T.C. Memo. 2021-107
UNITED STATES TAX COURT
GAYLE GASTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25899-17. Filed September 2, 2021.
Joseph A. Broyles, for petitioner.
Michael K. Park, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: Respondent determined income tax deficiencies of
$59,872 and $57,717 for petitioner’s tax years 2013 and 2014, respectively, and an
addition to tax under section 6651(a)(2) and a penalty under section 6662 for each
Served 09/02/21 -2-
[*2] year.1 After concessions,2 the issues for decision are: (1) whether petitioner
engaged in acting as a trade or business in the tax years at issue and, if so, whether
petitioner is entitled to deduct any reported expenses relating to that trade or
business, (2) whether petitioner engaged in jewelry sales as a trade or business in
the tax years at issue and, if so, whether petitioner is entitled to deduct any claimed
flowthrough losses relating to that trade or business, and (3) whether petitioner is
entitled to deduct contributions to an alleged qualified profit-sharing plan for the
tax years at issue.
FINDINGS OF FACT
Petitioner is a former national sales director for the Mary Kay, Inc (Mary
Kay). She began working for Mary Kay in 1967 and reached the position of
national sales director (NSD) in 1974. As an NSD, petitioner was entitled to
participate in Mary Kay’s deferred compensation program known as the Family
1 All section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. Some monetary amounts have been rounded to the nearest dollar. 2 Respondent has conceded the sec. 6651(a)(2) additions to tax and that he cannot meet his burden of production under sec. 6751(b) with regard to the sec. 6662 penalties. Petitioner has conceded that she is not entitled to deductions claimed on Schedule C, Profit or Loss From Business, for business use of her home or for any deduction to which the sec. 274(d) strict substantiation requirements apply. -3-
[*3] Security Program (FSP), which she joined in September 1991. The FSP
imposed a mandatory retirement age of 65 and provided that, upon her retirement,
petitioner would be paid a monthly distribution scaled to a percentage of the
average of her three highest commission years during the five years before
retirement.3
In 2008, two years before she reached the mandatory retirement age,
petitioner established the Gayle Gaston Sole Proprietor Profit Sharing Plan (plan).
The plan was drafted by Dennis Mehringer and defined the term “plan sponsor” to
mean “Gayle Gaston”. The plan does not identify a specific line of business to
which the plan relates, and Mr. Mehringer testified that the plan was not created
with respect to any particular trade or business of petitioner. The plan went into
effect on January 1, 2008, for “Gayle Gaston, a California Sole Proprietorship (the
‘Plan Sponsor’)”.
In 2010 petitioner retired from Mary Kay, having reached the FSP’s
mandatory retirement age. In her career with Mary Kay petitioner was highly
successful; accordingly, her annual distributions under the FSP were $518,779 and
$513,284 for 2013 and 2014, respectively.
3 For more details on the operation of the FSP, which are not determinative of this case, see Peterson v. Commissioner, 827 F.3d 968, 970-980 (11th Cir. 2016), aff’g in part, dismissing in part T.C. Memo. 2013-271. -4-
[*4] After her retirement from Mary Kay, petitioner took up a number of non-
Mary Kay activities. First, through a wholly owned S corporation, Gayle Gaston,
Inc., petitioner began to sell jewelry to her former Mary Kay associates. This
activity remained small, with petitioner devoting little more than 10 hours per
week to its progress. After the Mary Kay organization prohibited former national
sales directors from selling to the Mary Kay cosmetics sales force, petitioner
attempted to sell her jewelry to the general public but spent very little time or effort
doing so, and she ceased her jewelry sales activity shortly thereafter. Petitioner’s
jewelry sales activity generated losses in each year at issue. Second, petitioner also
explored whether she could begin a hair care products venture that would
manufacture certain hair care products in Peru and then import them to the United
States for sale. Petitioner did not produce a product for sale, never moving beyond
the stage of designing her requirements for a future product. With the exception of
two trips in 2013 and 2014 to Lima, Peru, which also included personal leisure,
petitioner devoted only a few hours per week to this activity.4
4 Petitioner did not address her hair care activity in her opening brief; consequently, we deem petitioner to have waived any argument with respect to the activity. See Mendes v. Commissioner, 121 T.C. 308, 312-313 (2003). Moreover, even if the hair care activity were still at issue, the record regarding this activity is devoid of any credible evidence that the activity ever went beyond the preliminary planning stage or evolved into a business for profit. -5-
[*5] In addition to these two activities petitioner also decided to start acting.
