Milligan v. C.I.R., 93-70273

• Decision Date: 25 October 1994
• Docket Number: No. 93-70273,93-70273
• Citation: 38 F.3d 1094
• Parties: -6714, 94-2 USTC P 50,565 Robert E. MILLIGAN, Petitioner-Appellant, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1094

38 F.3d 1094

74 A.F.T.R.2d 94-6714, 94-2 USTC P 50,565

Robert E. MILLIGAN, Petitioner-Appellant, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellee.

No. 93-70273.

United States Court of Appeals Ninth Circuit.

Argued and Submitted June 15, 1994.

Decided Oct. 25, 1994.

David L. Haga, Jr., Robert P. Solliday, Carolyn R. Matthews and Arthur W. Peterson, Mohr, Hackett, Pederson, Blakley, Randolph & Haga, Phoenix, AZ, for petitioner-appellant.

Alice L. Ronk, Asst. Atty. Gen., Tax Div., Dept. of Justice, Washington, DC, for the respondent-appellee.

Bogdan Rentea and Oren L. Connaway, Rentea & Associates, Austin, TX, amicus curiae, for United Farmer's Agent Ass'n, Nat. Ass'n of American Family Agents, and Nat. Ass'n of State Farm Agents, Inc.

Appeal from the United States Tax Court.

Before GOODWIN, PREGERSON, and RYMER, Circuit Judges.

PREGERSON, Circuit Judge:

Robert E. Milligan ("Milligan") appeals the tax court's order and decision upholding the Commissioner of Internal Revenue's determination of a deficiency in Milligan's federal income tax for the taxable year 1987 in the amount of $3,076.00. We have jurisdiction under 26 U.S.C. Sec. 7482(a)(1). We reverse.

BACKGROUND

On April 12, 1949, Appellant Milligan began working as an exclusive insurance agent, on an independent contractor basis, for State Farm Insurance Company ("State Farm"). As a State Farm insurance agent, Milligan sold and serviced insurance policies for four sub-companies of State Farm--State Farm Mutual Automobile Insurance Company ("State Farm-Auto"), State Farm Life Insurance Company ("State Farm-Life"), State Farm Fire and Casualty Company ("State Farm-Fire"), and State Farm General Insurance Company ("State Farm-General").

On March 1, 1977, Milligan and State Farm entered into the fourth of a succession of agency contracts entitled State Farm Agent's Agreement (the "Agent's Agreement"). (ER 52-77). According to the Agent's Agreement, Milligan's compensation consisted of commissions on all personally-produced policies, "service compensation" for his services on existing policies, and renewal Milligan retired on August 13, 1983, by providing written notice of termination of the Agent's Agreement (see ER 54: Sec. III.A) (agreement terminated upon Milligan's death or written notice by either party). Because the Agent's Agreement was terminated more than two years after its effective date, the termination made Milligan eligible to receive five years of monthly Termination Payments from State Farm. (ER 54: Sec. IV.A). The section of the Agent's Agreement entitled "Compensation" (Sec. II) did not include or refer to the section entitled "Termination Payments" (Sec. IV).

commissions on State Farm-Fire and State Farm-General policies previously written by him. (ER 53: Sec. II; 58, 60-61, 63-64, 66-67). State Farm compensated Milligan in full when and as he earned commissions, service compensation, and renewal commissions. No portion of his compensation was ever deferred to create "Termination Payments." (See ER 59, 62, 65, 68, 70) (Any unpaid compensation payable at the time of termination shall be paid as soon as ascertainable and shall constitute the final payment under the schedule of compensation payments.); (ER 89: 11/16/90 letter to Milligan).

For the first post-termination year, the Agent's Agreement required each of the State Farm companies to compute Termination Payments based on a percentage of Milligan's compensation during the previous twelve months (generally 20% of the income generated by personally-produced policies in that year), (ER 54-55: Sec. IV.A.1-2), "less any deductions for commission charge-backs ¹...." (Id. Sec. IV.A). ² For the subsequent four years of Termination Payments, each company was required to pay an amount equal to 1/12th the amount payable in the first post-termination year, (id. Sec. IV.A.1-2), less commission charge-backs. ³ None of these Termination Payments depended upon the length of Milligan's service for State Farm and overall earnings, or his commissions from assigned policies and other compensation during the final pre-termination year.

Milligan had no vested right to receive any Termination Payments. The Agent's Agreement conditioned the Termination Payments upon two contractual requirements, (ER 54, Sec. IV.A): (1) returning State Farm's property within ten days of termination entitled an agent to two months of Termination Payments, (ER 56, Sec. IV.B.1), and (2) refraining from competing with all of the State Farm sub-companies for a period of one-year entitled an agent to subsequent Termination Payments, (id. Sec. IV.B). After retiring in 1983, Milligan returned State Farm's property and did not engage in any insurance sales activities or other trade or business, (ER 20, p 31).

