The Real Tax rules for Amway IBOs

The following was published in the manual for the "Executive Planners" tax preparation service, which is marketed by Bill Britt to distributors in his organization. It clearly states that many of the potential deductions touted by Amway distributors are, in fact, not allowed by the IRS. Notice also that the IRS does not consider an Amway distributorship to be a legitimate business unless a substantial emphasis is placed on selling product...the exact opposite of what "The System" teaches. See Tax Court cases.

 

IRS POSITION LETTER

 

The Amway business has the appearance of a personal service business. Personal expenses are disguised as business deductions. The examiner may not be aware that he/she has an Amway return until the taxpayer and/or representative is sitting across from him/her. Therefore, it is necessary that the examiner be alert to possible deceptions.

 

AREAS OF DEVELOPMENT

Sections 162,183, 262, 274, and 280A of the lnternal Revenue Code should be considered when examining an Amway return. Section 162 allows ordinary and necessary expenses paid or incurred to carry on any trade or business. The examiner should infer the word "reasonable" when considering "ordinary and necessary."

 

Section 183 addresses activities not engaged in for a profit. Deductions of these activities are limited to the gross income derived from the activity and ordinary and necessary (and reasonable) expenses in accordance with section 162 and section 212.

Section 252 specifically disallows personal expenses.

Section 280A addresses office in home limitations.

Section 274 specifies substantiation requirements.

Three court cases upholding Section 183 for Amway returns are (1) Ranson v Commissioner (2) Elliot v Commissioner, and (3) Rubin v Commissioner. These cases all involved selling Amway products at retail. Taxpayers may have the potential to make a profit provided they conduct the activity in a business like manner and do not deduct unnecessary trips and personal expenses. As can be seen in the above-mentioned cases, the taxpayers did not conduct the activity in a business-like manner and deducted personal expenses. These cases may be helpful in developing the Section 183 issue.

 

DEVELOPMENT OF THE AMWAY CASE

Business history should be developed and documented in the examiner's workpapers. (See Figure RS 3-1 from Unit III Tax Auditor Distributorships Workshop for examples of questions to ask.) If Section 183 is indicated, the examiner should obtain copies of the prior year Schedule C's from the inception of the activity. These should be summarized by (1) sales (retail and wholesale should be differentiated), (2) Cost of sales, (3) Commissions from PV bonuses, (4) gross profit, (5} travel and entertainment (including separately stated items), (6) auto expense and ACRS/MACRS, (7) commissions paid out, (8) total expenses, and (9) net profit or loss. Also, primary sources of income should be scheduled (wages and/or primary Schedule C, Etc.), to illustrate the offsetting of income by personal expenses. Each of the nine factors of Section 183 should be developed.

 

GROSS INCOME should include gross receipts less cost of goods sold and net bonuses (bonuses received less bonuses paid). Cost of Goods Sold should be reduced by personal use items. If a taxpayer has purchased enough personal items to qualify for a discount, then the purchase discount on personal items should be removed from income for any given month to which the "bonus" would apply: Some taxpayers may include personal items purchased in gross receipts and cost of goods sold to give the appearance of more business activity than actually exists. This distortion is for the purpose of making expenses appear more reasonable.

 

TRAVEL AND ENTERTAINMENT have always been areas of abuse. Sections 162, 262, and 274 are always applicable and sometimes Section 183. Since most of the travel is primarily to attend social gatherings for entertainment and motivational purposes, any real business purpose is suspect. Unless the taxpayer can show that attending seminars, meetings, etc., meets the requirement of Section 162, the travel should be disallowed. Amway people have been unable to show that attending these meetings increased their sales. The agendas of these meetings appear to be primarily for entertainment, socializing, and listening to motivational speeches. The meetings have nothing to do with promoting the sale of Amway products to the general public. In fact, Amway distributors are specifically warned against mentioning either Amway or selling when recruiting potential downline people. Since it is not likely that the taxpayer will increase his sales by attending these functions, then there is not a reasonable business purpose for the trips.

Amway people frequently deduct MEALS AND GIFTS to friends and relatives as business expense. There is little justification for entertaining one's downline or potential downlines. This is one area where documentation is lacking. In some cases the entertainment is reciprocal. Most people entertain their friends and relatives; therefore, this is not an ordinary and necessary expense. Gifts are frequently disguised as "advertising" or "promotions." The examiner should be alert to these ploys. Amway people frequently deduct their own meals when attending local meetings with other Amway people. {See RIA L-5805, the "butter" rule). Local meals are not allowable.

 

CAR EXPENSE is another area of abuse. Occasionally, the taxpayer will deduct commuting expense to his primary job claiming that he is going to a second job since his Amway business is located in the house; however, this is rarely seen anymore. An Amway distributor usually picks up the products from the upline once a week. Once a certain volume of purchase is reached, the distributor may purchase products directly from the company.

Transportation expense, related to picking up the product, should be minimal. If the vast majority of purchases are for personal use, then the car expense should also be personal. The taxpayer may incur car expense recruiting other downlines, but care should be taken to determine if the primary purpose is to visit friends or relatives. If the taxpayer is selling retail, he may have to deliver the products. The examiner should be alert to the taxpayer writing off trips to visit friends or relatives in distant cities and claiming the purpose of the trip was to deliver products or recruit. The taxpayer may also deduct vacation trips. It appears that Amway distributors think that they only have to mention Amway to make any visit, trip, etc. a deductible business expense.

 

When examining GIFTS (under whatever name the taxpayer uses), Section 162, 262, and 274 should be considered. Most gifts are for close friends or family members and are personal in most cases.

 

ADVERTISING often includes gifts to friends and relatives. Any demonstration of Amway products would have a minimal cost to the distributor and should be well documented as to when, where, why, and who. The demo products should be kept separate. Using a small sample of a product for demonstration and then using the rest for personal use is a personal expense.

 

TELEPHONE EXPENSE is an area of abuse. Taxpayers frequently write off long distance calls to friends and relatives claiming they were trying to sign up downlines or sell product. Many taxpayers try to write off their entire phone bill.

 

OFFICE IN THE HOME limitation should always be considered. In most cases, use of the home is not allowed because of the loss. The examiner should be aware that expenses might be disguised to avoid the limitation.

 

TAPES, TOOLS, ETC. are a few of the categories used to write off motivational tapes and books. Most of the tapes do not have anything to do with selling Amway products. Unless the taxpayer can furnish specific information showing the tapes or books are for the purpose of promoting and selling the products, they should not be allowed as a business deduction. The taxpayer should have a list of all tapes, books, etc. used as an expense on his/her return. As with all Amway products deducted as an expense, the examiner should verify these items have been removed from purchases in the Cost of Goods Sold. It is not unusual to find these items deducted in both places. (See Exhibit B for list of tapes and books.)

 

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