One of the "advantages" of opening your own business, MLM proponents touted, was that you can deduct a lot expenses as cost of doing business. But can you really?
In terms related to MLM, can you deduct the trips (tickets, hotels, travel expenses, etc.) to attend meetings all over the country?
Under rules in the Federal Tax Code, Section 162 provides that a taxpayer who is carrying on a trade or business may deduct ordinary and necessary expenses incurred in connection with the operation of the business. The taxpayer has the burden of proving entitlement to a business expense deduction. The deductibility of their MLM expenses depended on whether their activity was engaged in for profit.
To determine whether an activity is engaged in for profit, Section 183 provides a list of factors for the court to consider: (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 losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation.
This brings us to the case of the Olletts in 2004. They joined Amway in 1996. They kept their day jobs and made about $100K in 1999 and 2000 respectively, and claimed Amway expenses of $17500 in 1999 and $23000 in 2000, both year with losses (-1450 in 1999 and -3235 in 2000). IRS denied their deductions and it went into tax court, where they were ruled against (i.e. deductions are disallowed) in 2004. Do you know why? The hints are listed above, but let's be specific...
So why were Olletts denied their deduction of tens of thousand yearly? Here's a few facts
1) After YEARS in Amway (1996-2000), Olletts only have 5 downlines, average of ONE downline a year.
2) Olletts admit 70-75% of the alleged sales they made were consumed by themselves.
3) Olletts claimed over $15000 tax deduction as "business travel" to attend training seminars hosted by their parent upline organization, and even purchased a Cadillac ($6000 deduction) as they prefer to drive rather than fly. And they went all over the country on those trainings as well as trips that yielded no results (i.e. no one recruited), where their training had not resulted in more recruitment or sales.
4) At least two trips were to Illinois were Olletts daughter was attending college... and one trip was to where their parents lived, though all were deducted as business trips. When questioned, Olletts claimed they brought their promotional material along and did tried to talk to a few people on the way.
5) There were almost $1500 purchase of training material like books, CDs, training manuals, and whatnot. Olletts have no explanation on why they needed training in their FOURTH year in business, with no appreciable improvement in any sort of metrics, and unlikely to improve in any time in foreseeable future.
The tax court ruled against the Olletts, that they had repeatedly misrepresented personal expenses as deductible business expenses, have no expected profit, and thus, not only were the deductions improper, Olletts are not even eligible to deduct the losses suffered from Amway from their REGULAR employment income.
So where does that leave you, the MLM participant?
A) IRS is watching for excessive and illegal deductions, such as "training trips"
B) If you didn't make profit for years, IRS may pay special attention to you
Now you may say, this may be a special case? Nope, Tax Court is well aware of people trying to join MLM and use it to hide expenses as deductible costs. Here's a few more Tax Court rulings, involving primarily Amway, but can be ANY MLM:
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.
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.
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.
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.
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
There are dozens more cases like this, dating back 20 years, and yes, one of those was an IRS agent.
Beware when you tried to "deduct" cost of MLM as losses. It may trigger an audit and if your expenses were disallowed, you may lose a LOT more than you expect.
The rest of you may want to consider... If MLM was used as a LOSS to hide regular income, is MLM really as profitable as people claimed it to be?