Originally published on Forbes.com.
I was surprised to see that I haven’t written about an Amway case in over two years. Well, a new one came out this week and James E. Hess, like pretty much every taxpayer who has ever disputed disallowance of Amway losses in Tax Court, lost. Amway cases are a subset of Section 183 (commonly known as hobby loss) cases.
The rule is that in order to post losses to your tax return, the underlying activity has to be one in which you were trying to make money. I have written about quite a variety of activities where the taxpayer has contested an IRS hobby loss determination- musicians, artists, drag racers, players of slot machines, even blogging to name a few. The most common though are horses and Amway. The horse people frequently win, but the Amway people pretty much always lose.
A Bit About Amway
The Hess decision is of interest because it has more in the way of discussion of the Amway IBO (Independent Business Owner) experience. There is the big picture of how you can make money in Amway.
Amway distributors can generate revenue by: (1) selling products directly to consumers; (2) earning points through Amway’s reward point system; and (3) sponsoring other individuals who join Amway as distributors. In the latter case, the original distributor is called an “upline” distributor, or a sponsor, in relation to his new recruit, the “downline” distributor. The upline distributor receives points when any member of his downline sells Amway products even though he does not participate in the sale. Those points can then be redeemed for cash in the form of a bonus check. If a downline distributor engages another individual to be his downline distributor, the original upline distributor takes a percentage of the sales of both downline distributors even though he had nothing to do with the activities of the new downline distributor. Thus, to maximize Amway-related income, a distributor must sell Amway products and also try to enlist other individuals as Amway distributors.
And then there is what you might call the Amway culture.
Petitioners attended Amway training functions organized by Worldwide Group, LLC (Worldwide Group). Worldwide Group is operated by several Amway distributors specifically to coordinate training and motivational seminars for other Amway distributors. Mr. Hess testified that the meetings provided petitioners with training that was necessary for them to start, and eventually grow, their Amway business. Each year petitioners attended each of Amway’s quarterly meetings, and they also attended local monthly meetings.
The Missing Business Plan
The Tax Court denied the losses because Mr. Hess did not have any sort of a business plan. What he received from Worldwide Group “did not contain information that is generally found in a formal business plan”. It was more of a description of how revenue could grow.
It is interesting to note that the Tax Court has become a little more relaxed in calling for formal business plans in Section 183 cases recognizing that people in essentially crap shoot businesses like art and horse breeding don’t need accountants to tell them how to make money. Yet it seems to be holding the line when it comes to Amway.
Mr. Hess reported net losses from 2005 to 2011 ranging from $10,000 to $25,000. In only one year did revenue exceed $1,500. Nothing changed.
Despite generating losses from their Amway activity year after year, petitioners operated the activity in the same manner regardless of the prior year’s results and did not seek advice from anyone other than their sponsoring distributors.
Tax Court Seems To Align With The Critics
What I found most intriguing about this decision, is that way that it mirrors critiques of the Amway experience, which seem to have their own section of the blogosphere. For example Joecool of Amway – The Dream Or The Scheme? recently wrote in a post called Amway Success?
Submission to upline was one of the things we were told. Our group was told that upline would never purposely lead us astray so we should trust them and never try anything without checking upline.
Our group was taught to reduce debt, but ironically, upline said it was okay to go deeper in debt if it was to attend a function or to buy more cds.
Anytime we asked about how much income uplines may have been earning, we were either told it’s none of our business or shown a photocopy of a 10 year old bonus check that someone upline may have received. Our proof that the business worked was upline showing off pictures of sports cars and mansions.
Losing money is success. Many times, our group was told that losing money was a sign of success. It was success because we were investing in our futures. That the business really is not about money but about friendships. I suppose upline taught this because everyone was losing money so it was nice to hear that success was around the corner, and that we were all nicer people and on our way to success if we just attended more functions and bought more standing orders.
You might also want to check out Married To An Ambot.
I have made a commitment to remain agnostic on the great profit potential of becoming an Amway IBO, but I do have to say that the record of Amway IBOs who have lost in Tax Court tends to support the critiques of the system.
The case law is probably the tip of the iceberg of a much larger number of audits. On the other hand, the audits are a very small sample of the people who have participated in Amway and any that posted consistent profits would not have been challenged on loss deductions. So I remain agnostic.
Other Coverage
Joe Kristan seems to share my love of Amway cases. He treated this one at some length noting how Mr. Hess’s credibility was hurt by his failure to remember who he had sponsored.
Most entrepreneurs remember their customers better than that, especially when they have so few.
He concludes:
The Moral? Perhaps you really can make money in multi-level marketing work. If so, you need to do so by means other than improving your tax return.