T.C. Summary Opinion 2004-59

UNITED STATES TAX COURT

RALPH D. AND BRENDA KONCHAR, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5388-01S. Filed May 13, 2004.

Ralph D. and Brenda Konchar, pro sese.

Jason W. Anderson and Thomas Yang, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the years at issue. The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority. 
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Respondent determined deficiencies in petitioners' Federal

income taxes of $5,404 for 1996, $5,978 for 1997, and $2,478 for

1998. The issue for decision is whether Brenda Konchar

(petitioner) conducted her Mary Kay Cosmetics distribution

activity with the intent to earn a profit, and if so, whether she

has substantiated that she incurred ordinary and necessary

business expenses.

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

The stipulation of facts and the exhibits received in evidence

are incorporated herein by reference. At the time the petition

was filed, petitioners resided in Hobart, Indiana.

Background

During the years at issue petitioners had four minor

children all of whom lived with them at home. Mr. Konchar worked

full time in construction. In 1996 and 1997, petitioner worked

about 17 hours a week at a Montgomery Ward department store as a

furniture salesperson. Petitioner changed her place of work to

the men's fragrance department of a May department store for

about a month, full time during the Christmas season of 1998.

In May of 1996, petitioner joined Mary Kay Cosmetics as an

"Independent Beauty Consultant". Before 1996, petitioner's

sister was a Mary Kay consultant. When petitioner became a

consultant in 1996, she took over 12 of her sister's customers

consisting of family members and friends. 
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During the subject years, three of petitioner's customers

lived in Pennsylvania, two lived in Florida, and seven lived in

Texas. In addition, all of petitioner's extended family live in

those three States, including her parents, who live in San

Antonio, Texas.

Petitioner owned a Dodge Caravan that she used in her Mary

Kay activity. For the year 1996 she maintained a mileage log for

her use of the Caravan. The log consisted of a notebook

containing dates, odometer readings, and daily mileage driven. 

During 1996 petitioner, accompanied by her children and sometimes

her husband, made several trips to Pennsylvania, Dallas and San

Antonio, Texas, and Florida. She recorded the trips in her log

and deducted the mileage on the Schedule C, Profit or Loss From

Business, attached to her 1996 Federal income tax return. 

Petitioner did not produce any log for 1997 or 1998, nor did she

provide substantiation for Schedule C expenses in those years. 

Petitioner did not maintain a separate checking account for her

Mary Kay activity for any year.

Petitioner reported returns and allowances plus cost of

goods sold (COGS) in excess of gross receipts on Schedule C for

1996 and 1997 for her Mary Kay activity. For 1998 petitioner

reported gross income, gross receipts exceeding returns and

allowances plus COGS, of $438. Net reported business losses for

the 3 years were $19,300, $21,308 and $9,132. Included in
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1Sec. 7491 is effective with respect to court proceedings

arising in connection with examinations by the Commissioner

commencing after July 22, 1998, the date of its enactment by the

Internal Revenue Service Restructuring and Reform Act of 1998,

Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.

petitioner's business expense deductions are automobile and

travel, and meals and entertainment expenses of over $10,000 for

1996 and 1997 and over $7,000 for 1998.

The parties agree that petitioner did not assess the

profitability of her Mary Kay activity and did not analyze any

records to determine whether she could improve her Mary Kay

profitability. 

Respondent determined that petitioner did not conduct her

Mary Kay activity with the honest objective to make a profit and

that if she did so conduct her activity, she has failed to

substantiate some of her business expenses for 1996 and has

failed to substantiate any of her business expenses for 1997 and

1998. 

Discussion

Because petitioner failed to meet the requirements of

section 7491(a)(2), the burden of proof does not shift to

respondent in this case.1

Section 183(a) generally provides that if an activity

engaged in by an individual is not entered into for profit, no

deduction attributable to the activity shall be allowed, except
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2Sec. 183(b)(1) permits a deduction for expenses that are

otherwise deductible without regard to whether the activity is

engaged in for profit, such as personal property taxes. Sec.

183(b)(2) permits a deduction for expenses that would be

deductible only if the activity were engaged in for profit, but

only to the extent that the gross income derived from the

activity exceeds the deductions allowed by sec. 183(b)(1).

as otherwise provided in section 183(b).2 An "activity not

engaged in for profit" means any activity other than one for

which deductions are allowable under section 162 or under

paragraph (1) or (2) of section 212. Sec. 183(c).

Deductions are allowed under section 162 for the ordinary

and necessary expenses of carrying on an activity that

constitutes the taxpayer's trade or business. Deductions are

allowed under section 212 for expenses paid or incurred in

connection with an activity engaged in for the production or

collection of income, or for the management, conservation, or

maintenance of property held for the production of income. With

respect to either section, however, the taxpayer must demonstrate

a profit objective for the activity in order to deduct associated

expenses. See Jasionowski v. Commissioner, 66 T.C. 312, 320-322

(1976); sec. 1.183-2(a), Income Tax Regs. The profit standards

applicable for section 212 are the same as those used for section

162. See Agro Science Co. v. Commissioner, 934 F.2d 573, 576

(5th Cir. 1991), affg. T.C. Memo. 1989-687; Antonides v.

Commissioner, 893 F.2d 656, 659 (4th Cir. 1990), affg. 91 T.C.
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686 (1988); Allen v. Commissioner, 72 T.C. 28, 33 (1979); Rand v.

