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ANOTHER WAY TO PAY FOR AMWAY

September 17, 2007

There's a lot of money in home-based businesses.

A lot of tax money, anyway.

The Treasury Inspector General For Tax Administration issued a report last week with some startling figures on how many taxpayers report improbable Schedule C "sole proprietorship" losses for amazing lengths of time. The report says 70,000 taxpayers with six-figure incomes reported Schedue C losses for four consecutive years (2002-2005) where the business expenses were at least five times revenues.

Another 30,000 taxpayers claimed schedule C losses for four straight years with no gross receipts at all, losing an average of $5,456 each over that period.

In real life, people smart enough to have $100,000 of income usually don't pour money down a rathole indefinitely. Where expenses dwarf revenues four consecutive years, real business owners usually take the hint that the business isn't a good idea.

This chart illustrates the report:

When losses like this continue for a long time, the IRS begins to assume that the business isn't really losing money; rather, the taxpayer is showing a loss by taking personal expenses as business expenses. Multi-Level marketing arrangements, like the former Amway, are notorious vehicles for this.

The tax law has a rule, Section 183, that disallows losses from activities not carried on for profit. Section 183 requires the IRS to look into the taxpayer's heart, to subjectively determine whether the business is really carried on for profit. The TIGTA report recommends instead a "bright line" rule for determining whether the activity is for profit, though it doesn't say what that rule should be.

Given the size of the problem TIGTA identifies - $2.8 billion in tax savings for "high income" taxpayers in 2005 alone -- it would seem like an attractive revenue-raiser for Congress. Considering that other taxpayers have to pick up the slack for these "business" losses of high-income taxpayers, it seems like an easy sell politically; still, with salesmen in every district, the MLM folks surely have some lobbying clout. We can expect legislation, but it's far from certain that Congress is capable of drawing a "bright line" that shuts down true "hobby losses" without clobbering legitimate businesses that happen to have a bad year or two.

The TaxProf has more.

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