# PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.T.C. Sum m ary Opi ni on 20 14 -4 0

UNITED STAT ES TAX COURT

SAMER M IKHAIL AND MARIANA MIKHAIL, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 20 19 9- 12 S. Fi le d Ap ril 22 , 20 14
.
Sam er Mi kh ai l an d M ari an a Mi kh ai l, p ro ses e. W il li am R. Bro wn, J r., forres po nd en t.

SUMM ARY OPINION GUY, Spec ia l Tri al Ju dg e: Thi s ca se was h eardpu rs uantto th e p ro vi si on s of sec ti on 74 63 of t he Int ern al Rev enue Co de ineffe ctwhenth e p et it io n was fil ed
. Pur su an t t o s ect io n 7 46 3( b) , th e d eci si on to be en te redis no t re vi ewab le by 1
Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the Int ern al Rev enue 1 (co nt in ue d...)- 2 -

an y ot he r co urt, an d t hi s o pi ni on sh al l n otbe tre at edas p rece de ntforan y ot he r cas e. Res po nd en t d et erm in eda de fic ie nc y of $ 8,2 86 inpe ti ti on ers ’ Fed eral in co m e ta x fo r 20 09 an d a n a ccu racy-rela te d p en al ty of $1 ,65 7 p ur su an t t o s ect io n 66 62 (a). Pet it io ne rs , hu sb an d a ndwife , fil eda ti m el y pe ti ti on forred et erm in at io n with t he Co urt p ur su an t t o s ect io n 6 21 3( a). The is su es forde ci si on are: (1) whet he r pe ti ti on ers en ga ge d i n s al es an d
recrui ti ng act iv it ie s fo r pr of itwithi n t he m ean in g o f se ct io n 1 83 , (2) if s o, wh ethe r pe ti ti on ers subs ta nt ia te d d educ ti on s the y cla im edforve hi cl e an d t rav el expe ns es , an d (3 ) whe th er p et it io ne rs are l iabl e fo r anaccu racy-rela te d p en al ty und er s ect io n 66 62 (a). To th e ex te ntno t d is cu ss edhe rei n, o th er ad jus tm en ts are co m

pu ta ti on al
an d fl ow fr om

our de ci si on inth is cas e.

Bac kg ro un d So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io n o f fact s an d t he acco m

pa nyin g e xh ib it s ar e in co rp or at edhe rei n b y th is refe ren ce. At th e ti m e th e p et it io n was fil ed , pet it io ne rs res id edinFlo rid a. (...co nt inue d) 1 Co de (Co de ), as am en de d a ndineffe ctfor20 09 , andRu le refe ren ces are t o t he Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. All m on et ary am ou nt s ar e ro un de d t o th e n eare stdo ll ar.- 3 -

I. Pet it io ne rs Dr. Mi kh ai l g radua te d fr om th e New York C ol le ge of Os te op athi c Me di ci ne in 20 04 an d c om

pl et edhi s m ed ic al res id en cy at t he Uni ve rs ity

of S ou th Flo rid a in 20 07 . Sin ce the n, h e h as work edful l t im e as a ph y si ci anpra ct ic in g i nt ern al
m ed ic in e ata ho sp it al op erat edby the U.S. Departm en t o f Vet eran s Aff ai rs in Fl or id a. The wage s tha t Dr. Mi kh ai l ea rn s as a ph y si ci anare p et it io ne rs ’ pr im ary so ur ce o f in co m e. Duri ng 20 07 , th e fi na l year of h is m ed ic al res id en cy , Dr. Mi kh ai l ea rn ed$6 4,0 97 . His wa ge s dur in g 2 00 8, 2 00 9, 2 01 0, an d 2 01 1 wer e $1 45 ,23 5, $ 15 7,6 21 , $1 65 ,14 6, an d $ 16 8,6 27 , res pe ct iv el y . Mrs . Mikha il gra du at edfro m Baru chCo ll eg e in New Yorkwith a ba ch el or ’s deg ree i n i nt ern at io na l m ark et in g i n 1 99 9. Sh e worke d fo r Myers In te rn at io na l an d l at er R.J . Reyno ld s i n New Yo rkCit y be twee n 1 99 9 a nd20 03
. Pet it io ne rs are the pa ren ts of t wo ch il dr en , a so n b orn i n 2 00 3 a nda daug ht er b orn i n 2 00 9. Si nc e 2 00 4, M rs . Mikha il ha s h adso m e sh ort-t erm , partti m e job s, b utsh e h as pri m ari ly beena ho m em ak er.- 4 -

II. Am way Am way Co rp . (Am

way ) is a supp li er o f ho us eh ol d, co sm et ic , andnu tri ti on al pr oduc ts th atare s ol d b y

in di vi du al s (d is tri bu to rs ) th ro ug h d ire ctm ark et in g. Am way ’s com

pe ns at io n o f it s d is tri bu to rs is ba se d o n t he vo lu m e o f th e di st rib ut or s’ sal es to cu st om ers an d t he vo lu m e o f sa le s m ad e b y “ do wnl in e” di st rib ut or s. Am

way di st rib ut or s ar e p erm it te d t o p ur ch as e Am way pro du ct s fo r pe rs on al co ns um

pt io n at a d is co un te d p ric e. Am way ’s com

pe ns at io n s y st em

fordi st rib ut or s re su lt s i n apyram id li ke
ne two rkof d is tri bu to rs . Und er thi s s y st em an“up li ne ” o r “ sp on so r” d is tri bu to r is
en co ur ag edto recrui t n ew “ do wnl in e” d is tri bu to rs to be co m e p artof h is or h er or ga ni zat io n. “ Down li ne ” d is tri bu to rs li ke wis e are en co ur ag edto recrui t n ew di st rib ut or s wh o i n turn b eco m e “ le gs ” o f th e o rig in al “up li ne ” d is tri bu to r’s
or ga ni zat io n. “ Down li ne ” d is tri bu to rs recrui te d b y th e sa m e “up li ne ” d is tri bu to r are r eferredto as “ cro ss li ne ” d is tri bu to rs . An “up li ne ” d is tri bu to r rec ei ve s b on us pa ym en ts fro m

