Schelble v. Commissioner

T.C. Memo. 1996-269

UNITED STATES TAX COURT

ROBERT SCHELBLE AND SUSAN SCHELBLE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12747-93. Filed June 12, 1996.

Richard Clark, for petitioners.

James Gehres, for respondent.

MEMORANDUM OPINION

FAY, Judge: By statutory notice of deficiency dated

March 17, 1993, respondent determined deficiencies in peti-

tioner's1 income tax for the taxable years 1989, 1990 and 1991,

in the amounts of $4,334, $4,489 and $1,362, respectively. The

sole issue for decision is whether termination payments provided

by petitioner's employer and received by petitioner after

retirement from service as an independent insurance agent are

1
All references to petitioner are to Robert Schelble.
 - 2 -

capital assets from the sale of petitioner's insurance agency or

are self-employment income subject to the self-employment tax

under sections 14012 and 1402. We hold that the payments are

self-employment income subject to self-employment tax.

This matter was submitted to the Court fully stipulated

pursuant to Rule 122. The stipulation of facts and the exhibits

attached thereto are incorporated by this reference.

At the time the petition was filed, petitioners resided in

Fort Collins, Colorado. On March 13, 1973, petitioner executed a

Career Agent's Agreement (the Agreement) with American Family

Life Insurance Co., American Family Mutual Insurance Co., and

American Standard Insurance Co. of Wisconsin (collectively the

Companies). The Companies' principal office was at Madison,

Wisconsin.

According to the Agreement, an insurance agent of the

Companies could be eligible for "extended earnings" when the

Agreement was terminated. Aside from certain paperwork and

reporting requirements, the elements which must be satisfied

under the Agreement in order for an agent to qualify for extended

earnings are: (a) Within 10 days of termination, the agent must

return to the Company all policies and policy records, manuals,

materials, advertising and supplies or other property of the

2
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
 - 3 -

Company; (b) the agent must have represented the Company for at

least 5 years; (c) the agent must have a specified number of

policies in force at the time of termination; and (d) the agent

must not "associate himself in any sales or sales management

capacity with another insurer engaged in writing any of the kinds

of insurance written by the company".

If an agent qualifies to receive extended earnings, the

amount of those earnings is a specified percentage of the renewal

service fees3 which were paid to the agent during his final 6 or

12 months prior to termination. The percentage increases with

the agent's consecutive years of service. The extended earnings

are payable under the Agreement regardless of the cause of termi-

nation and regardless of the age of the agent at the time of

termination. In the event of an agent's death prior to the

complete payout of the extended earnings, his legal representa-

tives are entitled to receive the earnings which the agent would

have received had he not died.

Petitioner needed to be a licensed insurance agent in order

to sell insurance for the Companies. Petitioner was responsible

for all business expenses involved in operating his insurance

agency. The Companies owned the policies, endorsements, policy

records, manuals, materials, and supplies used by petitioner to

3
Renewal service fees are payments made to an agent as a
service fee when an insurance policy is renewed and consist of a
percentage of the premiums paid by the insured.
 - 4 -

sell the Companies' insurance. Petitioner was obligated to

return all of these items to the Companies when the Agreement was

terminated. Petitioner was permitted to use the Companies' names

and symbols, until the Agreement was terminated. Additionally,

the Agreement provided that petitioner was not an employee of the

Companies but an independent contractor. Petitioner had control

of his activities as to the time, place, and manner of soliciting

clients.

As of March 31, 1988, petitioner terminated the Agreement

with the Companies and elected to receive his extended earnings

in 36 monthly installments. Petitioner was entitled to receive

$93,345.89 of extended earnings benefits payable in 35 monthly

installments of $2,592.95 with the last check in the amount of

$2,592.64. Petitioner received the extended earnings payments

from the Companies as follows:

1988 $20,743.60
1989 31,115.40
1990 31,115.40
1991 10,371.49

Total 93,345.89

Petitioners timely filed joint Federal income tax returns

for 1989, 1990, and 1991. Petitioners reported the extended

earnings received in 1989, 1990, and 1991 on Schedule D, Capital

Gains and Losses, as proceeds from the sale of an insurance

agency.
 - 5 -

On March 17, 1995, respondent sent, via certified mail, a

statutory notice of deficiency to petitioners setting forth

deficiencies in petitioners' Federal income tax for the taxable

years 1989, 1990, and 1991. Respondent contends that

petitioner's extended earnings are subject to the self-employment

tax under sections 1401 and 1402, because the extended earnings

paid to petitioner were derived from petitioner's prior insurance

business. Petitioners contend that the extended earnings are the

proceeds from the sale of petitioner's insurance agency to the

Companies and are, therefore, proceeds from the disposition of a

capital asset. In the alternative, petitioners argue that the

extended earnings are not sufficiently related to petitioner's

past insurance business in order to make the payments subject to

self-employment tax under sections 1401 and 1402.

