It’s the holiday season, and there are a lot of skin-care products, athleisure wear, kitchen gadgets, makeup and nutritional supplements for sale at home parties near you. You’ll get an invitation along the way at some point, if you aren’t flooded already, and the neighborly salesperson will present themselves as a big success and maybe even try to bring you in on the deal. But lurking somewhere beyond the sales pitch is a very bleak tax return.
“Most of the time it fails,” said Adam Markowitz, an enrolled agent and partner at Luminary Tax Advisors in Florida.
“I haven’t seen anyone make anything of substance,” added AJ Campo, a CPA whose firm is based in New Jersey.
Multilevel marketing is a business structure where salespeople buy products on speculation to sell independently on commission, and then they can also make a portion of the sales of anyone they recruit to sell. The business structure is legal, but the layered nature has given it the reputation of pyramid schemes, which are illegal and typically don’t involve any sales of products. Familiar MLM brands include Avon, Rodan & Fields, Amway, LuLaRoe, Tupperware and Mary Kay Cosmetics.
The Federal Trade Commission issues warnings regularly about MLMs, and one report estimates that 99% of those involved lose money. An AARP report from 2018 was a little more generous, estimating that 53% of the more than 20 million Americans who participate make less than $5,000.
Despite the statistics, MLM still attracts plenty of salespeople, because they think they will defy the odds and make money. Here’s what tax accountants, who have seen the receipts, say are the real challenges:
Buying product is too expensive
Since most of these businesses are product-based, everyone is underwater from the start.
“They end up stuck with inventory,” Markowitz said. “I had one client who sold LuLaRoe and they got stuck with so much useless inventory in the end that anything they could have made, they lost.”
CPA Ryan Losi said when he was working at a firm years ago that handled many MLM clients, “the rank and file we’d see would have big losses for buying product, then continue to have losses until they gave up. I didn’t see anyone in those years that was in MLM long enough, wanting to lose money for more than seven years.”
You need to keep good records
Part of running a business is bookkeeping, and the paperwork on MLMs can be onerous. “Most taxpayers are unaware of the record retention requirements for claiming business deductions, and they are even more confused by the rules concerning business tax deductions as a whole,” said Matthew Cordes, an enrolled agent with a tax services firm based in Indiana.
That means every party plate, every mile in the car going to clients, every phone call you make has to be tracked and accounted as a business expense in order to claim it on your Schedule C. Then you use those expenses to offset income. If there’s any remaining profit, you pay self-employment and regular income tax on it. “This has ranged from a few hundred dollars of loss to a few thousand, depending on the amount of up front cost that the taxpayer must take on from the parent company,” said Cordes.
You can’t take hobby losses
If you spend too much and make too little, you end up with a loss on your Schedule C. That’s fine at first, but the IRS doesn’t just let you take losses every year. “If the taxpayer involved in a MLM venture does not make a profit in year three, they run the risk of being deemed a hobby for income-tax purposes,” said Cordes. That means they can no longer deduct losses — but still have to pay tax on any profits. “That significantly impacts their tax liability,” he added.
The exceptions are exceptional
The few success stories that accountants see are not always just a matter of grit, but it does seem to help. Seed money helps too, along the theme of “you have to spend money to make money.”
“The one client I had that made money committed a significant amount of time and money,” said Cordes. “She posted daily to social media, bought advertising, and held many ‘parties’ to sell the products.”
Most of all, though, it takes working the pyramid structure. Cordes said this one success story also recruited many downline representatives. She kept great books and operated like any regular business would. How much did she make? “My recollection is that she netted around $30,000 from her own sales and the commission payments from her downline recruits,” said Cordes.
Losi said the success stories he saw had long before dropped selling products altogether. “They were doing conferences and bringing more people into the mix.”
The norm, however, is quitting.
“Ultimately, what usually happens is that people go all gung-ho, make a few thousand, and never make more than that,” said Markowitz. “They last six months.”
Come tax time next spring, most accountants probably won’t even have to try to talk their clients out of trying to continue. “By the time we get to their returns, most have already decided it’s not for them anymore,” said Campo. “They were hoping for that quick buck, but once everyone starts jumping on board, it’s past its prime.”