Good blog post by Peter J. Reilly
Somebody Somewhere Has To Be Buying Some Soap
There was also an Amway case. Amway is a major corporation that sells a variety of household products. Originally it was mainly soap. Their story is that their stuff is more expensive, but since it is more concentrated you don’t have to use as much of it. What they are better known for is their “multi-level” marketing system. If an Amway distributor invites you to a party to discuss something, he will not try to sell you soap. He will want to recruit you as a distributor. He will focus not so much on you selling the soap (I’m using the term as a shorthand for the broad range of Amway household products). He will focus on the opportunity you have to recruit other people who will become your “downline”. At one step removed, they are also part of his downline. In Amway terms, you are an “Independent Business Owner”. Somewhere in the chain above you (“upline”) there will be someone who has achieved Diamond status, which is your ultimate goal. Then you can just sit back and see how the money rolls in.
My short mention of the Amway case was picked up by another blog. This revealed to me that there is actually a small section of the blogosphere dedicated to criticizing the Amway system. My favorite is Married to An Ambot by a lady who is telling her story of what it is like to be married to an “Amway cult follower”. I was inspired to do a comprehensive study of how Amway IBO’s have fared in “hobby loss” cases. I found 23 cases going back as far as 1986 (There were some appeals, but I only counted the original case). It’s not an enormous number but it is enough for a Tax Court judge to have observed:
The Amway distributorship system is well known to respondent (i.e. IRS)and this Court
A brief summary of what the critics have to say about Amway is that very few people make money at it. Those that do may well exagerate their earnings to impress and motivate their “downline”. The relationship between the upline and downline has elements of cult like behavior. Most of the “soap” is bought by the IBO’s themselves. Those in the upline who are making a lot of money are making most of it from selling “tools” (motivational tapes and the like) to the downline. I don’t know whether this is all true or not, but the Amway hobby loss cases tend to support it. They almost all lost. Probably the most pervasive theme was that the IBO’s never seemed to try to control expenses and that they only sought advice from their upline, who were of course not going to give disinterested advice. I was able to draw a pretty clear lesson from the material.
If you would like to start a small home business so that you can deduct a lot of money that you would spend anyway, don’t do it. I didn’t need to study the cases to tell you that, of course. The study of the cases tells me that if you are going to not follow that good advice and are going to start a business so you can deduct a lot of personal expenses, the last thing you want to pick is becoming an Amway IBO.
The most ironic thing to me about hobby loss cases is that the Tax Court ends up sounding like a good managing partner bringing some business discipline into a public accounting firm. Most of us like the work and like our clients and staff and need somebody to remind us to keep money coming in the door.
Just for reference here are the factors:
(1) The manner in which the taxpayer carries on the activity;
(2) the expertise of the taxpayer in carrying on the activity;
(3) the time and effort expended by the taxpayer in carrying on the activity;
(4) the expectation that assets used in the activity may appreciate in value;
(5) the success of the taxpayer in carrying on other similar or dissimilar activities;
(6) the taxpayer’s history of income or loss with respect to the activity;
(7) the amount of occasional profits, if any, which are earned by the taxpayer;
(8) the financial status of the taxpayer;
(9) elements of personal pleasure or recreation.