Am way ba se d o n t he vo lu m e o f sa le s (a s o pp os edto pro fit s) ge ne rat edby the “ do wnl in e” d is tri bu to rs who are p artof h is or h er o rg an iz at io n. 2

See Ni ss le y

v. Co m m is si on er, T.C. Mem o. 2 00 0- 17 8, fo r a m or e co m pl et e 2 de sc rip ti on of Amway ’s com pe ns at io n s y st em .- 5 -

III. Pet it io ne rs ’ Am

way Acti vi ti es Dr. Mi kh ai l was recr

ui te d a s an Am

way di st rib ut orby his de nt is t i n 2 00 4,
an d h e b eg anto op erat e a d is tri bu to rs hi p u nd er the na m e “ The Log os ”. At the ti m e p et it io ne rs ha d n o e xp eri en ce i n d ire ctm ark et in g o r op erat in g asm al l bu si ne ss . Dr. Mi kh ai l t es ti fie d t ha t h e co nduc te d i nd ep en de ntres earc h t o l earnm or e ab ou t Am way . He con cl ud edth atne ga ti ve ass es sm en ts ab ou t the Am way bu si ne ss m od el are at tri bu tabl e to in di vi du al s “ who di d n otfol lo w th e syst em ”. Pet it io ne rs co nduc te d t he ir Amway act iv it ie s i n a cco rd an ce wi th in st ru ct io ns fro m

th ei r “up li ne ” d is tri bu to rs , edu cat io na l m at eri al s o bt ai ne d fr om anAm way -rel at ededuc at io na l s y st em kn own as Lea de rs hi p Tea m Deve lo pm en t (LTD), an d i nf

orm at io n o bt ai ne d wh il e at te nd in g Amway seminar s, wo rk sh op s, 3
an d c on fere nc es . Peti ti on ers di d n otsee k a dv ic e fro m di si nt eres te d p ro fes si on al s, de ve lo p abu si ne ss pl an , pre pa re p ro fitpro jecti on s, o r un de rta ke an y type o f
m ark etan al y si s. Pet it io ne rs att en de d wee kl y an d m on th ly Am

way m eet in gs he ldlo cal ly and el se whe re i n F lo rid a. Duri ng 20 09 th ey att en de d fi ve nati on al Am way
LTD sel ls bo ok s an d C Ds tha t co nt ai n i ns tru ct io n a ndtra in in g fo r Am way 3 di st rib ut or s.- 6 -

co nf eren ces m os t o f whi chwere h el d o utof S ta te . Peti ti on ers als o h os te d s om e week ly m eet in gs forAm

way di st rib ut or s an d re cru it s i n t he ir h om e. Pet it io ne rs to oktri ps to New Yorkan d Tex as to di sc us s Am way with fa m il y

an d fr ie nd s. Dr. Mi kh ai l t es ti fie d t ha t the ti m e h e d ev ot es to Am way act iv it ie s i s l arg el y di rect edat r ecru it in g n ew di st rib ut or s. He fu rth er t es ti fie d t ha t h e u su al ly spe nd s hi s l un chho ur , as wel l as anho uror t wo af te r work, an d app ro xi m at el y th ree ho ur s ev ery week en d o n Amway act iv it ie s an d t ha t Am

way is alwa y s “ atth e fo refr on t” of h is m in d. Dr. Mi kh ai l s pe ntm or e ti m e o n Amway act iv it ie s tha n Mrs . Mikha il
. Mrs . Mikha il tes ti fie d t ha t s he is res po ns ib le forbo okke ep in g, b us in es s m an ag em en t, an d o rg an iz at io n o f Am way pa rti es an d e ve nt s. Durin g 2 00 9 s he
m ai nt ai ne d re co rd s o f th e co up le ’s Am way -rel at edex pe ns es in cl ud in g am il eag e lo g, a s pr ead sh eetli st in g m on th ly exp en se s, an d c red itcardst at em en ts . Pet it io ne rs di d n otus e th ei r Am way reco rd s t o p rep are aform al bu dg etor c on du ct a b reak -ev enan al y si s. Pet it io ne rs so ldAm

way pro du ct s t o fa m il y

m em be rs , clo se fri en ds , and
co worke rs . At th e ti m e o f tr ia l, p et it io ne rs ha d 2 2 c us to m ers who pu rch as ed Am way pro du ct s fr om

th em sp or ad ic al ly. Pet it io ne rs tes ti fie d t ha t ap pr ox im at el y 70 -7 5% o f th ei r Am

way sal es vo lu m e was att rib ut ab le to pro du ct s an d s erv ic es- 7 -

th atth ey purch as edforpe rs on al co ns um pt io n s uc h a s fo od , di ap ers , clo th in g, an d ho us eh ol d p ro du ct s. Th ey als o e njo y edAm

way -rel at eddi sc ou nt s o n p ro du ct s an d
se rv ic es purch as edfro m

bu si ne ss es an d re ta il ers su chas Di sn ey , Son y , Nik e, an d Bes t Bu y . Pet it io ne rs in it ia ll y

att em pt edto recrui t fa m il y

m em be rs an d fr ie nd s as

“ do wnl in e” d is tri bu to rs bu t fo un d t ha t m os t o f th em were u nabl e to “ ov erco m e th ei r li fe ci rcu m st an ces an d c on ti nu e to bu il d Amway with u s” . Peti ti on ers lat er al te redth ei r rec ru it m en t s tra te gy by freque nt in g ups cal e res taur an ts an d s ho pp in g area s an d s tri ki ng up co nv ers at io ns with p eo pl e th ey en co un te redwith t he aim of id en ti fy in g wh atth ey

