Retail Industry ATG - Chapter 3: Examination Techniques for Specific
Industries (Direct Sellers)
Using Minnick v. Commissioner, T. C. Summary Opinion 2002-147, this section will briefly review how one court
evaluated each of the nine factors in deciding whether an activity was engaged in for profit. The taxpayer
operated a home-based direct selling business, but the principles involved are generic; that is, they apply in the
same way to any business.
Factor 1 (Manner in Which the Taxpayer Carries On the Activity) – The activities in Minnick were not conducted in
a sufficiently businesslike manner. Petitioners did not maintain their own business records other than notes of
meetings in a daily planner. Petitioners did not present evidence of any formal budgets, profit projections, or
break-even analyses that had been prepared in connection with their distributorship. (Factor favors government.)
Analysis: In addition, the trade or business must be carried on regularly and in a continuous manner to display
the intention of a going concern. This intent is noted through the business records, which should include:
* books and records
- indicating active management
* set reasonable goals
- continuous evaluation of these goals
- adjust business activities and expenditures based on actual goals
Each person maintains their own books and records in a manner appropriate to their business style. However, any
ongoing business needs books and records that give a picture of where the business is going, whether business
methods are profitable, and what changes should or can be made to brighten the picture, at least on a quarterly
basis. Some of the IRS’s concerns are:
* Not maintaining a separate business checking account
* Not maintaining a log tracking business miles driven
* Inability to determine success of business
* Customer/party files not maintained
* Continued expenditures in activities that show little or no profit potential (such as craft shows and exhibitions)
* Bartering transactions that are being done with parties, whether a book party or an in-home party
- Whenever an individual receives items with a fair market value of $600 or more in any one calendar year, they
are to be issued a Form 1099 for the full amount received. Since direct sellers operate their own business, they
are responsible for issuing this form to any host or hostess to whom it applies.
Factor 2 (The Expertise of the Taxpayer or His Advisors) – In Minnick, petitioners sought the advice of persons
who might be considered experts in their business activities. Petitioners attended various events conducted
regularly that they believed would provide the expertise necessary to make their distributorship profitable. (Factor
Analysis: A direct seller may not have prior sales training or expertise in direct selling, but that does not negate a
profit objective. The examiner should evaluate the direct seller’s willingness to learn the business and gain hands-
on experience. The more the direct seller knows about the business, the better prepared he is to sell the products
and represent them. For direct sellers, the most important source of useful business-building information will often
be other successful leaders in their business.
Factor 3 (Time and Effort Expended by the Taxpayer) – In Minnick, petitioners devoted approximately two nights
per week, and approximately two weekends per month, to the activity. This time was spent in delivering products
and in traveling to other individuals' homes for evening meetings as well as to monthly meetings and quarterly
"major functions." (Factor favors taxpayer.)
Analysis: The fact that a taxpayer carries on employment or more than one business at any given time is not
evidence of a lack of a profit motive. How the time is spent is more important than the amount of time spent on the
* Does the direct seller show that the use of their time clearly reflects efficiency and growth in their business, rather
than just plugging along and working at it haphazardly?
* Does the direct seller spend time evaluating whether a particular activity that shows very little profit potential
should be discarded and a more beneficial activity be picked up?
* Does the direct seller display a desire to recruit downliners, do they increase the number of sales or opportunity
presentations as time goes by, are they seeking out opportunities to make themselves more visible in the public
There should be several indicators of a desire to grow a business, rather than working at such a pace that the
activity may be considered a hobby rather than a true business.
Factor 4 (Expectation That Assets Would Appreciate in Value) – This factor is not relevant in Minnick. There were
no assets subject to significant appreciation.
Analysis: The fact that most direct sellers typically have few capital assets should not cause one to question the
legitimacy or viability of the business.
Factor 5 (Taxpayer’s Success in Other Activities) – In Minnick, no evidence was produced showing that either of
petitioners had ever engaged in similar activities, or that either had ever been involved with making other activities
profitable. (Factor favors government.)
Analysis: The fact that the taxpayer has engaged in similar activities in the past and converted them from
unprofitable to profitable enterprises may indicate that he/she is engaged in the present activity for profit, even
though it may not currently be profitable. The fact that the taxpayer has not been engaged in a similar activity in
the past does not negate a profit motive in the present activity.