Petitioner had a prior history in the entertainment business, having engaged in
some production activity in the 1980s. Petitioner also has family connections to
the entertainment industry: Her son was an actor in Japan and later a
cinematographer, and her daughter is (and was during the years at issue) one of the
most successful actresses in Hollywood.
To further her acting activity petitioner retained an assistant, Josline
Giragossian, who helped her identify casting opportunities and manage her
applications. Petitioner also engaged various casting services, retained an agent
and a business management company, secured professional headshots, advertised
her skills, and took acting and voice lessons. Petitioner devoted significant time to
this activity. Between the preparatory work, securing auditions, and acting in roles
she secured, petitioner personally spent at least 40 hours per week on her acting
activity. Petitioner worked hard at this activity, but she also enjoyed acting.
Although petitioner did not generate a profit from the acting activity in the years at
issue or in subsequent years, by 2011 she had secured her first film credit. In 2013
petitioner performed in at least one feature-length film. By 2019 petitioner had
secured at least 10 film credits and various other roles in commercials. -6-
[*6] Upon receiving her distributions from the FSP in 2013 and 2014, petitioner
contributed $51,000 from each year’s distribution to the retirement plan she had
established in 2008. On each of her 2013 and 2014 income tax returns, petitioner
reported the distribution from the FSP as income from a sole proprietorship on a
Schedule C and claimed a deduction for the contribution to her retirement plan.
On each Schedule C petitioner also claimed deductions for numerous expenses
relating to her acting activity. Additionally, in each year petitioner claimed
passthrough loss deductions from her S corporation on Schedules E, Supplemental
Income and Loss, which were generated by her jewelry sales activity.
Petitioner’s 2013 and 2014 returns were selected for examination. On
September 12, 2017, respondent issued a notice of deficiency that disallowed
petitioner’s claimed acting activity expense deductions, her claimed passthrough
loss deductions from her jewelry activity, and her claimed deductions for
retirement contributions and determined income tax deficiencies, additions to tax,
and penalties for petitioner’s tax years 2013 and 2014. On December 12, 2017,
petitioner, while residing in California, timely petitioned this Court for
redetermination of the deficiencies, additions to tax, and penalties. -7-
[*7] OPINION
I. Petitioner’s Acting Activity
Petitioner reported $83,041 and $98,818 in Schedule C expenses on her
2013 and 2014 returns, respectively. Petitioner contends that these expenses relate
to her acting career and are ordinary and necessary business expenses within the
meaning of section 162. Respondent disallowed deductions for these expenses on
the basis that petitioner cannot show that she engaged in her acting activity to make
a profit. Petitioner does not allege, nor has she proven, that the burden of proof
should shift to respondent pursuant to section 7491(a), and petitioner bears the
burden of proof as to all issues remaining in dispute. See Rule 142(a).
Whether a taxpayer may deduct an expense of an activity as an ordinary and
necessary business expense turns on whether: (1) the taxpayer can establish that
she engaged in the activity as a trade or business; i.e., the taxpayer engaged in the
activity with the “predominant, primary or principal objective” of making a profit,
Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), aff’g T.C. Memo. 1991-
212, and (2) the taxpayer can substantiate the reported expense as an ordinary and
necessary business expense, see sec. 183; Dreicer v. Commissioner, 78 T.C. 642,
645 (1982), aff’d without published opinion, 702 F.2d 1205 (D.C. Cir. 1983);
see also sec. 6001; sec. 1.6001-1(a), Income Tax Regs. Respondent has conceded -8-
[*8] that petitioner actually paid the reported expenses. We therefore must
determine only whether the expenses petitioner paid were ordinary and necessary
expenses of a business activity in which she engaged with the predominant,
primary, or principal objective of making a profit.