term ed“ le arn ers ”. Pet it io ne rs pu rch as edbo ok s an d C Ds fro m LTD andga ve th em

to po te nt ia l re cru it s. Altho ug h p et it io ne rs tes ti fie d t ha t the y reg is te redso m e “ do wnl in e” di st rib ut or s al on g t he way , by th e en d o f 20 08 th ey ha d n o “ do wnl in e” di st rib ut or s. Dr. Mi kh ai l ac kn owl ed ge d t ha t h e was un ab le to sp en d s uf fic ie nt ti m e o n Amway

act iv it ie s wh il e h e was ful fil li ng hi s m ed ic al res id en cy requi rem en ts be twee n 2 00 4 a nd20 07 . In 2 00 9 p et it io ne rs recrui te d a“ do wnl in e” di st rib ut orwho ap pa ren tl y be ga n t o re gi st er h er o wn “ do wnl in e” d is tri bu to rs (th ereb y ex pa nd in g p et it io ne rs ’ or ga ni zat io n)
.- 8 -

IV. Peti ti on ers ’ Am

way Los se s Pet it io ne rs fil edjoi ntFed eral in co m e ta x re turn s fo r th e y ears 20 05 th ro ug h 20 11 . Peti ti on ers att ach edto each of t ho se returns a Sch edul e C, Pro fitor Lo ss Fro m Bu si ne ss , id en ti fy in g Dr. M ikha il as t he “pr op rie to r” o f a “ sa le s an d
recrui ti ng ” b us in es s. As of t he ti m e o f tr ia l p et it io ne rs ha d n ev er re po rte d a n an nu al pro fitfro m

th ei r Am way act iv ity . From 20 05 to 20 11 pe ti ti on ers rep orte d
cu m ul at iv e n etlo ss es att rib ut ab le to th e Am way act iv ity of $ 19 2,4 27 as f

ol lo ws: Gros s Tax y ear recei pt s Net lo ss 20 05 $61 3 ($1 5,9 43 ) 20 06 1,92 4 (2 0,1 36 ) 20 07 3,72 5 (2 9,2 98 ) 20 08 3,22 9 (4 1,5 98 ) 20 09 4,81 1 (3 9,9 19 ) 20 10 5,72 8 (3 8,8 25 ) 20 11 9,45 9 (6,7 08 ) Tota l 29 ,48 9 (19 2,4 27 ) Pet it io ne rs tes ti fie d t ha t the y be li ev edth atth ey

wou ldev en tu al ly earn pr of it s fr om th e Am way act iv ity ov er the lo ng run an d t ha t the act iv ity wou ld pr ov id e fi na nc ia l b en efi ts to th ei r fam il y fory ears to co m e. Pet it io ne rs furth er- 9 -

te st ifi edth atth e lo ss es th ey ha ve in cu rredwil l b e o ffs etby gai ns th atth ey expe ct to earn in20 14 an d t he y ears th erea fte r. V. Peti ti on ers ’ 20 09 Tax R eturn Pet it io ne rs ti m el y

fil eda joi ntFed eral in co m e ta x re tu rnfor20 09 rep orti ng th atDr. Mikha il an d M rs . Mikha il earn edwage s o f $1 57 ,62 1 a nd$4 19 , res pe ct iv el y . Peti ti on ers att ach edto th e return aSch edul e C rep orti ng gro ss rece ip ts of $ 4,8 11 , exp en se s o f $4 4,7 30 , anda ne t l os s o f $3 9,9 19 inres pe ctof t he Am way act iv ity . Peti ti on ers rep orte d t he fol lo win g Amway -rel at edex pe ns es :

Item Am ou nt Veh ic le $1 7,5 48 Leg al /p ro fes si on al servi ces 1,3 25 Offi ce ex pe ns es 24 8 Supp li es 11 ,63 4

1 Trav el 8,0 03 Mea ls an d e nt ert ai nm en t 68 Oth er ex pe ns es 5,9 04 Tota l 44 ,73 0 Thi s i te m rep res en ts th e am ou ntpe ti ti on ers 1 pa idto LTD for Am

way tra in in g m at eri al s. Pet it io ne rs rep orte d t ot al tax of $ 9,9 94 for20 09
.- 10 -

VI. Not ic e o f Defi ci en cy an d In crea se d Def

ic ie nc y Res po nd en t i ss ue d ano ti ce o f de fic ie nc y to pe ti ti on ers di sa ll owi ng th e de du ct io ns th ey

cla im edonSch edul e C fo r ve hi cl e an d t rav el ex pe ns es for lac k o f
subs ta nt ia ti on . Res po nd en t d et erm in eda ta x d efi ci en cy of $ 8,2 86 an d a n accu racy-rela te d p en al ty und er s ect io n 6 66 2( a). Afte r fi li ng anin it ia l an swe r to th e p et it io n, re sp on de ntfil edanam en de d
an swe r al le gi ng th atpe ti ti on ers di d n oten ga ge inth e Am way act iv ity with t he in te ntof e arn in g apro fitin20 09 an d t he y are n oten ti tl edto de du ct io ns (in ex ces s of th ei r gr os s re cei pt s fr om th e act iv ity) in acco rd an ce wi thth e p ro vi si on s o f
se ct io n 1 83 . In co njunc ti on with t he se all eg at io ns , res po nd en t as se rte d t ha t pe ti ti on ers are l iabl e fo r anad di ti on al de fic ie nc y an d a n i nc reas edaccu racy-rela te d pe na lty un de r se ct io n 6 66 2( a). VII. Tax R eturn P rep arat io n Pet it io ne rs de li ve redth ei r ta x re co rd s fo r 20 09 to Ro n Hi en st an d, a c ert ifi ed publ ic acco un tant(C.P.A.), who ha s p rep aredth ei r ta x re tu rn s s in ce 2 00 8. Mr. Hi en st an d p rep aredth e return i n a cco rd an ce wi th pe ti ti on ers ’ ta x re co rd s an d fil edth e return e le ctro ni cal ly. Pet it io ne rs tes ti fie d t ha t the y rel ie d o n Mr. Hi en st an d t o p ro pe rly prep are t he ir r eturn.- 11 - Dis cu ss io n The Co m m is si on er’s d et erm in at io n o f a t axpa y er’s l iabi li ty in a n ot ic e o f de fic ie nc y

