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.
In May of 1996, Brenda Konchar joined Mary Kay Cosmetics as an "Independent Beauty Consultant". Before 1996, her sister was a Mary Kay consultant. When Brenda became a consultant in 1996, she took over 12 of her sister's customers consisting of family members and friends.
During the subject years, three of Brenda's customers lived in Pennsylvania, two lived in Florida, and seven lived in Texas. In addition, all of her extended family live in those three States, including her parents, who live in San Antonio, Texas.
The Konchars owned a Dodge Caravan that Brenda 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. She did not produce any log for 1997 or 1998, nor did she provide substantiation for Schedule C expenses in those years. She did not maintain a separate checking account for her Mary Kay activity for any year.
Brenda 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 she 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 her 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.
Brenda admits that she 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.
The IRS determined that Brenda 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.
Because Brenda failed to meet the requirements of section 7491(a)(2), the burden of proof does not shift to the IRS in this case.
If an activity engaged in by an individual is not entered into for profit, no deduction attributable to the activity shall be allowed, except as otherwise provided in section 183(b).
Deductions are allowed for the ordinary and necessary expenses of carrying on an activity that constitutes the taxpayer's trade or business. Deductions are also allowed 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. However, the taxpayer must demonstrate a profit objective for the activity in order to deduct associated expenses.
Whether the required profit objective exists is to be determined on the basis of all the facts and circumstances of each case.
While a reasonable expectation of profit is not required, the taxpayer's objective of making a profit must be bona fide. In making this factual determination, the Court gives greater weight to objective factors than to a taxpayer's mere statement of her intent.
There are nine nonexclusive factors that are to be considered in determining whether a taxpayer is engaged in a venture with a profit objective. They include: # the manner in which the taxpayer carried on the activity # the expertise of the taxpayer or her advisers # the time and effort expended by the taxpayer in carrying on the activity # the expectation that the assets used in the activity may appreciate in value # the success of the taxpayer in carrying on other similar or dissimilar activities # the taxpayer's history of income or loss with respect to the activity # the amount of occasional profits that are earned # the financial status of the taxpayer # 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.
After considering all the factors, we agree with the IRS that Brenda did not have an actual and honest objective of making a profit from her Mary Kay activity.
Brenda did not carry on the activity in a businesslike manner. 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 tax years at issue, an indication that the activity was not conducted with a profit objective. When questioned at trial about this fact, she could not explain it. Brenda did not seem to understand that it suggests here that she was selling her products at or near cost.
Brenda's Mary Kay activity had a substantial component of personal pleasure. Her 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. There is no evidence in the record of petitioner's prior experience operating her own business. Brenda 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. Although she 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. Brenda'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 ... [and] is not entitled to claim any deductions [in excess of her profits].
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