A. Petitioner Intended To Profit From Her Acting Activity.
In determining whether a taxpayer engaged in an activity with “the
predominant, primary or principal objective” of making a profit, we consider all
the facts and circumstances. See Wolf v. Commissioner, 4 F.3d at 713; see also
sec. 1.183-2(b), Income Tax Regs. We pay particular attention to the factors set
out in section 1.183-2(a) and (b), Income Tax Regs.: (1) the manner in which the
taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisors;
(3) the taxpayer’s time and effort expended in carrying on the activity; (4) the
expectation that assets used in the activity may appreciate in value; (5) the
taxpayer’s success in carrying on other similar or dissimilar activities; (6) the
taxpayer’s history of income or losses with respect to the activity; (7) the amount
of occasional profits, if any, which are earned; (8) the financial status of the
taxpayer; and (9) the presence of personal pleasure or recreation. No one factor is
controlling, and we consider the totality of the facts, giving greater weight to the
objective evidence than to the taxpayer’s statements of intent. Overall, however, -9-
[*9] the critical question is the presence or absence of the taxpayer’s intent to profit
from the activity, not necessarily the taxpayer’s actual success in that regard. An
objectively “reasonable expectation of profit is not required”. Dreicer v.
Commissioner, 78 T.C. at 645. We require only that the taxpayer engage in the
activity with the primary purpose of making a profit. Wolf v. Commissioner, 4
F.3d at 713.
Petitioner argues that she was engaged in the business of acting in
commercials and films. In support of her claim that she engaged in this activity for
profit, petitioner testified that she decided to take up acting to help supplement her
income after retiring from Mary Kay. Specifically, because her FSP payment
would be less than her compensation while actively working for Mary Kay, she
wanted to have an acting career to fill the gap between her pre- and post-retirement
income. Petitioner alleges that she approached the development of her career in a
businesslike way by retaining an assistant and a casting agency to help her identify
and apply for auditions for roles. Finally, petitioner asserts that, while she did not
generate significant revenue during the tax years at issue, in more recent years she
has secured several film roles on the basis of her early efforts to establish herself
during the years at issue. - 10 -
[*10] Acting is a difficult career, with a high risk of failure but a rare and lucrative
possibility of success. In our prior opinions discussing the profession we have
noted that the industry is “highly speculative”, “high risk”, and “arduous”. Green
v. Commissioner, T.C. Memo. 1989-599, 58 T.C.M. (CCH) 606, 608 (1989);
Isenberg v. Commissioner, T.C. Memo. 1987-269, 53 T.C.M. (CCH) 946, 955
(1987); Vandenhoff v. Commissioner, T.C. Memo. 1987-116, 53 T.C.M. (CCH)
271, 277 (1987). This industry often requires its participants to maintain a passion
for the work because, without such a passion, a taxpayer likely “would not
devote * * * [the necessary] time to its pursuit.” Green v. Commissioner, 58
T.C.M. (CCH) at 608. Accordingly, that an individual enjoys acting will not
foreclose a finding that the taxpayer also intended to profit from it. See id.
(“[S]uffering has never been made a prerequisite to deductibility.” (quoting
Jackson v. Commissioner, 59 T.C. 312, 317 (1972))). When analyzing whether
particular taxpayers have proven that they entered into acting activities with an
intent to profit, we have considered such industry-specific factors as whether they:
(1) belong to an acting network or union, (2) take classes or otherwise formally
develop their skills, (3) develop industry contacts, (4) seek or secure multiple
auditions or roles, (5) advertise their services, (6) prepare headshots or a portfolio,
(7) retain an agency or assistant to help secure roles, and (8) maintain their efforts - 11 -
[*11] over time, given the nature of the industry. See Richards v. Commissioner,
T.C. Memo. 1999-163, 77 T.C.M. (CCH) 2006, 2013 (1999); Green v.
Commissioner, 58 T.C.M. (CCH) at 608; Regan v. Commissioner, T.C. Memo.
