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AMWAY AND TAXES

July 30, 2004

The Tax Court this week provided another illustrations of the tax hazards of the Amway business. The court disallowed a host of travel and other deductions for an Illinois Amway distributor under the so-called "hobby loss" rules, on the grounds that the distributorship wasn't entered into for profit.

Amway distributors sell household items out of their homes. (Amway is now called "Alticor".) The court described the Amway system:

   An Amway distributor earns income by 
   selling products and recruiting new 
   downline distributors. Under Amway's 
   compensation system, a distributor earns a 
   "performance bonus" based not only on 
   the sales volume generated by the 
   distributor himself but also on the sales 
   volume generated by the distributor's 
   downline network.  Generally, distributors 
   earning large performance bonuses have 
   developed a large and broad network of 
   downline distributors.

Many Amway distributors have ended up crossways with the IRS. A quick search of a tax law database shows over 40 cases where Amway distributors have lost court fights with the IRS. The earnings pattern in the Illinois case illustrates why the IRS gets into disputes with some distributors:

   Year       Income             Expenses      Net Losses
    1996         $10            ($ 1,625)       ($ 1,615)
    1997         357             (13,177)        (12,820)
    1998         625             (17,504)        (16,879)
    1999       1,450             (17,384)        (15,934)
    2000       3,235             (23,001)        (19,766)
                _____             _______       _______ 
    Total       5,677             (72,691)       (67,014)

The consistent pattern of taxpayer defeats in Amway cases has even led one commentator to question whether Amway losses will ever clear the "hobby loss" hurdle. He cites three problems that Amway distributors have in court: "a sustained series of losses; the use of Amway losses to offset other income; and a failure to conduct the distributorship in a businesslike manner."

While such a sweeping conclusion may not be warranted, taxpayers with loss patterns like this can expect IRS trouble - especially when much of the income is from sales to themselves and the expenses are primarily travel-related. Such patterns make courts suspicious:

   Petitioners repeatedly used their Amway 
   activity as an attempt to mask obviously 
   personal expenses as deductible business 
   expenses. In effect they attempted to live a 
   deductible lifestyle. The conferences at 
   times of the year associated with vacation 
   and recreation are consistent with this 
   same mindset. Most importantly, petitioners 
   reported no significant revenue from their 
   Amway activity and no reason for them to 
   believe they ever were going to have 
   significant revenue from this activity.

The moral? If you sell Amway, your profits will need to be from the business, not from the IRS.

Cite: Ollett v. Commissioner, T.C. Summ. Op. 2004-103

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