Oates v. Comm'r of Internal Revenue

• Citation: 18 T.C. 570
• Decision Date: 20 June 1952
• Docket Number: 27397.,Docket Nos. 27396
• Parties: JAMES F. OATES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ESTATE OF RALPH H. HOBART, DECEASED, JOHN H. HOBART, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

18 T.C. 570

JAMES F. OATES, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ESTATE OF RALPH H. HOBART, DECEASED, JOHN H. HOBART, EXECUTOR, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 27396

27397.

Tax Court of the United States.

Promulgated June 20, 1952.

Petitioners were for a good many years general agents of Northwestern Mutual Life Insurance Company. Following their retirement as general agents they were entitled to receive certain commissions on renewal premiums. At the time of their retirement on April 27, 1944, they had the right to elect either to receive these commissions in cash in the same years as they were paid to the company or they could elect to amend their contracts and receive them in monthly installments over a period of not to exceed 180 months. An election when once made was irrevocable. Petitioners when they retired elected to have their contract amended so they would each receive $1,000 a month for a period not to exceed 180 months. They did receive this $1,000 a month in each of the taxable years. These amounts petitioners have returned as taxable income. The Commissioner had added to their income in each taxable year renewal commissions which were credited to their accounts by Northwestern on its books but which petitioners did not receive and could not receive in the taxable years. Held, petitioners being on the cash basis are taxable only on the amount which they actually received in each of the taxable years and are not taxable on the commissions credited to their accounts which they did not receive and are not entitled to receive under their contract until some future year. J. Gilmer Korner, Jr., Esq., Stanley Worth, Esq., Robert H. Kinderman, Esq., and Ray Garrett, Esq., for the petitioners.

William Schwerdtfeger, Esq., for the respondent.

The respondent determined deficiencies in petitioners' income tax for the calendar years 1944, 1945, and 1946, as follows:

+--------------------------------------------+
                ¦Year  ¦Docket No. 27396  ¦Docket No. 27397  ¦
                +------+------------------+------------------¦
                ¦1944  ¦$11,368.41        ¦$12,551.54        ¦
                +------+------------------+------------------¦
                ¦1945  ¦20,256.30         ¦23,339.16         ¦
                +------+------------------+------------------¦
                ¦1946  ¦12,324.21         ¦13,768.74         ¦
                +--------------------------------------------+
                

The petitioners, who as partners were engaged in the life insurance business as general agents, retired in April 1944. The deficiencies result primarily from the inclusion in the income of each petitioner terminal commissions, the receipt of which was deferred until subsequent taxable years under an amendment to their former contract which was executed prior to their retirement. The issue is whether these commissions were income to petitioners during the taxable years, though they did not actually receive them. There are some minor adjustments which are not contested. The adjustments which are in issue are illustrated in Docket No. 27396 by adjustment (a) to the net income as disclosed in the income tax return of James F. Oates for the year 1944. This adjustment is explained in the deficiency notice, as follows:

(a) It is held that 50% of the renewal commissions credited to the Fund of Hobart and Oates on the books of the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin during the year 1944, as the result of payment by the insured of renewal premiums on policies written on applications previously procured by its general agents, Ralph H. Hobart and James F. Oates, are taxable to you in 1944. This is in accordance with the provisions of sections 22 (a) and 42 of the Internal Revenue Code. It is further held that the socalled Amendment of April 27, 1944 to your general agent's contract, which is an authorization to the insurance company to remit to you after retirement such renewal commissions as you may be entitled to under that contract, in a certain manner, has no effect on the taxability of such income.

Accordingly your gross renewal commissions from The Northwestern Mutual Life Insurance Company have been increased $16,587.49 which is 50% of $33,174.98 balance in the Fund of Hobart and Oates as of December 31, 1944, exclusive of interest.

A similar adjustment for the year 1944 is in issue in Docket No. 27397, estate of Ralph H. Hobart, deceased. Also similar adjustments are in issue in both docket numbers for the taxable years 1945 and 1946.