1979-340, 38 T.C.M. (CCH) 1330, 1332-1333 (1979).
In the light of these factors and those listed in section 1.183-2(b), Income
Tax Regs., we conclude that petitioner intended to profit from her acting activity
and that her intent to make a profit from acting was her principal objective. To
start, petitioner secured roles in feature-length films, including one during the years
at issue. She testified credibly that she spent approximately 35 to 45 hours per
week researching, applying, and auditioning for roles. She studied and trained to
enhance her skills through acting and voice lessons, evincing her desire to increase
her marketability. She also maintained subscriptions to various casting services,
whereby her portfolio and headshots would be presented to industry casting
directors. To assist her in securing roles, she retained an assistant and an agent to
research and submit her materials for opportunities to audition. Taken together,
these actions indicate that petitioner carried on her affairs in a businesslike manner,
with substantial investment of time and effort, and that her activities in the years at
issue increased her acting opportunities in later years. - 12 -
[*12] Respondent’s arguments to the contrary are unconvincing. Respondent
argues that if petitioner truly had a profit motive she could have secured far more
bookings than she did simply by consulting with her daughter, one of the most
successful actresses in Hollywood. Moreover, respondent contends that because
her daughter is a successful actress, petitioner gained substantial enjoyment from
working in the same industry and therefore could not have had a bona fide intent to
make a profit. Finally, respondent notes that petitioner has never generated a profit
from her acting activity, and so, respondent contends, she could not have engaged
in the activity with an intent to profit.
We see no reason to require petitioner to bootstrap her daughter’s successes
to secure her own. While consulting with experts in a given industry is one
indication of a profit motive, see sec. 1.183-2(b)(2), Income Tax Regs., petitioner’s
desire to not involve her daughter in her career is understandable. Moreover,
petitioner separately retained an agency to assist her in securing roles. Although it
may be true that petitioner enjoyed acting and that she enjoyed working in the
same industry as her daughter, we do not agree that this requires a finding that
petitioner did not also intend to profit from her work. See Jackson v.
Commissioner, 59 T.C. at 317 (“Success in business is largely obtained by - 13 -
[*13] pleasurable interest therein.” (quoting Wilson v. Eisner, 282 F. 38, 42 (2d
Cir. 1922))).
Finally, it is true that petitioner’s acting activity did not generate a profit
during the years at issue or in later years. The acting activity generated a loss for
each year that petitioner used to offset substantial income for each year at issue and
for later years. While a history of losses is one factor that we consider in
determining whether the taxpayer had the principal objective of making a profit
from an activity, the presence or absence of profits is not determinative. Petitioner
need only show that making a profit from her acting activity was her principal
objective in conducting that activity, and on this record, after considering all of the
relevant factors, we conclude that she has done so and thus was engaged in the
trade or business of acting during the years in issue.
B. Petitioner Has Not Substantiated All Reported Acting Activity Expenses.
We now turn to an analysis of whether petitioner has substantiated her
reported expenses. Although we have found that petitioner engaged in her acting
activity during the years at issue primarily to make a profit, her acting activity does
not entitle her to deduct every expense she paid in the ordinary course of a work
day. - 14 -
[*14] Deductions are a matter of legislative grace and a taxpayer must provide
adequate substantiation to prove entitlement to a deduction for a particular
expense. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Section
162(a) permits a deduction for “all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business”. A taxpayer
is required to maintain records sufficient to substantiate the items underlying the
deductions claimed on the taxpayer’s return. See sec. 6001. If a taxpayer proves
that she is entitled to some deduction but cannot substantiate the full amount
claimed, generally the Court may estimate the amount of the allowable expense
deduction to the best of its ability, “bearing heavily * * * upon the taxpayer whose
inexactitude is of * * * [her] own making.” Cohan v. Commissioner, 39 F.2d 540,
544 (2d Cir. 1930) (Cohan rule). For the Court to estimate the amount of an
expense, there must be a reasonable basis in the record to support that estimate.
Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
The Cohan rule, however, does not apply to certain expenses delineated in
section 274(d). See sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg.