Commissioner, 34 T.C. 1146, 1149 (1960).

Whether the required profit objective exists is to be

determined on the basis of all the facts and circumstances of

each case. See Hirsch v. Commissioner, 315 F.2d 731, 737 (9th

Cir. 1963), affg. T.C. Memo. 1961-256; Golanty v. Commissioner,

72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d

170 (9th Cir. 1981); sec. 1.183-2(a), Income Tax Regs. While a

reasonable expectation of profit is not required, the taxpayer's

objective of making a profit must be bona fide. See Elliott v.

Commissioner, 84 T.C. 227, 236 (1985), affd. without published

opinion 782 F.2d 1027 (3d Cir. 1986). In making this factual

determination, the Court gives greater weight to objective

factors than to a taxpayer's mere statement of her intent. See

Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d 724 (9th Cir.

1986), affg. Lahr v. Commissioner, T.C. Memo. 1984-472; Dreicer

v. Commissioner, 78 T.C. 642, 645 (1982), affd. without published

opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income

Tax Regs. 

Section 1.183-2(b), Income Tax Regs., sets forth nine

nonexclusive factors that should be considered in determining

whether a taxpayer is engaged in a venture with a profit

objective. They include: (1) The manner in which the taxpayer

carried on the activity; (2) the expertise of the taxpayer or her
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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

that are earned; (8) the financial status of the taxpayer; and

(9) whether elements of personal pleasure or recreation are

involved. 

No single factor is controlling, and we do not reach our

decision by merely counting the factors that support each party's

position. See Dunn v. Commissioner, 70 T.C. 715, 720 (1978),

affd. 615 F.2d 578 (2d Cir. 1980); sec. 1.183-2(b), Income Tax

Regs. Rather, the relevant facts and circumstances of the case

are determinative. See Golanty v. Commissioner, supra at 426.

After considering all the factors, we agree with respondent

that petitioner did not have an actual and honest objective of

making a profit from her Mary Kay activity. 

Petitioner did not carry on the activity in a businesslike

manner. See sec. 1.183-2(b)(1), Income Tax Regs. She maintained

no separate checking account for her business and no business

records, except for the automobile mileage log for 1996.

According to her Schedule C, petitioner's returns and

allowances and COGS exceeded her gross receipts for two of the
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tax years at issue, an indication that the activity was not

conducted with a profit objective. See Theisen v. Commissioner,

T.C. Memo. 1997-539. When questioned at trial about this fact,

she could not explain it. Petitioner did not seem to understand

that it suggests here that she was selling her products at or

near cost.

Petitioner's Mary Kay activity had a substantial component

of personal pleasure. See sec. 1.183-2(b)(9), Income Tax Regs. 

Petitioner's customers appear to have been mostly family and

friends. She traveled, with her children and sometimes her

husband, as far as Pennsylvania, Florida, and Texas to conduct

her Mary Kay activity. As a result, she and her family were able

to see her parents, her sister, and other relatives and friends.

The expertise of the taxpayer or her advisers is a factor to

be considered. See sec. 1.183-2(b)(2), Income Tax Regs. There

is no evidence in the record of petitioner's prior experience

operating her own business. Petitioner has provided no evidence

that, before she commenced her Mary Kay activity in 1996, she

sought to consult someone who could have provided an objective

opinion on the advantages and disadvantages of conducting a Mary

Kay distributorship. 

There could have been no expectation that the assets

petitioner used in the Mary Kay activity would appreciate in

value. See sec. 1.183-2(b)(4), Income Tax Regs. Although
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petitioner testified that she hoped to develop a customer base,

she did not explain how she would realize a profit from such a

customer base aside from selling Mary Kay products. 

Another important factor is that there is no indication that

petitioner had any chance of ever recovering the losses she

suffered. See Bessenyey v. Commissioner, 45 T.C. 261, 274

(1965), affd. 379 F.2d 252 (2d Cir. 1967); sec. 1.183-2(b)(6),

Income Tax Regs. Petitioner's Mary Kay activity has shown large

net losses in each of the years at issue. Moreover, petitioner

agreed with respondent that she did not assess the profitability

of Mary Kay or analyze any Mary Kay records to determine whether

she could improve her profitability. This suggests that making a

profit was not the primary objective of the Mary Kay activity. 

Petitioners have substantial income from sources other than

petitioner's Mary Kay activity. The Mary Kay expense deductions

sheltered that income to a large degree. Only the significant

salary of Mr. Konchar enabled petitioner to incur the losses

generated by her Mary Kay activity.

The Court has considered the remaining factors and finds

them either neutral or unhelpful to petitioner. 

The Court finds that petitioner did not engage in her Mary

Kay activity with the actual and honest objective of making a

profit. Petitioner's Schedules C for her Mary Kay activity

indicate that she is not entitled to claim any deductions
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"otherwise allowable" under section 183(b)(1). Because

petitioner reported no gross income from her Mary Kay activity

for 1996 and 1997, she is not entitled to any deductions under

section 183(b)(2) for those years. 

For 1998 petitioner reported gross income of $438, and her

deductions for that year are limited to that amount. Id.

Respondent, however, determined that petitioner did not

substantiate any of her expenses for the year, and petitioner

produced no such evidence at trial. Petitioner is therefore not

entitled to any deductions for her Mary Kay activity for 1998.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

for respondent.