The Agent's Agreement also conditioned the Termination Payments upon certain adjustments to reflect: (1) the amount of income the State Farm companies received on Milligan's book of business during the first post-termination year, and (2) the number of his personally-produced policies cancelled During taxable years 1985 and 1986, Milligan reported the Termination Payments he received for both income tax and self-employment tax. However, for taxable year 1987, when Milligan received $25,121.00 in Termination Payments, he reported the payments only for income tax. The Commissioner of Internal Revenue (the "Commissioner") issued Milligan a Notice of Deficiency in the amount of $3,076.00 for unpaid self-employment tax for 1987.

during that year. See ER 54-55: Secs. IV.A.1(c), IV.A.2(c) (Payment amounts were "subject to appropriate adjustments following a determination of the net premium collections [received and recorded on State Farm-Auto policies, and the level of commissions State Farm-Fire and State Farm-General received on Milligan's personally-produced renewal premiums, in the twelve months following the date of termination] ... and the number of policies in force [during the same twelve month post-termination period].").

On February 11, 1991, Milligan filed a petition in the tax court seeking a redetermination of the tax deficiency asserted against him. He contested the deficiency based on $24,776.00 in payments from State Farm-Auto, State Farm-Fire, and State Farm-General. ⁴

On November 12, 1992, the tax court entered a decision that determined a deficiency in the amount of $3,076.00. The tax court found that the entire amount of 1987 Termination Payments was deferred compensation that State Farm offered to induce agents to enter into the Agent's Agreement. The court reasoned that, as deferred compensation, the Termination Payments "derived" or "emanated" from Milligan's insurance sales business and were therefore subject to self-employment tax. Milligan appeals.

ANALYSIS

The tax court concluded that Milligan's 1987 Termination Payments were taxable as individual self-employment income. We review the tax court's findings of law de novo, Pacific First Fed. Sav. Bank v. Commissioner, 961 F.2d 800, 803 (9th Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 209, 121 L.Ed.2d 150 (1992), and findings of fact for clear error, Vukasovich v. Commissioner, 790 F.2d 1409, 1411 (9th Cir.1986). None of the underlying facts in this case are in dispute. Rather, the parties' dispute relates to the conclusion that should be drawn from the underlying facts--"whether the facts satisfy the statutory standard" for self-employment tax. Pullman-Standard v. Swint, 456 U.S. 273, 290 n. 19, 102 S.Ct. 1781, 1791 n. 19, 72 L.Ed.2d 66 (1982). This is a mixed question of law and fact, reviewable de novo. Id.

The Self-Employment Contributions Act ("SECA"), Secs. 1401-1403 of the Internal Revenue Code, imposes a separate tax on the annual self-employment income of every individual. 26 U.S.C. Sec. 1401. To be taxable as self-employment income, an individual's income must be (1) derived, (2) from a trade or business, (3) carried on by that individual. See 26 U.S.C. Sec. 1402(b) (defining "self-employment income" as "the net earnings from self-employment derived by an individual ... during any taxable year"); 26 U.S.C. Sec. 1402(a) (defining "net earnings from self-employment" as "the gross income [minus exclusions from gross income ⁵ ] derived by an individual from any trade or business carried on by such individual").

Milligan agrees with the tax court that the "trade or business" and "carried on" requirements have been satisfied. In other words, he agrees that the Termination Payments are subject to self-employment tax if they were "derived" from the carrying on of his previous work as an insurance agent. Simpson v. Commissioner, 64 T.C. 974, 989, 1975 WL 3150 (1975) (self-employment tax on insurance agent's trade or business earnings, e.g., commissions, as an independent contractor); Erickson v. Commissioner, 64 T.C.M. (CCH) 963, 966, 1992 WL 245517 (1992), aff'd without op., 1 F.3d 1231 (1st Cir.1993) (self-employment tax on deferred payments of unpaid commissions and renewal commissions to former insurance agent). It is immaterial that Milligan was no longer self-employed in 1987 when he received the Termination Payments. Treas.Reg. Sec. 1.402(a)-1(c) (as amended in 1974) (Gross income derived from a trade or business "includes gross income received ... in the taxable year even though such income may be attributable in whole or in part to services rendered or other acts performed in a prior taxable year...."); Shumaker v. Commissioner, 648 F.2d 1198, 1200 (9th Cir.1981) (affirming self-employment tax on sale proceeds from wheat taxpayer grew in the past: "[S]elf-employment income is determined by the source of the income, not the taxpayer's status at the time the income is realized.") (Emphasis added.)

Milligan disputes only whether the 1987 Termination Payments were "derived" from the trade or business carried on by him within the meaning of the tax code and regulations. The term "derive" requires "a nexus...