46014 (Nov. 6, 1985). For those expenses (e.g., expenses relating to travel, meals
and entertainment, gifts, or other “listed property” as defined in section
280F(d)(4)), a taxpayer must meet the strict substantiation requirements set out in - 15 -
[*15] section 274. To satisfy the strict substantiation requirements, a taxpayer
must introduce sufficient evidence to corroborate (1) the amount of the expense or
other item; (2) the time and place of travel, entertainment, or use of the property;
(3) the business purpose of the expense or other item; and (4) the business
relationship of the taxpayer to the persons entertained or using the property. See
sec. 274(d). With respect to the use of listed property, the taxpayer must establish
the amount of business use and the amount of total use. Sec. 1.274-5T(b)(6)(i),
Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
Respondent has conceded that petitioner actually paid most of the expenses
reported on her Schedule C for both tax years. Respondent disputes, however, that
petitioner has proven that any of the reported expenses were ordinary and
necessary expenses relating to her acting business. In her posttrial brief, petitioner
conceded that she cannot meet the strict substantiation requirements imposed by
section 274 as they apply to any relevant reported expense. We therefore must
examine the record to see whether petitioner has proved she is entitled to deduct
any reported expense not subject to section 274, bearing in mind the Cohan rule.
Petitioner claimed deductions for myriad expenses, including some that
appear inherently connected with a career in acting and others that, absent specific
proof, appear to be nondeductible personal expenses. For the sake of brevity, as to - 16 -
[*16] any reported expense that is not discussed specifically below, we conclude
that petitioner has failed to carry her burden of proving that the expense was an
ordinary and necessary expense of her acting activity business.
i. Expenses Inherently Connected With Acting
As just noted, petitioner has reported some expenses that on their face
appear inherently connected with her acting activity.
One type of expense in this category is photography. Headshots and various
other photography projects are a necessary element of any actor’s portfolio, and we
have recognized that such expenses are indicative of an intent to profit from acting.
See Richards v. Commissioner, 77 T.C.M. (CCH) at 2014 (“Expenses for * * *
agent fees, photo session[s], and duplicate photos are all ordinary and necessary
expenses of an actress-model activity.”). Respondent disallowed petitioner’s
reported photography expenses on the basis that she was not engaged in a trade or
business. Because we found that she was engaged in the business of acting, we
further conclude that the reported photography expenses were inherently connected
with that business. Accordingly, we allow the reported photography expense
deductions.5
5 Specifically, these are as follows: for tax year 2013, $140 paid to Better Photos, $153 to Hollywood Retouching, and $250 to an unidentified photographer (continued...) - 17 -
[*17] Similarly, we have concluded that fees paid to a casting agency are ordinary
and necessary expenses for an actor. Id. For the same reasons just stated with
respect to the photography expenses, we conclude that the amounts petitioner paid
to retain a casting agency are inherently connected with her acting activity.
Accordingly, we allow those amounts.6
Finally, another expense we have found to be ordinary and necessary for an
actor is the cost of enhancing the individual’s acting skills. See Green v.
Commissioner 58 T.C.M. (CCH) at 608 (“[The taxpayer] continually hones and
refines his skills.”). Petitioner retained the services of two individuals, John
Deaver and Linda Valentino, to give her voice and dance lessons, and paid them
$1,150 and $350, respectively, during 2013. We conclude that petitioner took these
classes to enhance her range as an actor, and accordingly, we allow deductions for
these amounts.
5 (...continued) stipulated by the parties; and for tax year 2014, $292 to Sammy’s Camera. 6 Specifically, we allow petitioner’s reported expense of $1,678 paid to casting agencies for 2013. - 18 -
[*18] ii. Other Expenses
a. Assistant Expenses
Petitioner reported expenses of $28,219 and $29,565 on her Schedules C as
compensation to her personal assistant, Ms. Giragossian, for tax years 2013 and
2014, respectively. The parties have stipulated these amounts and that they were in
fact paid to Ms. Giragossian. As with the other expenses reported on petitioner’s
Schedules C, respondent disallowed deductions for these amounts on the basis that
she was not engaged in a trade or business.
