T.C. Memo. 2004-249

UNITED STATES TAX COURT

DUANE A. DWORSHAK, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15268-02. Filed November 3, 2004.

Duane A. Dworshak, pro se.

Linette Angelastro, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined a deficiency in

petitioner’s Federal income tax of $3,875 for 1997 and an

addition to tax for failure to timely file under section

6651(a)(1) of $305.

After concessions, the issues for decision are:
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1. Whether petitioner operated his direct marketing

activity for profit in 1997. We hold that he did.

2. Whether petitioner may deduct business expenses for 1997

in an amount greater than respondent conceded. We hold that he

may not.

3. Whether petitioner is liable for an addition to tax

under section 6651(a)(1) for failure to timely file his return

for 1997. We hold that he is.

Section references are to the Internal Revenue Code as

amended and in effect for 1997. Rule references are to the Tax

Court Rules of Practice and Procedure.

FINDINGS OF FACT

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

A. Petitioner

Petitioner resided in California City, California, when he

filed his petition.

Petitioner has been employed by the Los Angeles County

Probation Department since 1984. Petitioner was employed as a

supervisor at a juvenile detention camp at all times relevant to

this case. Petitioner received wages from Los Angeles County of

$41,139 in 1995, $42,372 in 1996, and $48,913 in 1997.
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B. Cell Tech

Around 1995, petitioner purchased and began using some

health care and nutritional products sold by the Cell Tech Co.

(Cell Tech). Petitioner liked the Cell Tech products he used.

Cell Tech directly marketed and distributed its products to

the public through outside sales representatives. The Cell Tech

sales representative who sold petitioner these products asked him

whether he wanted to become a Cell Tech sales representative. As

a Cell Tech sales representative petitioner could earn

commissions on: (1) Customer orders of Cell Tech products placed

through him; and (2) customer orders placed through other Cell

Tech representatives recruited by petitioner and other Cell Tech

representatives recruited by them and their recruits. The Cell

Tech sales representative told petitioner that she knew of

several Cell Tech representatives who earned sizable commissions. 

Petitioner became a Cell Tech representative in June 1995. 

Cell Tech was his first independent business venture. Petitioner

was interested in engaging in an activity that would supplement

or eventually replace his income from the Probation Department. 

Petitioner believed that his income from direct marketing would

increase sufficiently to eventually replace his wages from the

Probation Department. 

The sales representative told petitioner that to get started

he would need to spend about $2,000 for: (1) Cassette tapes and
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other sales materials promoting Cell Tech and its products, (2) a

mailing list of potential customers, and (3) mailing envelopes in

which to enclose the cassette tapes and sales materials.

From June 1995 through most of 1996, petitioner mailed Cell

Tech sales material packages to potential customers. About 2

percent of the people to whom he mailed materials purchased

products from him during that time.

Petitioner planned to increase the quantity of the products

he sold and the number of sales representatives he recruited. He

tested products, evaluated potential companies, and tried to

identify the most efficient method of selling products. 

Petitioner also bought and read books and periodicals about

direct marketing in general and specific companies for which he

became or was considering becoming a sales representative. 

Petitioner kept records of his customer base, his mailings and

whether they resulted in sales or recruits, and his income and

expense receipts for his marketing activity.

By late 1996, petitioner had become dissatisfied with being

a Cell Tech representative. In late 1996 and in 1997, the

positive response to petitioner’s Cell Tech mailings declined to

less than .5 percent, and many of his customers stopped buying

Cell Tech products. Petitioner concluded that it was not

productive for him to continue mailing Cell Tech materials. He 
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stopped mailing unsolicited sales materials to potential

customers and began using telephone calls and meetings to make

sales. Although petitioner continued to be a Cell Tech

representative, he reduced his efforts to sell Cell Tech products

and began to look for sales positions with other direct marketing

companies.

