Wednesday, July 16, 2008

Is Mary Kay Cosmetics A Hobby, Trade or Business?

Ladies, this is one that you need to take great heed from. Before you invest in all those Pampered Chef, cosmetic sales and even “pleasure toy” shows, you might want to talk with Brenda Konchar, a Mary Kay Cosmetics representative who took her case before the Tax Court in Ralph D. Konchar, et ux. V. Commissioner, Tax Court Summary Opinion 2004-59.

Brenda Konchar reported net losses on Schedule C for her Mary Kay activity in 1996, 1997, and 1998. The IRS disallowed the business losses, since the activity was not a trade or business entered into for profit. It was a hobby. Furthermore, even if the activity had been conducted with a profit motive, most of her business expenses could not be substantiated.

Under §183(b), if an activity is not engaged in for profit, expenses are generally only deductible to the extent of the gross income from the activity. The deductions that exceed gross income cannot create a business loss.

An activity is conducted for profit if deductions are allowable under

1. §162 as ordinary and necessary trade or business expenses; or
2. §212 as expenses for the production or collection of income.

Under either section, the taxpayer must intend to make a profit. Whether an activity is conducted with a profit motive is based upon all relevant facts and circumstances.

Under §1.183-2(b), the Courts consider nine nonexclusive factors to determine whether an activity is engaged in for profit:

1. The manner in which the taxpayer carried on the activity.
2. The expertise of the taxpayer or his advisors.
3. The time and effort expended by the taxpayer in carrying on the activity.
4. The expectation that the 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 that are earned.
8. The financial status of the taxpayer.
9. Whether elements of personal pleasure or recreation are involved.

The Court determined that Brenda Konchar did not intend to make a profit in her Mary Kay activity based upon the following factors:

1. She did not conduct the activity as a business. She did not maintain a separate checking account or any business cards.
2. In general, her returns and allowances plus cost of goods sold exceeded her gross receipts, which indicate that she was selling her products at or near cost.
3. She had an element of personal pleasure in the activity, since most of her customers were family and friends. She took huge business mileage deductions for long distance travel to visit these customers for business and personal reasons.
4. She had no experience in operating her own business, and she did not seek any professional advice.
5. She had large losses each year and no possibility of ever recovering those losses. She never developed a plan to improve her profitability.

The Court concluded and ruled that Brenda did not have an honest objective to make a profit. She conducted her Mary Kay activity as a hobby. As a result, her business deductions were limited to the gross income from the activity. No business losses were allowed.

1 comment:

peter said...

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