no rm al ly is p res um edco rrec t, an d the tax pa y er b ears th e b ur de n o f pr ov in g t ha t the de te rm in at io n i s i nc orrect . Rul e 1 42 (a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 1 15 (19 33 ). The C omm is si on er b ears th e b ur de n o f pr oo f, ho wev er, i n res pe ctof a n i nc reas edde fic ie nc y . Rul e 1 42 (a)( 1) . As pr ev io us ly m en ti on ed , res po nd en t fi le d a n a m en de d a ns wer as se rti ng th atpe ti ti on ers are l iabl e fo r an in crea se d d efi ci en cy

an d a ccu racy-rela te d p en al ty on the gro un d t he y di d n ot en ga ge inth e Am

way act iv ity with t he requi si te pro fitob jecti ve . Con se qu en tl y , res po nd en t b ears th e b ur de n o f pr oo f on th atis su e. See s ec. 7 49 1( a)(1 ) an d (2 ); Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 4 42 -4 43 (20 01 ). I. Sect io n 1 83 Und er s ect io n 1 83 (a), i f anact iv ity is no t en ga ge d i n fo r pr of it , th enno de du ct io n a ttrib ut ab le to th atact iv ity is all owe d e xc ep t t o t he ex te ntpro vi de d b y se ct io n 1 83 (b ). In p ert in en t p art , sec ti on 18 3( b) all ows th os e d educ ti on s tha t wou ldha ve be enall owabl e h adth e act iv ity be enen ga ge d i n fo r pr of iton ly to the
ex te ntof g ro ss in co m e d eri ve d fr om th e act iv ity

(reduc edby deduc ti on s at tri bu tabl e to th e act iv ity th atare al lo wab le witho utreg ardto whet he r th e act iv ity was en ga ge d i n fo r pr of

it ).- 12 -

Sect io n 1 83 (c) d efi ne s an act iv ity no t en ga ge d i n fo r pr of

itas “ any act iv ity ot he r th anon e wit h re sp ectto whi chde du ct io ns are al lo wab le forth e ta xabl e y ear un de r se ct io n 1 62 or u nd er p arag rap h (1 ) or(2) of s ect io n 2 12 .” Dedu ct io ns are al lo wab le un de r se ct io n 1 62 or u nd er s ect io n 2 12 (1 ) or(2) if the tax pay er i s en ga ge d i n t he act iv ity

with t he “ actua l an d h on es t o bjec ti ve of m ak in g apro fit ”. Drei cer v . Comm is si on er, 7 8 T.C. 6 42 , 64 5 (1 98 2) , aff’d wit ho utpubl is he d op in io n, 7 02 F.2d12 05 (D.C. Cir . 19 83 ); Go la nt y v. Co m m is si on er, 7 2 T.C. 4 11 , 42 6- 42 7 (1 97 9) , aff’d wit ho utpubl is he d o pi ni on , 64 7 F .2d17 0 (9 th Cir . 19 81 ). The ex is te nc e o f th e requi si te pro fitob jecti ve is a qu es ti on of f

actth atm us t be de ci de d o n t he ba si s o f th e en ti re re co rd . Elli ot t v . Comm is si on er, 8 4 T.C. 2 27 , 23 6 (1 98 5) , aff’d wit ho utpubl is he d o pi ni on , 78 2 F .2d10 27 (3dCir . 19 86 ); Drei cer v . Comm is si on er, 7 8 T.C. at64 5; sec . 1.1 83 -2 (b ), In co m e Tax Reg s. In
res ol vi ng th is factua l que st io n, g reat er wei gh t i s g iv ento ob jecti ve fact s tha n t o a ta xp ay er’s s ta te m en t o f in te nt . See Westbr oo k v . Comm is si on er, 6 8 F .3d86 8, 87 5- 87 6 (5 th Cir . 19 95 ), aff’g T.C. Me m o. 1 99 3- 63 4; sec . 1.1 83 -2 (a), In co m e Tax Reg s. Fo r pu rp os es of d eci di ng whet he r th e ta xp ay er h as th e requi si te pro fit ob jecti ve , pro fitm ean s ec on om ic pro fit , in de pe nd en t o f ta x s av in gs . Surl of f v. Co m m is si on er, 8 1 T.C. 2 10 , 23 3 (1 98 3)
.- 13 -