Respondent contends that the "extended earnings" paid to

petitioner by the Companies constitute self-employment income for

purposes of the self-employment tax under sections 1401 and 1402,

because the payments were derived from a trade or business

carried on by petitioner. Petitioners have the burden of proving

respondent's determination is incorrect. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933). Petitioner argues that his

relinquishment to the Companies of the records and lists he

maintained with respect to the policies he sold and the policy-

holders to whom he provided service was tantamount to the sale of

business "goodwill" to the Companies. Thus, petitioners argue
 - 6 -

that the "extended earnings" qualify for capital asset treatment

under section 1221, since they arose from the sale of assets used

in a business. Petitioners cite Killian v. Commissioner, 314

F.2d 852 (5th Cir. 1963), affg T.C. Memo. 1961-83, and Kenney v.

Commissioner, 37 T.C. 1161 (1962), to support their theory that

the "extended earnings" payments constitute proceeds from the

sale of "goodwill". These cases are of no particular assistance

to petitioners. Neither case involved "extended earnings" or

similar payments made under an agency contract in lieu of future

renewal commissions upon termination of the agency contract; both

cases clearly involved an express sale.

Where we have upheld a taxpayer's claim that there was
a sale of assets, the agreement at issue expressly
referred to the transaction as a sale, and an abundance
of evidence demonstrated the existence of vendible
tangible assets, as well as vendible goodwill in the
form of insurance expirations. * * *

Erickson v. Commissioner, T.C. Memo. 1992-585, affd. without

published opinion 1 F.3d 1231 (1st Cir. 1993). Here, the

evidence does not support a finding of a sale of assets of a

business. The record clearly shows that there was no express

sales agreement, nor was there any evidence of vendible business

assets. Thus, we conclude that petitioners have failed to

satisfy their burden of proof that the "extended earnings"

constitute gain from the sale or exchange of capital assets.

Having resolved the capital asset issue, we must now address

whether the extended earnings payments that petitioner received
 - 7 -

during the years in issue represent self-employment income within

the meaning of section 1402. For the following reasons we hold

that they do.

Section 1401 imposes a tax "on the self-employment income of

every individual". Self-employment income is defined in section

1402 to mean "the net earnings from self-employment derived by an

individual * * * during any taxable year". Sec. 1402(b).

Section 1402(a) defines "net earnings from self-employment" to

mean "the gross income derived by an individual from any trade or

business carried on by such individual, less the deductions

allowed by this subtitle which are attributable to such trade or

business".

In Newberry v. Commissioner, 76 T.C. 441, 444 (1981), this

Court held that, for income to be taxable as self-employment

income, "there must be a nexus between the income received and a

trade or business that is, or was, actually carried on." Under

the Court's interpretation of the "nexus" standard, "any income

must arise from some actual (whether present, past, or future)

income-producing activity of the taxpayer before such income

becomes subject to * * * self-employment taxes". Id. at 446.

Section 1.1402(a)-1(c), Income Tax Regs., provides that, where

the required nexus exists, payments may be subject to self-

employment tax even when they are attributable in whole or in

part to services rendered in a prior taxable year. See also
 - 8 -

Dacey v. Commissioner, T.C. Memo. 1992-187; Rev. Rul. 68-498,

1968-2 C.B. 377.

The issue of whether an independent insurance agent's

"extended earnings" are subject to self-employment tax was most

recently addressed by this Court in Koszewa v. Commissioner, T.C.

Memo. 1994-458. In Koszewa, the taxpayer signed the same "Career

Agent's Agreement" with the same Companies as petitioner. In

Koszewa, we concluded that there was a sufficient nexus between

the extended earnings payments received by the taxpayer and the

trade or business activity in which he was engaged while

associated with the Companies. Thus, the extended earnings

received by the taxpayer in Koszewa were subject to the self-

employment tax.

Applying the Newberry nexus standard and the reasoning used

in Koszewa to petitioner, we conclude that the extended earnings

payments received by him during 1989, 1990, and 1991 related to

the trade or business activity in which he was engaged while

associated with the Companies. First, to qualify for such

payments, petitioner had to be associated with the Companies for

a certain number of years, have a certain number of policies in

place at the time of termination, and refrain from direct compe-

tition with the Companies. All of those requirements relate to

petitioner's original business with the Companies. Second, the

amount of such payments was calculated by reference to the

renewal commissions that petitioner earned in his final months
 - 9 -

with the Companies, a criterion obviously tied to petitioner's

services with the Companies. Finally, the agreement which

provided for such payments stated that petitioner was to be

considered "an independent contractor for all purposes and in all

situations". We find the extended earnings payments were clearly

received in respect of a prior "'trade or business * * * actually

carried on'" by petitioner. Koszewa v. Commissioner, supra

(quoting Newberry v. Commissioner, supra at 444). Thus, the

extended earnings received by petitioner are subject to self-

employment tax on the grounds that they were from a trade or

business carried on by petitioner within the meaning of section

1402. See also Dunn v. Commissioner, T.C. Memo. 1994-414;

Erickson v. Commissioner, supra.