Because we have rejected respondent’s argument that petitioner was not
engaged in a trade or business, we turn to petitioner’s contention that the full
amounts paid to Ms. Giragossian are ordinary and necessary business expenses.
While we accept the parties’ stipulation as to the fact and amounts of payments to
Ms. Giragossian, this is not enough--on its own--to entitle petitioner to a deduction
for the entirety of each of those amounts. Petitioner must also prove the
connection with her acting activity.
At trial petitioner credibly testified that Ms. Giragossian assisted her with
her acting business during the years at issue. But petitioner also credibly testified
that Ms. Giragossian assisted her with her jewelry sales activity and the potential
hair care venture. As discussed below, we conclude that neither of those activities - 19 -
[*19] was a trade or business. Accordingly, the time Ms. Giragossian spent on
those matters was spent on petitioner’s personal hobbies, and we must reasonably
account for the time spent on nondeductible personal activities. Consequently, we
cannot and do not allow petitioner to deduct the full amount paid to Ms.
Giragossian for either year as a business expense relating to her acting activity.
Rather, because we believe that petitioner is entitled to some deduction for
the amounts paid to her assistant, we apply the Cohan rule to approximate, as best
we can with an eye toward petitioner’s own inexactitude, the appropriate deduction
for each year. We find petitioner’s testimony regarding Ms. Giragossian’s
activities credible. We also find petitioner’s testimony regarding the number of
hours she spent each week on her acting business and other various activities to be
credible. We therefore conclude that we have a reasonable basis to make a Cohan
rule approximation because that testimony provided a discernible--if imprecise--
allocation of Ms. Giragossian’s activities. See Vanicek v. Commissioner, 85 T.C.
at 742-743. Specifically, petitioner spent roughly 40 hours per week on her acting
business, as well as 10 hours on her jewelry sales activity and fewer on her hair
care products activity. We think it is reasonable to infer that her assistant’s time
allocation tracked petitioner’s own, with time spent on actions relating to - 20 -
[*20] petitioner’s acting business representing approximately 75% of her work.7
Accordingly, we find it reasonable to allocate the compensation proportionately.
We therefore allow as a deduction 75% of the compensation claimed for each year,
and we disallow 25%.
b. Professional Service Expenses
Petitioner reported professional service expenses relating to her acting
business for each year at issue. Specifically, for tax year 2013 petitioner reported
$440 in legal expenses, $235 in accounting expenses, and $1,325 in fees to a
business management company, and for tax year 2014 she reported $420 in legal
expenses and $9,645 in fees to a business management company. Respondent
disallowed deductions for all reported expenses. We conclude that some, but not
all, of the reported professional services expenses are connected with petitioner’s
acting activity, and therefore are properly deductible.
As with the reported assistant expenses, petitioner argues that the mere fact
that she engaged in acting as a business requires that all these reported expenses
are properly deductible. Yet, petitioner must also prove the connection between
7 To reach this number, we credit petitioner with working 40 hours per week on her acting business, 10 hours per week on her jewelry sales activity, and 3 hours per week on her hair care products activity. Reduced to a fraction, her acting business therefore represented 75.47% of her total activities. - 21 -
[*21] the amounts paid and her acting business. As with the assistant expenses, we
agree that petitioner ran an acting business and paid some amounts of
administrative and professional expenses that are typical of any business.
Accordingly, we again turn to the Cohan rule.
We start with her reported legal expenses. Petitioner testified that these
expenses were paid for the drafting of management contracts and to collect on a
loan she issued to an individual to produce a film project. Petitioner further
testified that the management contracts were related to the management of a singer
but offered little detail regarding petitioner’s alleged management activities. While
these expenses appear to be tangential to her acting business, there is insufficient
evidence in the record to firmly establish a connection between these expenses and
her acting business. Accordingly, we sustain respondent’s disallowance of these
deductions.