The reg ul at io ns setforth a no ne xh au st iv e li stof f act or s tha t m ay

be
co ns id eredinde ci di ng whet he r a p ro fitob jecti ve ex is ts . Thes e fac to rs are: (1) th e m an ne r in whi chth e ta xp ay er ca rri es on th e act iv ity ; (2 ) th e ex pe rti se of t he ta xp ay er o r hi s ad vi se rs ; (3 ) th e ti m e an d e ffo rt e xp en de d b y th e ta xp ay er i n carry in g o n t he act iv ity ; (4 ) th e ex pe ct at io n t ha t the ass et s u se d i n t he act iv ity m ay ap pr eci at e in va lu e; (5) th e ta xp ay er’s s uc ces s i n c arrying on othe r si m il ar o r 4 di ss im il ar ac ti vi ti es ; (6 ) th e ta xp ay er’s h is to ry of i nc om e o r lo ss es with re sp ectto th e act iv ity ; (7 ) th e am ou ntof o ccas io na l p ro fit s, i f an y , whi chare ea rn ed ; (8 ) th e fin an ci al st atus of t he tax pa y er; an d (9 ) an y ele m en ts in di cat in g p ers on al pl eas ur e orrecr eat io n. Se c. 1.1 83 -2 (b ), In co m e Tax Reg s. No s in gl e fac to r, no r ev enth e ex is te nc e o f a m ajor ity of f act or s s up po rti ng orreb ut ti ng th e ex is te nc e o f a p ro fitob jecti ve , is co ntro ll in g. Id . Rath er, al l fa ct s an d c irc um st an ces with re sp ectto th e act iv ity are t o b e ta ke n i nt o a cco un t. Gol an ty v. Comm is si on er, 7 2 T.C. at42 6; sec . 1.1 83 -2 (b ), In co m e Tax Reg s. A. Man ne r in Whi chPet it io ne rs Carr ie d Onth e Am way Acti vi ty If a t ax pa y er ca rri es on th e act iv ity ina bu si ne ss li ke m an ne r an d m ai nt ai ns co m pl et e an d a ccu rat e b oo ks an d re co rd s, i t m ay in di cat e a p ro fitob

jecti ve . Sec.
Pet it io ne rs di d n otid en ti fy an y ass et s u se d i n t he Am

way act iv ity th atth ey 4 ex pe ct edto ap pr eci at e in va lu e. Thu s, thi s fa ct oris no t re le va ntto ou r an al y si s.- 14 -

1.1 83 -2 (b )(1 ), In co m e Tax Reg s. Ho wev er, i f th ere i s a l ackof e vi de nc e th atth e ta xp ay er’s rec or ds were u se d t o i m pr ov e th e p erfo rm an ce o f a l os in g o pe rat io n, su chreco rd s g en eral ly do n otin di cat e a p ro fitob jecti ve . Gol an ty v. Co m m is si on er, 7 2 T.C. at43 0; see Cam pb el l v . Comm is si on er, T.C. Mem o. 2 01 1- 42 , 20 11 W L 66 79 73 , at * 5- *6 . Keepi ng reco rd s o nl y forpu rp os es of p rep ari ng ta x re turn s i s n otin di cat iv e o f a p ro fitob jecti ve . See Ro wde n v . Comm is si on er, T.C. Mem o. 2 00 9- 41 ; Ki nn ey v. Co m m is si on er, T.C. Mem o. 2 00 8- 28 7. Altho ug h p et it io ne rs ke ptreco rd s o f th ei r Am way ex pe ns es , th ey

di d n ot us e th os e rec or ds to an al yze the ir b us in es s p erfo rm an ce o r to pre pa re p ro fit pr ojec ti on s, a b reak -ev enan al y si s, o r a fo rm al bu dg et . Desp it e se ve ral y ears of act iv ity du rin g wh ic h t he y

real iz edcu m

ul at iv e n etlo ss es of $ 19 2,4 27 , pet it io ne rs fai le d t o m ak e an y

m ean in gf

ul ch an ge inth ei r st rat eg y or t act ic s i n an e ffo rt t o in crea se th e li ke li ho odof e arn in g apro fit . On th is reco rd , itis a fai r in fere nc e th at pe ti ti on ers us edth ei r rec or ds on ly to co m pu te th e am ou nt s o f lo ss es att rib ut ab le to th e Am way act iv ity when pre pa rin g t he ir t ax returns . Con si de rin g a ll th e fac ts an d ci rcu m st an ces , we con cl ud e th atpe ti ti on ers di d n otco nduc t the Am way act iv ity in a b us in es sl ik e m an ne r.- 15 -

B. Exp ert is e o f Pet it io ne rs or Th ei r Adv is ers Prep arat io n fo r th e act iv ity by ext en si ve study

of i ts acce pt edbu si ne ss pr act ic es , or c on su lt at io n wi th th os e who are ex pe rt t he rei n, m ay in di cat e a p ro fit ob jecti ve wher e th e ta xp ay er ca rri es onth e act iv ity inacco rd an ce wi th su ch pr act ic es . Sec. 1 .18 3- 2( b) (2 ), In co m e Tax Reg s. Pet it io ne rs ha d n o e xp eri en ce i n di rectm ark et in g a ct iv it ie s o r op erat in g asm al l b us in es s b efo re Dr. Mi kh ai l was
recrui te d a s an Am

way di strib ut orin20 04 . Peti ti on ers ob ta in edadvi ce o nl y fro m

“up li ne ” d is tri bu to rs --p ers on s wh o h ada di rectfin an ci al in te res t i n t he
m ax im iz at io n o f pe ti ti on ers ’ sa le s v ol um e, witho utreg ardto whet he r th ey wou ld real iz e a p ro fit . See Og de n v . Commis si on er, T.C. Mem o. 1 99 9- 39 7 (Amway

“up li ne ” d is tri bu to rs ’ advi ce m ay be bi as edbe cau se of fi na nc ia l i nt eres t i n

“ do wnl in e” d is tri bu to r’s sa le s v ol um e), aff ’d, 24 4 F .3d97 0 (5 th Cir . 20 01 ). Mo reo ve r, co ns id eri ng th ei r la ckof e xp ert is e, we fi nditno te worth y th at pe ti ti on ers di d n otatt em

ptto educ at e th em se lv es by con du ct in g a n i nd ep en de nt
m ark etan al y si s o r dr aft in g abu si ne ss pl anforth e Am way act iv ity . This fact or weig hs ag ai ns t p et it io ne rs .- 16 -