C. Other Companies

Petitioner used some products from other companies to decide

whether he wanted to sell those products. In 1996 and 1997,

petitioner considered becoming a sales representative for several

other direct marketing companies such as Awareness Co., Telecard

Network Co., The People’s Network (TPN), and Vaxa Co. In 1996

and 1997, petitioner briefly sold telephone cards as a Telecard

Network Co. representative, but he stopped when he concluded that

he could not produce the profits he sought.

Petitioner became a TPN representative in 1997. TPN sold

subscriptions to the TPN satellite television channel, household

and personal care products, and vitamins offered on TPN’s

satellite channel and in TPN’s sales catalog. The TPN satellite

channel also featured motivational speakers who provided advice

and guidance to individuals on self-improvement and/or personal

development. As a TPN representative, petitioner earned

commissions on subscribers he brought to the TPN satellite
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channel and on any TPN products purchased by his customers from

the TPN satellite channel or sales catalog.

Petitioner focused his marketing activity on selling TPN and

its products. He called and sent TPN cassettes, videotapes, and

sales materials to potential customers of TPN products.

In 1997, petitioner attended several conferences for TPN

representatives in Dallas, Texas, where TPN was headquartered. 

The conferences featured direct marketing industry professionals

and suppliers of TPN materials and products.

Petitioner made lists of people he believed were potential

customers of TPN products and who might be interested in becoming

sales representatives. Petitioner met with these people and

distributed sales materials to them. From June 1995 to December

1997, petitioner spent 10 to 20 hours per week on his marketing

activity.

D. Petitioner’s Tax Returns

Petitioner reported gross income, expenses, and losses from

his marketing activity on his 1995, 1996, and 1997 returns, and

respondent conceded that petitioner substantiated business

expenses for 1997, as follows:
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 Amount

 respondent

 concedes

 petitioner

 Reported by petitioner substantiated

 1995 1996 1997 for 1997

Other income:

 Commissions $2,307 $7,326 $2,070

Gross income 2,307 7,326 2,070

Expenses:

 Advertising 5,224 2,643 2,955 $2,955

 Car and truck 918 1,530 1,861 1,861

 Depreciation 507 348 318 -0-

 Legal and - 50 - -

 professional

 services

 Repairs and 70 - - -

 maintenance

 Supplies 265 357 315 -0-

 Travel - 497 1,290 267

 Meals and - 594 1,394 1,395

 entertainment

 Utilities 327 737 617 -0-

 Other:

 Business courses 126 473 409 -0-

 Books 22 442 97 -0-

 Subscriptions 62 206 522 -0-

 Business education - 329 645 -0-

 Distributorship/ 1,515 233 1,320 1,320

 franchise fees

 New product - 2,896 784 -0-

 samples

 Product testing 1,379 2,490 4,616 1,846

 Total expenses 10,415 13,825 17,143 9,644

 

 Net loss (8,108) (6,499) (15,073)

Petitioner untimely filed his return for 1997 on September

15, 1999. Petitioner reported on the Schedule C, Profit or Loss

From Business, he attached to that return that his principal

business and product or service was “Network Marketing: Personal
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Care, Nutritional Products, Personal Development and Distributor

Services”.

OPINION

A. Whether Petitioner Operated His Direct Marketing Activity

for Profit in 1997

1. Background

The issue for decision is whether petitioner operated his 

direct marketing activity for profit in 1997. The parties agree

that petitioner’s undertakings as a sales representative for

various direct marketing companies are one activity.

A taxpayer conducts an activity for profit if he or she does

so with an actual and honest profit objective. Surloff v.