We next address the accounting expenses that petitioner deducted on her
2013 Schedule C. Petitioner testified that the expenses related to “a black
operative investigation” against her and that she paid the disputed amount to have a
consultant examine her computer. While we appreciate that the world of espionage
has provided fruitful ground for generations of actors and film makers, we fail to
see how the reported expense is connected with petitioner’s acting - 22 -
[*22] business. Accordingly, we sustain respondent’s disallowance of these
expense deductions.
By contrast, there is sufficient evidence in the record to conclude that some
portion of petitioner’s expenses relating to her business management company was
connected to her acting business. Petitioner credibly testified that these expenses
were paid to a company that paid her business’ bills, handled its bookkeeping,
assisted in preparation of her tax returns, and other administrative expenses that
ordinarily arise in the course of any business. Moreover, petitioner’s business
manager also testified at trial about the nature and scope of her work, confirming
petitioner’s own testimony. Specifically, her business manager credibly testified
that she helped manage expenses and accounting for three types of activities:
petitioner’s acting business, her jewelry sales activity, and her hair care products
activity. Just as we allocated the amounts paid to petitioner’s assistant, we
conclude that the amounts paid to petitioner’s business manager should also be
allocated among the three activities in proportion to the time that petitioner and her
business manager presumably spent on them. Accordingly, we allocate the
amounts paid to petitioner’s business management company, Klein Mendelblatt, in
the same proportion, allowing 75% of the reported expense deductions and
disallowing the remaining 25%. - 23 -
[*23] II. Petitioner’s Jewelry Sales Activity
In contrast to her acting activities petitioner has not proven that she engaged
in her jewelry sales activity for profit. Accordingly, we sustain respondent’s
determination disallowing the passthrough loss deductions from those activities
claimed on petitioner’s 2013 and 2014 Schedules E.
Petitioner deducted the expenses of her jewelry sales activity on S
corporation returns for 2013 and 2014 and claimed the resulting loss deductions on
Schedules E of her individual income tax returns. Although section 183 applies at
the corporate level with respect to the activities of an S corporation, sec. 1.183-
1(f), Income Tax Regs., we examine the intent of petitioner, the S corporation’s
sole shareholder, in deciding whether the S corporation had the requisite profit
objective, see, e.g., Baldwin v. Commissioner, T.C. Memo. 2002-162, 83 T.C.M.
(CCH) 1915, 1926-1927 (2002).
As noted above, in analyzing whether a taxpayer engages in an activity for
profit we consider the totality of the circumstances surrounding that activity, with
particular regard for the factors set forth in section 1.183-2(b), Income Tax Regs.
The record does not indicate that petitioner carried on her jewelry sales activity in a
businesslike manner or did anything meaningful to elevate this activity to a
business capable of generating a profit. Rather, the record indicates that - 24 -
[*24] petitioner’s jewelry sales activity was a haphazard, intermittent affair.
Petitioner testified that she spent only 10 hours per week on the activity. This is in
stark contrast to her testimony regarding the time she spent on her acting business,
which commanded 35 to 45 hours per week. Moreover, there is no indication that
petitioner sought out expertise in the jewelry industry. Finally, we find it of
particular note that even the intermittent sales petitioner made were to former
associates from her Mary Kay career. Petitioner did not make a sustained effort to
sell to the general public outside this network and ceased her jewelry sales activity
when she could no longer sell to her former Mary Kay associates. On this record,
we conclude that petitioner did not operate her jewelry sales activity with the
primary purpose of making a profit. Accordingly, we sustain respondent’s
determination disallowing the passthrough loss deductions from the jewelry sales
activity that petitioner claimed on her Schedules E.
III. Retirement Contributions
Petitioner claimed deductions of $51,000 for each year at issue for
contributions made to her purported retirement plan from the FSP payments she
received. Respondent disallowed the claimed deductions on the basis that
petitioner was retired and not engaged in any trade or business, Mary Kay-related
or otherwise. Respondent further contends that no deduction is allowed because - 25 -
[*25] petitioner had no “earned income” within the meaning of section
401(c)(2)(A).
Petitioner concedes that the revenues reported on her Schedules C as income
from her trade or business actually represented payments from the Mary Kay FSP.