Petitioners by appropriate assignments of error contest the correctness of these adjustments. Inasmuch as both proceedings involve a common issue, they have been consolidated.

FINDINGS OF FACT.

James F. Oates and Ralph H. Hobart prepared their Federal income tax returns for the calendar years 1944, 1945, and 1946 on a cash receipts and disbursements basis. These returns were filed with the collector of the first district of Illinois.

Petitioner James F. Oates is an individual residing in Evanston, Illinois. Ralph H. Hobart died on December 29, 1949, and the other petitioner in this proceeding is the estate of Ralph H. Hobart, deceased. The duly qualified and acting executor of decedent's estate is John H. Hobart of Winnetka, Illinois. For the sake of convenience Oates and the decedent are referred to herein as the petitioners.

On January 1, 1911, petitioners formed a partnership which operated as a general insurance agency in Chicago under the name of Hobart & Oates. The petitioners shared equally in partnership profits. The partnership, as a general agent of Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin,¹ was engaged in the business of soliciting applications for life insurance and servicing of life insurance policies.

In 1928, petitioners and Northwestern executed a general agency contract which continued in effect without amendment until a short time prior to petitioners' retirement. This contract was more or less a standard one, being used by Northwestern and most of its general agents. The contract provided that petitioners were independent contractors and that they were not employees of Northwestern. The general agents of Northwestern are the field representatives of the insurance company. The general agent establishes and maintains his own office at his own expense, hires his own employees, and supervises the work of the subagents. He is a combination of salesman, sales manager, businessman, and general manager of the area covered by his agency.

The general agent's income is received primarily from three sources. First, to the extent that he personally sells insurance, the commissions on those sales constitute income to him. Second, fees are received for collecting premiums on and servicing policies written by other general agents. His third and main source of income is from a so-called ‘margin‘ or ‘overriding commission.‘ Usually a general agent has subagents working for him writing insurance policies. A subagent receives the major portion of the commission computed on the premium paid on that policy while the remainder of such commission goes to the general agent as his ‘overriding commission.‘

The general agency contract sets forth the fees and commissions that the general agent was entitled to, and the amount of those commissions depended not only upon the amount paid as the initial premium on the policy but also upon renewal premiums on the policies paid during the next succeeding 9 years. The schedule of commissions as contained in the general agency contract provided various rates of commissions for the different policies written by the general agent. An example of the operation of the commission is the ordinary life insurance policy, where the general agent is entitled to 55 per cent of the first year's premium and 7 1/2 per cent of the renewal premiums for each year, second to tenth, both inclusive. Of the first year's premium the general agent would retain 55 per cent, with the balance of that premium being remitted to Northwestern. In many instances, 5 per cent of the first year's premium would be retained by the general agent and the balance of the commission, or 50 per cent of the first year's premium, would be paid to a subagent. Then, in the ensuing 9 years if the renewal premiums were paid, the general agent was entitled to a commission of 7 1/2 per cent of the premium. Of this commission on renewal premiums the general agent might retain 2 1/2 per cent as his margin and pay 5 per cent to the subagent who made the sale. On all but single premium and 5-year premium policies Hobart & Oates was entitled to a percentage of the renewal premiums during the period from the second through the tenth year of the policy.

The premiums on life insurance are collected from the policyholder by a going general agent. From the premiums collected on policies written by him, the general agent deducts the commission due him under the contract and remits the net balance to the Company. From the premiums collected on policies not written by him, the general agent deducts a collection fee or service charge as provided under the agency contract and he remits the balance to the Company. When the general agent has retired, the premiums on business written by him are received from the policyholder by his successor general agent. After retirement, the general agent receives his commission on renewal premiums from the Company and not from the successor general agent.

The agency contract provided that upon retirement the general agents were to receive commissions on renewal premiums as they were earned during the 9-year period following the date of retirement, with provision for reduced payments under certain retirement conditions not applicable to the petitioners herein. Under the contract the general agent would receive a comparatively large amount of commissions on renewal premiums during the first year of his retirement, with a decrease in each year thereafter, until at the...