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Tax Planning for Multi-Level Marketers

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Tupperware parties used to be all the rage for housewives who just wanted to escape their families for a few hours and enjoy some girl time, but now with hundreds of multi-level marketing companies to choose from, not only are people still attending these parties in homes and shopping online; they are joining the companies to earn some extra income.

With millions of consultants worldwide, it stands to reason that these consultants will need a tax professional like yourself to help guide the tax ramifications of owning these mini-franchises.

An Underserved Client Segment

In my experience, multi-level marketers have very little background knowledge of how joining one of these companies will affect their taxes. They usually join because the promise of earning extra money without a huge financial commitment is so appealing, and they are sometimes also promised a ton of tax write-offs. Unfortunately, by the time they come to your office the following year to file that first tax return after opening up shop, they are extremely disappointed by the reality of what is actually deductible.

I believe the multi-level marketer segment goes underserved by tax professionals for two reasons. First, the reality is that no one wants to be the bearer of bad news and explain to the client about all the tax write-offs they were promised and didn’t get. Second, multi-level marketers don’t know what they don’t know. Usually, they look to their upline (the person who signed them into the business) or home office for advice, but the upline and corporate office avoid giving much advice to avoid personal liability and/or because they just don’t know the answers.

As a result, you have the opportunity to provide value to a subset of potential clients you didn’t realize needed your assistance.

I bet you are wondering how I know so much about this particular group of individuals. I was a successful consultant in multi-level marketing for more than 10 years; today, I stay up to date with the trends because I still have a bunch of former teammates as tax clients.

Business vs. Hobby

It’s important to understand the business vs. hobby rules spelled out in Sec. 1.183-2 (b) of the Federal Tax Regulations. Essentially, you need to make sure you are helping your clients answer the following questions in order to determine how income and expenses of the activity should be treated:

  1. Do they carry on the activity in a businesslike manner, and maintain complete and accurate books and records?
  2. Does the time and effort they put into the activity indicate they intend to make it profitable?
  3. Do they depend on income from the activity for their livelihood?
  4. Are the losses due to circumstances beyond their control, or are they normal in the startup phase of their type of business?
  5. Do they change their methods of operation in an attempt to improve profitability?
  6. Do they or their advisors have the knowledge necessary to carry on the activity as a successful business?
  7. Have they been successful in making a profit in similar activities in the past?
  8. Has the activity made a profit in prior years, and how much profit has it made?
  9. Can they expect to make a future profit from the appreciation of the assets used in the activity?

Asking and documenting answers to these questions will ensure you do your due diligence in designating income or losses correctly.

Now, as to the write-offs, what I didn’t mention earlier is that these write-offs are usually promised on things the client would normally be paying for anyway – things that are personal in nature such as cellphones or clothing. So, the whole idea behind joining the multi-level marketing company sometimes is to offset these everyday costs.

As the tax professional, you must ensure that you aren’t helping these clients evade their tax responsibilities. Your job is also to educate them so they can become better business owners and help them with recordkeeping in order to prepare an accurate tax return.

In light of the new Tax Cuts and Jobs Act, hobby expenses are no longer tax deductible. The section of Schedule A where these expenses were reported is gone, so it’s more important than ever to ensure the client’s business is truly operating as a business!

But, in good news, the new tax plan added a new deduction that multi-level marketers should be eligible for: the Qualified Business Income (QBI) deduction. If eligible, the client will be able to take a deduction of up to 20 percent on net qualified business income (subject to total income limitations as well as business entity type) as a deduction in order to reduce taxable income.

This is yet another reason to ensure the activity is qualified as a business and not a hobby. In my experience, multi-level marketing businesses can show losses over several years – another reason these clients aren’t so popular with tax preparers. I caution you that with the new tax law, negative QBI is calculated on business losses, and will be carried forward and netted against any positive QBI deductions in future years.

Multi-level marketers are still one of my favorite groups to serve. I hope you will join me in the quest to make their tax lives easier!

Editor’s note: Be sure to read this article on hobby loss examinations on the Intuit® ProConnect™ Tax Pro Center.

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