Petitioner, accordingly, acknowledges that these revenues do not relate to the
expenses reported on the Schedules C for petitioner’s acting business. Petitioner
contends, however, that these revenues are not merely retirement income that
should have been reported as such. Rather, petitioner contends that these payments
represented self-employment income subject to self-employment taxes. In support,
petitioner cites our opinion in Peterson v. Commissioner, T.C. Memo. 2013-271,
aff’d in part, dismissed in part, 827 F.3d 968 (11th Cir. 2016), where this Court
held that FSP payments to a Mary Kay NSD were subject to self-employment taxes
because they were self-employment income within the meaning of section 1402(a)
and (b). Building on this holding, petitioner argues that because this Court has
held that FSP payments are taxable self-employment income within the meaning of
section 1402(a) and (b), they must also be “earned income” within the meaning of
sections 401(c)(2)(A) and 404(a)(8)(B). As a result, petitioner argues, the
contributions she made from the FSP payments to her profit-sharing plan are
deductible under sections 401 and 404. - 26 -
[*26] Section 404(a) allows an employer to deduct certain contributions to
deferred compensation plans that are paid or accrued on account of an employee.
With respect to self-employed individuals, section 404(a)(8)(C) provides that
contributions to a plan are deductible “to the extent that such contributions do not
exceed the earned income of such individual * * * derived from the trade or
business with respect to which such plan is established”. Section 404(a)(8)(B)
provides that “earned income” has the meaning assigned by section 401(c)(2),
which, in turn, provides that “earned income” means the net earnings from self-
employment as defined by section 1402. However, for purposes of section 401(c),
such net earnings are determined only with respect to a trade or business in which
the personal services of the taxpayer are a material income-producing factor. Sec.
401(c)(2)(A)(i).
Petitioner’s argument rests on the premise that, because FSP payments are
subject to self-employment taxes under section 1402, they must also qualify as
“earned income” within the meaning of sections 401 and 404. Although petitioner
relies on Peterson v. Commissioner, T.C. Memo. 2013-271, for the proposition that
her FSP payments were earned income subject to self-employment under section
1402, petitioner acknowledges on brief that “the Peterson case did not reach the
question presented in this case”: whether FSP payments may be used to fund - 27 -
[*27] deductible contributions under sections 401 and 404 to a qualified retirement
plan. Respondent’s argument is that because petitioner, in his view, was not
engaged in any trade or business in the years at issue, there is no employer entitled
to make contributions under section 401. Additionally, respondent contends that
petitioner’s FSP payments are not “earned income” within the meaning of section
401(c)(2) because petitioner did not render any personal services to Mary Kay in
the years at issue, even though personal services she rendered in prior years are
undoubtedly a material income-producing factor.
Whether petitioner’s FSP payments are “earned income” within the meaning
of sections 401 and 404 is only the second of two hurdles presented by section
404(a)(8)(C) that petitioner must clear in order for her contributions to the plan to
be deductible. The first is that contributions are deductible only to the extent that
they do not exceed the “earned income * * * derived from the trade or business
with respect to which * * * [the] plan is established”. Sec. 404(a)(8)(C) (emphasis
added). Petitioner has not shown that the plan was established with respect to her
Mary Kay business, which is the undisputed source of the income at issue. The
plan document does not identify to which trade or business petitioner’s plan
relates, and Mr. Mehringer credibly testified that the plan was not created with
respect to any specific trade or business. Whether petitioner’s FSP income is - 28 -
[*28] “earned income” within the meaning of sections 401 and 404 is a question
we need not reach because petitioner has not proven that the plan was established
with respect to her former Mary Kay activity.
We conclude that petitioner may not deduct the contributions that she made
to her allegedly qualified plan because she has not proven that the income
contributed was derived from a trade or business with respect to which the plan
was established. The only trade or business in which P engaged in during the years
at issue was acting, which generated no taxable income. We therefore sustain
respondent’s disallowance of her claimed retirement contribution deductions.
Decision will be entered under
Rule 155.