503. How are the commissions of a sales representative taxed?Nuco Employeercline212014-07-24T14:56:00Z2014-07-24T14:56:00Z515578875UMKC73201041214Site Map/General Income Taxation/Individuals/Gross Incomeagent2005-01-25T00:00:00ZTaxFactsDefaultArticle118930803-00-tf1.xml803.00;#1727;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1How are the commissions of a sales representative taxed?
122300.000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-15T00:50:50Z503.01. How are the commissions, including insurance commissions, of a sales representative taxed?Commissions are generally taxable as ordinary income in the year received, regardless of whether the taxpayer is on a cash or accrual method of accounting, and regardless of whether the taxpayer has a contingent obligation to repay them. Commissions on insurance premiums, however, are a special situation. (See Q 3515 regarding the limitation on certain employers’ deductions).General rule for insurance commissions. First year and renewal commissions are taxable to the agent as ordinary income in the year received. If the agent works on commission with a drawing account, the amount he reports depends upon his contract with the company. If the drawing account is a loan that must be repaid (or upon which he remains personally liable) if he leaves, he reports only commissions actually received. If the drawing account is guaranteed compensation, he reports this compensation and any commissions received in excess of the amount that offsets his draw. This rule applies even if the agent uses the accrual method of accounting.See Rev. Rul. 75-541, 1975-2 CB 195; Security Assoc. Agency Ins. Corp. v. Comm., TC Memo 1987-317; Dennis v. Comm., TC Memo 1997-275. The procedure by which an insurance company may obtain automatic consent to change its method of accounting for cash advances on commissions paid to its agents is set forth in Revenue Procedure 2001-24.2001-10 IRB 788.The Tax Court held that an agent’s advance commissions were not compensation where they were repayable on demand, bore interest, and were secured by earned commissions as well as by the personal liability of the agent. Thus, even though the amounts were reported to the taxpayer as income on Form 1099-MISC, they were not income.Gales v. Comm., TC Memo 1999-27; acq. in result, 1999-2 CB 3. The IRS determined that cash advances made to an agent by an insurance company were income in the year of receipt where the agent was not unconditionally obligated to repay the advances, and any excess in advances over commissions earned would be recovered by the insurance company only by crediting earned commissions and renewals against such advances.TAM 9519002. These positions are consistent with other IRS rulings and prior case law.See Rev. Rul. 83-12, 1983-1 CB 99 (also released as IR 82-150); Geo. Blood Enter., Inc. v. Comm., TC Memo 1976-102. (See Rev. Proc. 83-4, 1983-1 CB 577 for guidance in complying with these rules.) A salesman who was discharged from the obligation to repay advance commissions received in previous years was required to recognize income in the year of discharge.McIsaac v. Comm., TC Memo 1989-307. See also Cox v. Comm., TC Memo 1996-241; Diers v. Comm., TC Memo 2003-229. The Tax Court determined that an agent had cancellation of indebtedness income where earned commissions had been used to offset advanced commissions (which were actually loans). Accordingly, the agent was held to have received gross income at the time any pre-existing deficiency in her commission account was offset, irrespective of the fact that she never received an actual check.Harper v. Comm., TC Summary Op. 2007-133.The Tax Court has held that amounts received by a district manager upon the termination of his agency contract are treated as ordinary income, and not capital gain resulting from the sale of a capital asset, if the money received was compensation for the termination of the right to receive future income in the form of commissions.Clark v. Comm., TC Memo 1994-278. See also Farnsworth v. Comm., TC Memo 2002-29, Parker v. Comm., TC Memo 2002-305.The Tax Court also held that where a retired insurance agent did not actually own any company assets he returned to the insurance company upon his retirement, termination payments received by the agent were not proceeds from a sale of capital assets subject to capital gain treatment, but instead were ordinary income.Baker v. Comm., 118 TC 452 (2002), aff’d, 2003 U.S. App. LEXIS 15509 (7th Cir. 2003). See also Trantina. v. United States, 512 F. 3d 567, 2008-1 USTC ¶50,138 (9th Cir. 2008).503.02. How are the commissions on an insurance agent’s own policies taxed? Commissions on policies purchased by the agent for himself, on his own life or on the life of another, are taxable to him as ordinary income. Such commissions are considered compensation, not a reduction in the cost of the policies.Ostheimer v. U.S., 264 F.2d 789 (3rd Cir. 1959); Rev. Rul. 55-273, 1955-1 CB 221. This rule applies to brokers as well as to other life insurance salesmen.Comm. v. Minzer, 279 F.2d 338 (5th Cir. 1960); Bailey v. Comm., 41 TC 663 (1964); Mensik v. Comm., 37 TC 703 (1962), aff’d, 328 F.2d 147 (7th Cir. 1964).503.03. How are an insurance agent’s commissions taxed if they are received pursuant to a deferred income plan?If, before he retires, an insurance agent enters into an irrevocable agreement with the insurance company to receive his renewal commissions in level installments over a period of years, only the amount of the annual installment will be taxable to him each year–instead of the full amount of commissions as they accrue.Comm. v. Oates, 207 F.2d 711 (7th Cir. 1953); Rev. Rul. 60-31, 1960-1 CB 174; Let. Ruls. 9540033, 9245015. Although the Oates case and Rev. Rul. 60-31 concern deferred compensation arrangements during retirement years, the same principle should apply if the agent during his lifetime elects a level commission arrangement for payments after his death. The IRS determined that an insurance agent’s contributions of commissions to his company’s nonqualified deferred compensation plan will not be includable in the agent’s gross income or subject to self-employment tax until actually distributed.Let. Rul. 9609011. In Olmsted, the insurance company, by agreement with the agent, substituted an annuity contract for its obligation to pay future renewal commissions. The Tax Court