Petitioners rely on the Court of Appeals for the Ninth

Circuit's reversal of the Tax Court in Milligan v. Commissioner,

38 F.3d 1094 (9th Cir. 1994), revg. T.C. Memo. 1992-655. In

Milligan, the taxpayer was an independent contractor who sold

State Farm Insurance policies for over 30 years. The taxpayer's

contract with State Farm provided that, upon termination, an

agent who had 2 or more years of service with the company would

receive "termination payments" for 5 years following termination.

Id. at 1096. The amount of the payments for the first post-

termination year depended on the income generated by the agent

during 12 months prior to termination. Id. For the subsequent 4

years, the payments were based on a fraction of the amount
 - 10 -

payable in the first post-termination year, less commission

charge-backs. None of the termination payments depended on the

length of the taxpayer's service for State Farm and his overall

earnings. Id. In Milligan, we rejected the taxpayer's

contention that the termination payments represented payment for

the sale of the taxpayer's insurance business and held that the

"termination payments" were subject to self-employment tax.

Milligan v. Commissioner T.C. Memo. 1992-655. We found that

there was a sufficient nexus between the income received and the

taxpayer's trade or business to render the payments self-

employment income. Id.

The Court of Appeals acknowledged that in order for

Mr. Milligan to receive termination payments, he had to have

worked for State Farm as an independent contractor for 2 years or

more. Milligan v. Commissioner, 38 F.3d at 1098. The court

stated, however, that this fact by itself did not create a close

enough nexus to establish that the termination payments were

derived from Mr. Milligan's prior business activity within the

meaning of the self-employment tax. Id. The Court of Appeals

concluded that Mr. Milligan already had been fully compensated

for his services and that his business activity was not the

"source" of the termination payments. Id. at 1099.

We conclude that this case is distinguishable on its facts

from Milligan due to substantial differences that exist between
 - 11 -

petitioner's payments herein and the payments at issue in

Milligan.

The Court of Appeals in Milligan v. Commissioner, supra at

1098, found that "To be taxable as self-employment income,

earnings must be tied to the quantity or quality of the

taxpayer's prior labor, rather than the mere fact that the

taxpayer worked or works for the payor." Here, both the quantity

and quality of petitioner's labor directly affected the amount of

his extended earnings payments.

Unlike the termination payments to the taxpayer in Milligan,

petitioner's extended earnings were based in part on how long he

had been in service for the Companies. The percentage of

petitioner's renewal service fees which would be paid to him as

"extended earnings" was determined by how many years he had

served as an agent to the Companies. To qualify for the lowest

percentage of "extended earnings" petitioner had to have repre-

sented the Companies for at least 5 years. Additionally, peti-

tioner had to have 400 or more American Family mutual casualty

fire and health policies in force and at least 50 American

Standard policies in force at the time the Agreement was

terminated in order to qualify for extended earnings. Thus, the

extended earning payments received by petitioner were tied to the

quantity, quality, and duration of his prior labor.

Another distinction is that the termination payments in

Milligan v. Commisisoner, supra at 1099:
 - 12 -

did not depend upon the level of Milligan's prior
business activity because the Termination Payments were
subject to two adjustments unrelated to any business
activity on Milligan's part for State Farm. The State
Farm companies adjusted the Termination Payments to
reflect the amount of income received on Milligan's
book of business during the first post-termination
year, and the number of his personally-produced
policies cancelled during that year. If all of
Milligan's customers had cancelled their State Farm
non-life policies during the first post-termination
year, then Milligan would have received nothing. The
adjusted payment amount depended not upon Milligan's
past business activity, but upon the successor agent's
future business efforts to retain Milligan's customers
and to generate service compensation for State Farm.
* * *

Milligan v. Commisisoner, supra at 1099. Petitioner's extended

earnings were based on renewal service fees paid to him during

the final months preceding the Agreement's termination. No

adjustment was made, as in Milligan, to reflect income or

cancellations during any post-termination year.

In that respect, unlike the situation in Milligan v.

Commissioner, supra, the extended earnings received by petitioner

were not paid as a consequence of some factor unrelated to

petitioner's prior business activity as an insurance salesman.

The extended earnings depended upon the amount of renewal

commissions earned by petitioner in the last months prior to

termination, the length of petitioner's service, and the level of

petitioner's prior business activity. We find that there is a

"nexus between the income received and a trade or business that

is, or was, actually carried on", within the meaning of Newberry

v. Commissioner, 76 T.C. at 444. Thus, the extended earnings
 - 13 -

received by petitioner are subject to self-employment tax on the

grounds that they were derived by petitioner from a trade or

business carried on by petitioner within the meaning of section

1402.

For the foregoing reasons, we hold that the "extended

earnings" received by petitioner, in the amounts stipulated, are

subject to self-employment tax under sections 1401 and 1402.

Decision will be entered

for respondent.