C. The Ti m e an d Eff

ort Ex pe nd edby Peti ti on ers inCarry in g On the Acti vi ty The fa ctth atth e ta xp ay er d ev ot es subs ta nt ia l t im e an d e ffo rt t o c arrying on anact iv ity

m ay in di cat e anin te nt io n t o d eri ve a pr of it . Sec. 1 .18 3- 2( b) (3 ), In co m e Tax Reg s. Pet it io ne rs att en de d l oc al Am way m eet in gs week ly andm on th ly, an d th ey att en de d Amway

co nf eren ces (of

te n o utof S ta te ) reg ul arl y . Neverth el es s, Dr. Mi kh ai l ca nd id ly adm it te d t ha t h e was no t ab le to de vo te su ffi ci en t t im e an d effo rt t o t he Am

way act iv ity du rin g 2 00 4 t o 2 00 7- -th e p eri odof h is m ed ic al
res id en cy . As we se e it , he l ik ewis e was no t ab le to de vo te su ffi ci en t t im e to th e act iv ity aft er 2 00 7 t ak in g i nt o a cco un t h is ob li ga ti on s as a fu ll -ti m e p hysic ia n. Pet it io ne rs ackno wled ge d t ha t Dr. Mi kh ai l s pe ntm or e ti m e o n t he act iv ity th an Mrs . Mikha il . Und er the cir cu m st an ces , we con cl ud e p et it io ne rs di d n otsp en d a si gn ifi can t am ou ntof t im e o n t he Am way act iv ity . See Kin ne y

v. Co m m is si on er, T.C. Mem o. 2 00 8- 28 7. Th is fact orweig hs ag ai ns t p et it io ne rs . D. Peti ti on ers ’ Su cces s i n C arrying OutOth er Si m il ar o r Dis si m il ar Acti vi ti es The factth atth e ta xp ay er h as en ga ge d i n s im il ar ac ti vi ti es inth e p as t an d
co nv ert edth em

fro m unpr of it ab le to pro fit ab le en te rp ris es m ay in di cat e th atth e act iv ity inqu es ti on was e ng ag edinfor pro fit , eve n t ho ug h t he act iv ity is pre se nt ly
unpr of it ab le . Sec. 1 .18 3- 2( b) (5 ), In co m e Tax Reg s. Pet it io ne rs ha d n o p rio r- 17 -

ex pe rie nc e en ga gi ng ina di rectm ark et in g d is tri bu to rs hi p o r m an ag in g asm al l bu si ne ss of a ny sort. Thi s fa ct orweig hs ag ai ns t p et it io ne rs . E. Peti ti on ers ’ His to ry

of I nc om e o r Los s A seri es of l os se s dur in g the in it ia l o r st artup st ag e o f anact iv ity m ay no t ne ces sa ril y

be anin di cat io n t ha t the act iv ity is no t en ga ge d i n fo r pr of it . Sec. 1.1 83 -2 (b )(6 ), In co m e Tax Reg s.; see Gol an ty v. Comm is si on er, 7 2 T.C. at42 7. Howev er, wh ere l os se s co nt in ue to be su st ai ne d b ey on d t he pe rio d wh ic h
cu st om ari ly is n eces sa ry

to bri ng th e o pe rat io n t o p ro fit ab le st atus , su chco nt in ue d lo ss es , if n otex pl ai nabl e, m ay in di cat e th atth e act iv ity

is no t en ga ge d i n fo r pr of it
. Sec. 1 .18 3- 2( b) (6 ), In co m e Tax Reg s. Th e “ go al m us t b e to real iz e a p ro fiton th e en ti re o pe rat io n, wh ic h p res up po se s n oton ly futu re n etearn in gs bu t al so su ffi ci en t ne t ea rn in gs to reco up th e lo ss es whi chha ve m ean whi le be ensu st ai ne d i n t he in te rv en in g years.” Bes se nyey v. Co m m is si on er, 4 5 T.C. 2 61 , 27 3- 27 4 (1 96 5) , aff’d, 3 79 F.2d25 2 (2 d C ir. 1 96 7) ; s ee al so Nis sl ey v. Co m m is si on er, T.C. Mem o. 20 00 -1 78
. At the ti m e o f tr ia l p et it io ne rs ha d n ev er re po rte d a n a nn ua l p ro fitinres pe ct of th e Am way act iv ity . To th e co nt rary, they repo rte d c um ul at iv e n etlo ss es of $1 92 ,42 7 fr om

20 05 th ro ug h 2 01 1. Th e m od es t g ro ss rece ip ts th atpe ti ti on ers de riv edfro m

th e act iv ity

ha ve be enecl ip se d b y

th e subs ta nt ia l ex pe ns es th ey- 18 -

in cu rredov er the y ears . Alth ou gh pe ti ti on ers tes ti fie d t ha t the y be li ev e th e Am way act iv ity wil l ev en tu al ly gen erat e p ro fit s, we ca nn otdi sc ernon th is reco rd
an y de fin it iv e tr en d t o t he up si de forpe ti ti on ers , andth ere c ert ai nl y is no in di cat io n tha t the y

are o n t he ir way

to th e le ve l o f pr of

it ab il ity th atwou ldall ow th em to reco up th e subs ta nt ia l cu m ul at iv e lo ss es th ey

ha ve in cu rredto da te . In
su m , pet it io ne rs ’ hi st ory

of c on si st en t an d s ub st an ti al lo ss es is in di cat iv e o f a l ack of pro fitob jecti ve . See Go la nt y

v. Co m m is si on er, 7 2 T.C. at42 7; Ogd env. Co m m is si on er, T.C. Mem o. 1 99 9- 39 7. Th is fact orweig hs ag ai ns t p et it io ne rs . F. Occas io na l Pr of

it s The am ou ntof p ro fit s i n re la ti onto th e am ou ntof l os se s i nc urred , andin rel at io n t o t he am ou ntof the tax pa y er’s i nv es tm en t an d t he va lu e o f th e as se ts us ed in th e act iv ity , m ay

pro vi de us efu l cr it eri a inde te rm in in g t he tax pa y er’s i nt en t. Sec. 1 .18 3- 2( b) (7 ), In co m e Tax Reg s. As di sc us se d abo ve , pet it io ne rs ’ Am way act iv ity ha s p ro du cedli tt le inth e way of a nn ua l re cei pt s an d n o p ro fit s an d
res ul te d i n asu st ai ne d p at te rnof s ub st an ti al lo ss es . Peti ti on ers ’ in ab il ity to earn a pr of itis in di cat iv e o f th ei r la ckof p ro fitm ot iv e. See Go la nt y v. Co m m is si on er, 7 2 T.C. at 4 27 ; Ni ss le y

v. Co m m is si on er, T.C. Mem o. 2 00 0- 17 8. Th is fact or weig hs ag ai ns t p et it io ne rs .- 19 -

