is unable to explain where this large sum of cash came from, other than implausibly claiming he accumulated it through interest and savings.


An approximate calculation of the Defendant Ciccolini's legitimate after-tax earnings and inheritance to the time of sentencing totals about $1,506,000. By the end of 2003, his total legitimate earnings and inheritance totaled about $1,336,000. These figure fall far short of the $5,590,313 in liquid assets that Ciccolini accumulated by the time of his sentencing. Thus, even under the Court's generous calculations, it is quite clear that Ciccolini is unable to legitimately account for about $4,500,000.


However, with the exception of the $1,288,683 that he already admitted to embezzling from the Interval Brotherhood Home, Ciccolini denies that any of the money is derived from criminal activity. Instead, says that because he lived at the Immaculate Conception Church rectory he had no personal expenses and was able to save all of his earnings. Additionally, he says that because he was saving all of his money that his savings gained significant compounding interest over a thirty-year period.

Ah yes - the miracle of compound interest.

The case was about what his sentence for tax evasion should be.  It ended up pretty mild :

After a thorough consideration of the parties' arguments, the advisory guidelines range, and the other relevant 18 U.S.C. § 3553(a) factors, the Court choose to fashion a non-guidelines sentence. The Court finds that a sentence of one day imprisonment, a fine of $350,000, and a restitution order of $3,500,000 reflects the seriousness of the offense, promotes respect for the law, provides just punishment for the offense, affords adequate deterrence to criminal conduct, and protects the public from further crimes of the Defendant. See 18 U.S.C. § 3553(a)(2). The Court also orders a three-year term of supervised release and a special assessment of $200.

I wonder if he paid the $200 in cash.

Jack Townsend also picked this up in his federal tax crimes blog and is speculating whether there is a larger trend to call for restitution rather than prison time.  As the longest serving member of the board of Just Detention International , I don't joke about such things, but I have to think that the biggest problem a 68 year old priest would have in prison is convincing the other prisoners he is there for income tax evasion.  Maybe that was in the back of the judge's mind.

Their are more candidates for the legion, but that's enough for one post.