Factor 6 (Taxpayer’s History of Income or Losses) and Factor 7 (Amount of Occasional Profit, If Any) - A profit
objective is strongly indicated where the taxpayer has experienced a series of profitable years. A series of losses
incurred during the startup stage of an activity does not necessarily indicate the lack of a profit objective, but it may
so indicate if the losses continue beyond the customary startup period and are not otherwise explainable as due to
customary business risks. In Minnick, the taxpayers sustained substantial losses in their distributorship activities
for at least six consecutive years, no profits were ever earned from the activity, and there was no indication that the
business would eventually become profitable. (Factors favor government.)
Analysis: For the Service it is no different for the direct sellers than it is for any other business out there. A direct
seller normally goes into business with the hope and intent that their endeavor will become profitable. If, after a
suitable start-up period, a business shows no profit or trend toward profitability, it is appropriate for the examiner to
evaluate the actions the business owner has taken to become profitable. The examiner should generally expect to
see evidence that the seller has adjusted their business in ways that are intended to increase sales, mitigate costs,
or both. This requires a very factually specific inquiry and should consider both the seller’s long and short range
plans and actions. While it should be rare to see a seller stay in business over a long period of time if they do not
demonstrate any trend towards profitability, an examiner must also consider the extent to which the seller’s early
period activities may constitute an investment in the business’ long-term viability. It should also be noted that the
presumption articulated in Section 183(d) does not stand for a finding that in the absence of the taxpayer realizing
at least three profitable years out of five, an activity is prima facie not-for-profit.
If the direct seller is audited in the first or second year after start-up, the direct seller can elect to postpone an IRS
determination as to whether the presumption under IRC Section 183(d) applies. The direct seller may file Form
5213, Election to Postpone Determination, if an activity has not been carried on for a 5-year period. How does this
benefit them? The IRS will generally postpone its determination of whether the activity is engaged in for profit and
will not restrict deductions during the 5-year period.
In order to take advantage of this election, the Form 5213 must be filed within 3 years after the due date of the
return for the first year of the activity, or, if earlier, within 60 days after the IRS issues a written notice proposing to
disallow deductions attributable to the activity. Filing the form automatically extends the period of limitations for tax
assessment on any year in the 5-year period until 2 years after the due date of the return for the last year of the
period. The period is extended only for deductions attributable to the activity and any deductions that are affected
by changes made to adjusted gross income.
Factor 8 (Financial Status of the Taxpayer) – In Minnick, petitioners' separate wage and salary income provided a
substantial source of income apart from the distributorship. (Factor favors government.)
Analysis: While it can be true that the absence of any other substantial source of income may strongly indicate a
taxpayer’s profit motive, the presence of income from other sources does not, by itself, negate a profit objective.
Factor 9 (Elements of Personal Pleasure or Recreation) - Profit need not be the only objective, and personal
motives may coexist with an actual and honest intent to derive a profit. In Minnick, the court found the significance
of personal motives difficult to gauge. On the one hand, petitioners expended a substantial amount of time in
activities, such as driving long distances that would appear to lack elements of pleasure or recreation. On the
other hand, much of petitioners' activities involved elements that were very personal in nature, such as frequently
visiting family members who were also involved in the same business. (Factor determined to be neutral.)
Analysis: The direct seller can enjoy his/her business and receive personal pleasure from it, but still be engaged
in it for profit. It should be considered whether any significant recreational or entertainment element was ordinary
and necessary to grow the business. (Is the direct seller engaged in the activity for personal pleasure or for the
building of a business that will create income? Is the direct seller engaged in the business because he or she likes
the product and all the amenities that go along with it?)
The direct sellers’ business requires meeting people and carrying on active social interaction– recruiting other
sellers and selling to ultimate individual purchasers. Normally, a prudent direct seller organizes various quasi-
social environments in which to market its products or connect with ‘prospects,’ which often involves family, friends,
and acquaintances. These business activities should not be discounted on their face if they can be shown to have
been appropriate and helpful in developing the business.
The weight of the factors will vary with the taxpayer and with the type of activity. In Minnick, the court placed great
weight on the manner in which the business was carried on (Factor 1) and the history of losses and lack of profits
(Factors 6 and 7) in determining that there was a lack of profit motive.
The type of business activity and the taxpayer will dictate which factors are more important in relation to each
other. With respect to direct sellers, Factors 1, 3, 6, and 8 are generally dominant, Factors 2, 5, and 9 less
important, and Factor 4 rarely will come into play. Factor 7 (amount of occasional profits) deserves special note
and applies in all situations.
Nine Factors and Analyses
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