G. Peti ti on ers ’ Fi nanc ia l St atus The factth atth e ta xp ay er d oe s n otha ve subs ta nt ia l i nc om e o r cap it al fro m so ur ces ot he r th anth e act iv ity m ay in di cat e th atanact iv ity

is en ga ge d i n fo r pr of it . Sec. 1 .18 3- 2( b) (8 ), In co m e Tax Reg s. Subs ta nt ia l i nc om e fro m so ur ces ot he r th anth e act iv ity , parti cu la rly if th e lo ss es fro m th e act iv ity

ge ne rat e subs ta nt ia l t ax be ne fit s, m ay in di cat e th atth e act iv ity

is no t en ga ge d i n fo r pr of it
. Id
. Dr. Mi kh ai l i s a s uc ces sf ul ph y si ci an , andhi s wag es are the pri m ary so ur ce of pe ti ti on ers ’ in co m e. Duri ng 20 07 , th e fi na l year of h is res id en cy , he e arn ed wag es of $ 64 ,09 7. Du rin g 2 00 8, 2 00 9, 2 01 0, an d 2 01 1 h is wage s i nc reas edto $1 45 ,23 5, $ 15 7,6 21 , $1 65 ,14 6, an d $ 16 8,6 27 res pe ct iv el y . The l os se s tha t pe ti ti on ers ha ve cla im edfro m th e Am way act iv ity serve d t o o ffs etsubs ta nt ia l
am ou nt s o f Dr. Mi kh ai l’s wag es , dec reas in g p et it io ne rs ’ ta xabl e in co m e an d ach ie vi ng subs ta nt ia l t ax sav in gs . This fact orweig hs ag ai ns t p et it io ne rs . H. Elem en ts of P ers on al Ple as ur e o r Rec reat io n The pre se nc e o f pe rs on al m ot iv es incarry in g o n an a ct iv ity m ay in di cat e th atth e act iv ity

is no t en ga ge d i n fo r pr of it , esp eci al ly whe re the re ar e el em en ts of
recr eat io n o r pe rs on al pl eas ur e. Sec. 1 .18 3- 2( b) (9 ), In co m e Tax Reg s.- 20 -

W e h av e p rev io us ly obs erv edth at“ th ere are s ig ni fic an t el em en ts of pe rs on al pl eas ur e at ta ch edto th e act iv it ie s o f anAm way di st rib ut or sh ip ” an d t ha t

“ ‘an Am way di strib ut or sh ip pre se nt s t ax pa y ers with o pp ortu ni ti es to ge ne rat e bu si ne ss de du ct io ns for

ess en ti al ly pers on al ex pe nd itur es ’” Cam pb el l v
. Co m m is si on er, T.C. Mem o. 2 01 1- 42 (qu ot in g B ren na n v . Comm is si on er, T.C. Mem o. 1 99 7- 60 ). The reco rdsh ows th atpe ti ti on ers us edth ei r Am way di st rib ut or sh ip as a m ean s t o g en erat e d educ ti on s fo r es se nt ia ll y pe rs on al expe nd itur es an d t o e njo y di sc ou nt s o n i te m s the y

pu rch as edforpe rs on al co ns um pt io n. Th e av ai labi li ty of
co ns um er p ro du ctdi sc ou nt s fo r pe rs on al us e m erch an di se is a fact or supp orti ng th e co nc lu si on th atpe ti ti on ers lac ke d apro fitob jecti ve . See Ca m

pb el l v
. Co m m is si on er, T.C. Mem o. 2 01 1- 42 ; Ni ss le y v. Co m m is si on er, T.C. Mem o. 20 00 -1 78 ; Og de n v . Comm is si on er, T.C. Mem o. 1 99 9- 39 7. W e al so no te th atpe ti ti on ers (1) tra ve le d t og ethe r to att en d Amway se m in ars an d c on fere nc es inva rio us cit ie s, (2 ) to oktri ps to New Yorkan d Tex as to di sc us s Am

way with fa mil y

an d fr ie nd s, an d (3 ) ho st edm eet in gs th atha d a
so ci al co m

po ne nt . All thi ng s co ns id ered , we con cl ud e th atpe ti ti on ers de riv ed pe rs on al be ne fit s an d p le as ur e fro m th e Am way act iv ity . This fact orweig hs ag ai ns t p et it io ne rs .- 21 -

I. Co nc lu si on Co ns id eri ng all th e fac ts an d c irc um st an ces , we ho ldth atpe ti ti on ers di d n ot co nduc t the Am

way act iv ity ina bu si ne ss li ke m an ne r an d re sp on de ntha s de m on st rat edby a prep on de ran ce o f th e ev id en ce tha t the y di d n oten ga ge inth e act iv ity with t he requi si te pro fitob jecti ve du rin g t he tax ab le y ear 2 00 9. Co ns eque nt ly, we su st ai n re sp on de nt ’s ass ert io n, s etforthinhi s amendm en t t o an swe r, th atpe ti ti on ers are n oten ti tl edto a de du ct io n fo r th e n etlo ss of $ 39 ,91 9 th atth ey rep orte d o n S ch edul e C i n re sp ectof t he Am way act iv ity for20 09
. II. Accu racy-Rel at edPen al ty Sect io n 6 66 2( a) an d (b )(1 ) an d (2 ) im po se s a p en al ty equ al to 20 % of t he
am ou ntof a ny un de rp aym en t o f ta x t ha t i s at tri bu tabl e to : (1 ) ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns or ( 2) an y subs ta nt ia l u nd ers ta te m en t o f in co m e ta x. Th e te rm