and the U.S. Court of Appeals for the Eighth Circuit held that the agreement was effective to defer tax until payments were received under the annuity.Comm. v. Olmsted Inc. Life Agency, 35 TC 429 (1960), aff’d, 304 F.2d 16 (8th Cir. 1962). However, the IRS did not acquiesce to the Olmsted decision.Non-acq., 1961-2 CB 6.503.04. What are the tax consequences if an insurance agent sells or assigns the agent’s right to receive renewal commissions?Assignment of renewal commissions. If the agent assigns the agent’s right to renewal commissions as a gift, he still must pay income tax on them as they are received by the donee.Helvering v. Eubank, 311 U.S. 122 (1940); Hall v. U.S., 242 F.2d 412 (7th Cir. 1957). The Tax Court determined that an insurance agent had to pay income tax on his commission income despite the assignment of that income to his S corporation. The court noted that the agent was the true earner of the income and that he made no valid assignment of his employment agreement with the insurance company.Isom v. Comm., TC Memo 1995-383. In Zaal, a 1998 memorandum decision, the Tax Court held that an agent’s transfer to a corporation of his right to receive renewal commissions was ineffective for tax purposes, since it constituted an anticipatory assignment of income rather than a sale of property. Citing Helvering v. Eubank, the court held that the commission income continued to be taxable to the agent, not to the corporation to which he transferred the rights.Zaal v. Comm., TC Memo 1998-222. See also McManus v. Comm., TC Summ. Op. 2006-68.Sale of renewal commissions. It appears likely that a bona fide, arm’s length sale of a right to receive renewal commissions can successfully transfer the federal income taxation of renewal commissions to the purchaser. The Court of Appeals for the Second Circuit has held that in the event of a sale of the right to receive renewal commissions, the sale price would constitute ordinary income to the agent in the year received.Cotlow v. Comm., 228 F.2d 186 (2nd Cir. 1955); see also, Turner v. Comm., 38 TC 304 (1962). The court in Cotlow added that the purchaser receives the renewals tax free until he recovers his cost; then the excess is taxable to him as ordinary income as it is received. Other cases have held that the purchaser must amortize his cost. In other words, he can exclude from gross income each year only that portion of the purchase price that the renewals received in that year bear to the total anticipated renewals.Latendresse v. Comm., 243 F.2d 577 (7th Cir. 1957); Hill v. Comm., 3 BTA 761 (1926).503.05. How are commissions received after the death of the insurance agent taxed?Commissions owed to an agent before he died, but paid after his death, are includable in his gross income on his final return. Renewal commissions payable after his death are “income in respect of a decedent”; consequently, the value of the right to the commissions is includable in the agent’s gross estate. The renewal commissions are taxable income to whoever receives them (e.g., his estate, beneficiaries, or a trust).Latendresse v. Comm., above; Est. of Goldstein v. Comm., 33 TC 1032 (1960), aff’d, 340 F.2d 24 (2nd Cir. 1965); Est. of Remington v. Comm., 9 TC 99 (1947). However, the person who receives the commissions is entitled to take an income tax deduction against them for any portion of federal estate taxes and generation-skipping transfer taxes attributable to their value. If the decedent has purchased renewal commissions from another agent, the recipient will be allowed to amortize any portion of the decedent’s cost unrecovered at his death.Latendresse v. Comm., above. If the recipient of the right to commissions sells or otherwise disposes of his right to receive them, he is taxed on the fair market value of the right in the year of sale or other disposition (e.g., gift). But if the recipient dies, the fair market value of the right to commissions will not be included in his final return; the person who receives the income right from the second decedent by will or inheritance pays tax on the commissions as they are received by him.IRC Sec. 691(a); Treas. Reg. §1.691(a)-1.503.06. How are an insurance agent’s commissions treated for self-employment tax purposes?Termination payments received by former insurance salesmen are not included in self-employment income if: (1) the amount is received after the termination of the agent’s agreement to perform for the company; (2) the agent does not perform services for the company after the date of the termination of the service agreement and before the end of the taxable year; (3) the agent enters into a covenant not to compete with the company for at least a 1-year period beginning on the date of the termination; and (4) the amount of the payment (a) depends primarily on policies sold by or credited to the agent’s account during the last year of the service agreement or to the extent such policies remain in effect for some period after termination of service, or both, and (b) does not depend to any extent on the length of service or overall earnings from services performed for such company (without regard to whether eligibility for payment depends on length of service).IRC Sec. 1402(k). For termination payments that do not fall within the above description, earlier case law and rulings may apply. The Tax Court held that because an independent insurance agent’s renewal commissions were tied to the quantity and quality of the taxpayer’s prior labor, and those payments derived from the carrying on of the taxpayer’s business as an independent insurance agent, the taxpayer’s renewal commissions were not exempt from self-employment tax.Gilbert v. Comm., TC Summary Op. 2005-176. The Tax Court also held that an insurance agent was liable for self-employment tax because he was not a statutory employee, but instead was engaged in a self-employed trade or business activity.Byer v. Comm., TC Summary Op. 2006-125.The Eleventh Circuit Court of Appeals held that the FICA statute does not impliedly provide a private cause of action to purported “employees” – in this case, insurance agents claiming they had been improperly classified as independent contractors – to sue their purported “employer” for nonpayment of the employer’s portion of FICA taxes.See McDonald v. Southern Farm Bureau Life Ins. Co., 291 F. 3d 718, 2002 U.S. App. LEXIS 9110 (11th Cir. 2002).