Commissioner, 81 T.C. 210, 233 (1983); Dreicer v. Commissioner,

78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205

(D.C. Cir. 1983). In deciding whether petitioner operated the

direct marketing activity for profit, we consider the following

nine factors: (1) The manner in which the taxpayer carried on

the activity; (2) the expertise of the taxpayer or his advisers;

(3) the time and effort expended by the taxpayer in carrying on

the activity; (4) the expectation that the assets used in the

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

in carrying on other similar or dissimilar activities; (6) the

taxpayer's history of income or loss with respect to the

activity; (7) the amount of occasional profits, if any, which are
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earned; (8) the financial status of the taxpayer; and (9) whether

elements of personal pleasure or recreation are involved. Sec. 

1.183-2(b)(1) through (9), Income Tax Regs. No single factor

controls. Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.

1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax

Regs.

2. Applying the Factors

Respondent contends that the factors in section 1.183-2(b),

Income Tax Regs., favor respondent, except respondent agrees that

the appreciation of assets factor does not apply.

Respondent contends that petitioner did not conduct his 

activity in a businesslike manner, keep proper books and records,

or have a business plan. We disagree. A business plan may be

evidenced by actions of the taxpayers where there is no written

business plan. Phillips v. Commissioner, T.C. Memo. 1997-128. 

Petitioner’s actions show that he had an informal business plan. 

He expected to improve his business by increasing the number of

customers and recruiting more sales representatives. He sought

to identify the best companies with which to do business, the

best products for sale, and the most efficient method for

marketing those products and for recruiting sales

representatives. He expected that his income from his marketing

activity would ultimately replace his wages from the Probation

Department.
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Petitioner kept records of income and expenses from his

marketing activities, and he kept records of the success rates of

his mailings and the size of his customer base.

A change of operating methods or abandonment of unprofitable

methods in a manner consistent with an intent to improve

profitability may indicate a profit objective. Krebs v.

Commissioner, T.C. Memo. 1992-154; Pirnia v. Commissioner, T.C.

Memo. 1989-627; sec. 1.183-2(b)(1), Income Tax Regs. Beginning

late in 1996, petitioner made numerous changes in his direct

marketing activity in an attempt to make a profit. Petitioner

searched for different companies for which to sell, and he

changed his methods when they were not successful. He obtained

sales positions with other direct marketing companies after he

became dissatisfied with being a Cell Tech representative. He

stopped sending unsolicited Cell Tech mailings after concluding

they were ineffective as a sales technique and began to use

telephone calls and meetings to make sales. He briefly became a

Telecard Network Co. representative in 1996 and 1997 but stopped

when he concluded that the Telecard Network Co. would not produce

the profits he sought. In 1997, he became a TPN representative

and concentrated his efforts on selling TPN and its products. 

This factor favors petitioner.

Respondent contends that petitioner lacked any expertise in

direct marketing. We disagree. Efforts at gaining experience
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and a willingness to follow expert advice may indicate a profit

objective. Krebs v. Commissioner, supra. Similarly, preparation 

for an activity by study of its accepted business, economic, and

scientific practices, and consultation with those who are expert

therein, may indicate that the taxpayer entered into the activity

for profit. Id.; Pirnia v. Commissioner, supra; sec. 1.183-

2(b)(2), Income Tax Regs. Petitioner read books and periodicals

and attended workshops and conferences to learn about direct

marketing. This factor favors petitioner.

From June 1995 to December 1997, petitioner worked 10 to 20

hours per week on his marketing activity. Respondent concedes

that petitioner spent a significant amount of time on this

activity. Respondent contends that petitioner should have been

doing more than he did, but respondent does not say what else

petitioner should have done. This factor favors petitioner.

Petitioner had no previous success in similar activities. 

This factor favors respondent.

Respondent contends that the fact that petitioner had losses

from his marketing activity in 1995, 1996, and 1997 shows that

petitioner did not have a profit objective. We disagree. Losses

incurred during the startup stage of an activity do not indicate

that the activity is not operated for profit if the taxpayer’s

losses were not sustained for a period beyond that which is

reasonably necessary for him or her to achieve a profit. 
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Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), affd. 379

F.2d 252 (2d Cir. 1967). This factor is neutral.