“ ne gl ig en ce” i nc lu de s an y fai lure t o m ak e a rea so nabl e at te m ptto co m pl y with t ax laws , and“ di sr eg ard ” in cl ud es an y care le ss , reck le ss , or in te nt io na l d is reg ardof rul es or r eg ul at io ns . Sec. 6 66 2( c). An u nd ers ta te m en t
m ean s the ex ces s o f th e am ou ntof t he tax requi redto be sh own onth e return o ve r th e am ou ntof t he tax im

po se d wh ic h i s s ho wn o n t he return, re du cedby any reb at e. Sec. 6 66 2( d) (2 )(A). An u nd ers ta te m en t i s s ub st an ti al inth e cas e o f an in di vi du al if the am ou ntof the un de rs ta te m en t fo r th e ta xabl e y ear e xc eed s the- 22 -

gr eat er o f 10 % of t he tax requi redto be sh own on th e return o r $5 ,00 0. Se c. 66 62 (d )(1 )(A). Sect io n 6 66 4( c)(1 ) pr ov id es anex cep ti onto th e im po si ti onof t he accu racyrel at edpe na lty

if the tax pa y er es tabl is he s tha t the re was reas on ab le cau se for , and th e ta xp ay er ac te d i n g oo d fa ith wi th res pe ctto , th e und erp aym en t. Sec . 1.6 66 4- 4( a), In co m e Tax Reg s. Th e d et erm in at io n o f whe th er the tax pa y er ac te d wi th
reas on ab le cau se an d i n g oo d fa ith i s m ad e o n acas e-b y -cas e b as is , tak in g i nt o acco un t the pe rti ne ntfact s an d c irc um st an ces . Sec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. Re li an ce o n atax pro fes si on al m ay de m on strat e th atth e ta xp ay er h ad
reas on ab le cau se an d a ct edingo odfai th wher e th e ta xp ay er es tabl is he s tha t (1 ) th e advi se r was a co m pe te ntpro fes si on al with s uf fic ie ntexpe rti se to jus ti fy th e ta xp ay er’s rel ianc e, (2 ) th e ta xp ay er p ro vi de d t he advi se r with n eces sa ry an d
accu rat e in fo rm at io n, an d (3 ) th e ta xp ay er ac tu al ly reli edingo odfai th on th e advi se r’s jud gm en t. 3 K Inv . Partne rs v. Co m m is si on er, 1 33 T.C. 11 2, 1 17 (20 09 ); DeCl een e v . Comm is si on er, 1 15 T.C. 45 7, 4 77 (20 00 ). W ith re sp ectto anin di vi du al tax pa y er’s l iabi li ty for an y pe na lty , sec ti on 74 91 (c) p la ces on th e Co m mis si on er the bu rd enof p ro du ct io n, the reb y requi rin g th e Co m m is si on er t o c om e fo rwardwith s uf fic ie ntev id en ce i nd ic at in g t ha t i t i s ap pr op ria te to im

po se th e p en al ty. Hig be e v . Comm is si on er, 1 16 T.C. at 4 46 -4 47
.- 23 -

Onc e th e Co m

m is si on er m eet s h is bu rd enof p ro du ct io n, the tax pa y er m us t co m e fo rwardwith p ers ua si ve ev id en ce tha t the Co m m is si on er’s d et erm in at io n i s in co rrec t. Id . at 4 47 ; s ee Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. at 1 15
. Res po nd en t h as di sc ha rg edhi s b ur de n o f pr oduc ti on un de r se ct io n 7 49 1( c) b y sh owi ng th atpe ti ti on ers ha d asubs ta nt ia l u nd ers tate m en t o f in co m e ta x fo r 20 09 withi n t he m ean in g o f se ct io n 6 66 2( d) (1 )(A). 5 Befo re fi li ng th ei r ta x re tu rnfor20 09 , pet it io ne rs ha d c la im edde du ct io ns in
res pe ctof l os se s at tri bu tabl e to th e Am way act iv ity forsev eral y ears witho ut ch al le ng e b y

th e In te rn al Rev enue Serv ic e. Pet it io ne rs m ai nt ai ne d re co rd s o f th ei r an nu al Am

way -rel at edex pe ns es an d, o n t hi s re co rd , we can no t s ay th atth os e reco rd s wer e in co m

pl et e, in accu rat e, orinan y way m is le ad in g. Pe ti ti on ers rel ie d
on Mr. Hie ns ta nd , a C.P.A., to pre pa re a co m pl et e an d c orrectreturn fo r th e y ear in is su e. Co ns id eri ng all th e fac ts an d c irc um st an ces , we con cl ud e th atth ere was reas on ab le cau se for , andpe ti ti on ers act edingo odfai th with re sp ectto , th e un de rp aym en t. Sec . 1.6 66 4- 4( a), In co m e Tax Reg s. Co ns eque nt ly, we ho ldth at pe ti ti on ers are n otli ab le foranaccu racy-rela te d p en al ty for 2 00 9. Res po nd en t o rig in al ly det erm in eda de fic ie nc y of $ 8,2 86 forth e y ear i n 5 is su e--a n am ou ntth atex ceed s 1 0% o f th e ta x re qu ire d t o b e sh own on th e return. The un de rs ta te m en t o f in co m e ta x a ttrib ut ab le to th e d is al lo wan ce o f a d educ ti on equa l t o p et it io ne rs ’ ne t l os s fr om th e Am way act iv ity for20 09 wil l ex ceedth e or ig in al de fic ie nc y

am ou nt .- 24 -

To re fle ctth e fo reg oi ng , Deci si on wil l b e en te red
un de r Ru le 15 5.