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Beauty Consultant's Retirement Contributions Were Deductible Business Expenses.
(Parker Tax Publishing December 07, 2013)

While a limited partnership formed by a Mary Kay consultant could not deduct retirement contributions to the consultant's deferred compensation plan, the consultant herself could deduct the contributions as employer business expenses; post-retirement distributions from the company were taxable as self-employment income derived from her trade or business. Peterson v. Comm'r, T.C. Memo. 2013-271 (11/25/13).

Christine Peterson was an independent beauty consultant for Mary Kay, Inc., a wholesale distributor of cosmetics, toiletries, skin care, and related products. She sold Mary Kay brand products and recruited other individuals to join the company. In 1991, Christine entered into a national sales director (NSD) agreement with Mary Kay. She earned commissions from the wholesale purchases of Mary Kay products from her network of independent beauty consultants, sales directors, and national sales directors. Christine entered into a Family Security Program (FSP) and Great Futures Program (GFP) with Mary Kay. Both agreements provided that Mary Kay would make monthly distributions to Christine after completion of five years of NSD service and upon retirement from the company. The distributions would be calculated using a percentage of her average commissions before her retirement, the post-retirement wholesale purchases of her network, and her age at retirement. The agreements stated that each program was intended to be a nonqualified deferred compensation arrangement that was intended to meet the requirements of Code Sec. 409A.

In 2000, Christine and her husband, Roger, entered into the Christine Peterson Defined Benefit Plan and Trust (CP Plan), which was a qualified plan, designating themselves as the trustees and Christine as the employer. In 2002, Christine and Roger formed NSD Interests, L.P., a Georgia limited partnership. Subsequently, the CP Plan was amended to designate NSD Interests as the employer and the couple remained the trustees. Christine received nonemployee compensation from Mary Kay of over $750,000, $799,000, and $890,000 in 2006, 2007, and 2008, respectively. Christine retired from Mary Kay in 2009 and received nonemployee compensation of almost $490,000 under the FSP and GFP agreements. NSD Interests reported the 2006, 2007, and 2008 amounts as income and claimed deductions for retirement contributions to the CP Plan for those years.

The IRS issued notices of deficiency, disallowing the deduction for retirement contributions made by NSD Interests. The IRS contended that NSD Interests was not engaged in a trade or business and, therefore, was not entitled to deduct retirement contributions to the CP Plan under Code Sec. 404(a). The IRS also determined that the post-retirement distributions Christine received in 2009 under the FSP and GFP agreements were subject to self-employment tax.

Code Sec. 404(a) provides in general that contributions paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan or compensation paid or accrued on account of any employee under a plan deferring receipt of the compensation are deductible by the employer as business expenses or expenses for the production of income, subject to certain limitations. Reg. Sec. 1.404(a)-1(b) states that a partnership activity does not constitute a trade or business unless the partnership engages in the activity with the predominant purpose and intention of making a profit.

Christine and Roger acknowledged that NSD Interests was not engaged in a trade or business, but instead was created to be the passive recipient of Christine's earnings from Mary Kay. The couple also acknowledged that NSD Interests had no income in 2006, 2007, and 2008, and the income reported on the entity's returns should have been reported on the couple's joint returns. Christine and Roger argued that the distributions they received in 2009 under the FSP and GFP agreements were not subject to self-employment tax.

The Tax Court held that NSD Interests was not entitled to deduct the retirement plan contributions for 2006, 2007, and 2008 because the partnership was not engaged in a trade or business. However, the court found that Christine could deduct the retirement plan contributions to the CP Plan for the three years in issue. Christine was engaged in carrying on a Mary Kay business and was designated the employer when she formed the CP Plan. Although the plan was subsequently amended to designate NSD Interests as the employer, Christine (i.e. a predecessor who maintained the plan) was an employer pursuant to the plan and the retirement contributions were expenses that would be deductible under Code Sec. 162.

The court also held that the post-retirement 2009 distributions under the FSP and the GFP deferred compensation agreements were subject to self-employment tax. Before her retirement, Christine was engaged in a trade or business. Under the two agreements, Christine's distributions were based on her average commissions before her retirement, the volume of wholesale purchases by her network, and her age at retirement. Thus, the court concluded that the distributions were derived from her trade or business. Moreover, the agreements expressly provided that the distributions would be deferred compensation.

For a discussion of the employer deduction for contributions to a qualified plan, see Parker Tax ¶132,100. (Staff Editor Parker Tax Publishing)

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Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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