Respondent contends that the financial status factor favors

respondent because petitioner was employed full time. We

disagree. Petitioner earned wages of less than $50,000 per year

in 1995, 1996, and 1997. It does not appear that his aim was to

shelter income from tax. This factor favors petitioner.

Respondent contends that petitioner conducted his direct

marketing activity because he derived pleasure from it. We

disagree. We do not believe petitioner derived a significant

amount of personal pleasure from his direct marketing activity. 

This factor favors petitioner. 

We have previously decided whether various direct marketers

had profit objectives. For example, we held that the taxpayers

lacked a profit objective in Elliott v. Commissioner, 90 T.C.

960, 969-973 (1988), affd. without published opinion 899 F.2d 18

(9th Cir. 1990); Nissley v. Commissioner, T.C. Memo. 2000-178;

and Poast v. Commissioner, T.C. Memo. 1994-399. In those cases,

the taxpayers derived significant amounts of personal pleasure

from their Amway activities through hosting social gatherings in

their homes for prospective customers and attending conventions

and seminars for Amway representatives, thus using the marketing

activity to deduct personal travel expenses as business expenses. 

See, e.g., Elliott v. Commissioner, supra (week in Hawaii);
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1 The Commissioner conceded that the taxpayer in Brennan v.

Commissioner, T.C. Memo. 1997-60, engaged in an Amway sales

activity for profit.

2 Respondent’s counsel stated at trial that petitioner

“probably intended to make a profit” from 1995 to 1997 as an

outside sales representative for direct marketing companies.

However, we have decided this issue on the record, not on the

basis of respondent’s counsel’s statement at trial.

Nissley v. Commissioner, supra (trips to New York, Denver,

Atlanta, Orlando, and Minneapolis); Poast v. Commissioner, supra

(repeated trips to the Indianapolis Speedway, and trips to

Washington, D.C., California, Texas, and Michigan).1

Petitioner did not use his marketing activity to deduct personal

travel expenses. The taxpayers in Nissley said they would

continue selling Amway products whether or not they were

financially successful. Here, as discussed above, petitioner

changed companies and abandoned unsuccessful sales methods. 

Respondent does not contend that this case is like the Amway

cases.

In view of the time and effort petitioner spent on his

marketing activity, the startup nature of the activity, and his

changes in operations and abandonment of unprofitable methods, we

find that petitioner operated his direct marketing activity for

profit in 1997.2
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B. Whether Petitioner May Deduct More Business Expenses Than

Respondent Conceded

Petitioner contends that he may deduct more expenses for his

direct marketing activity for 1997 than respondent conceded

($9,644). We disagree. At trial, petitioner admitted that some

of the products he bought may have been for his own use and not

for product-testing purposes. Petitioner did not offer credible

evidence that he had more direct marketing expenses for 1997 than

the $9,644 that respondent conceded.

C. Whether Petitioner Is Liable for the Addition to Tax for

Failure To Timely File His 1997 Income Tax Return

A taxpayer is liable for an addition to tax up to 25 percent

for failure to timely file a return unless the failure was due to

reasonable cause and not willful neglect. Sec. 6651(a)(1).

Respondent has met the burden of production under section

7491(c) as to the addition to tax for failure to timely file

under section 6651(a)(1) because petitioner filed his 1997 return

on September 15, 1999, 17 months after it was due on April 15,

1998. Secs. 6072(a), 6012(a)(1). 

Petitioner testified that he filed his return late because

he was busy with his marketing activity. This is not reasonable

cause for late filing. Dustin v. Commissioner, 53 T.C. 491, 507

(1969), affd. 467 F.2d 47 (9th Cir. 1972). Petitioner made no

other argument that he is not liable for this addition to tax. 
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We hold that petitioner is liable for the addition to tax under

section 6651(a)(1) for failure to timely file his 1997 return.

To reflect concessions and the foregoing,

Decision will be

entered under Rule 155.