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distributors. These lower level distributors are collectively
referred to as petitioner's down-line distributors.
Petitioner sells products directly to his customers at the
regular retail price, and he sells products to his distributors
at a discounted price. Petitioner is paid a commission on the
sales he makes directly to his customers, and he is paid a
commission, called a "royalty" by the companies,2 on the sales
made by his first-level distributors. Once a distributor sells a
certain dollar value of products, the distributor becomes a
"breakaway distributor". The breakaway distributor buys products
directly from the company, rather than from petitioner. Although
the breakaway distributor is no longer under the supervision of
petitioner and no longer purchases the company's products through
petitioner, petitioner receives royalty payments from the company
on the purchases made by the breakaway distributor.
Petitioner's first-level distributor, who recruits a second-
level distributor, receives a royalty for all of the sales by
that second-level distributor. Petitioner also receives a
royalty for each sale by the second-level distributor. The
number of distributor levels below petitioner for which he
2 The companies refer to these payments as "royalties". We
use this word in describing the payments for convenience without
accepting this categorization in a legal context. Yoakum v.
Commissioner, 82 T.C. 128, 140 (1984) (the language used may
indicate the form of the payment but does not control the
character).
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