Gump v. U.S.

Decision Date12 June 1996
Docket NumberNo. 95-5092,95-5092
Citation86 F.3d 1126
Parties-2462, 96-1 USTC P 50,312, 20 Employee Benefits Cas. 1409, Unempl.Ins.Rep. (CCH) P 15245B Herbert J. GUMP and Marilyn Gump, Plaintiffs-Appellants, v. The UNITED STATES, Defendant-Appellee.
CourtU.S. Court of Appeals — Federal Circuit

Thomas J. O'Rourke, Shaw, Bransford & O'Rourke, Washington, D.C., argued, for plaintiffs-appellants.

Bruce R. Ellisen, Tax Division, Department of Justice, argued, for defendant-appellee. With him on the brief were Gary R. Allen, Chief, Appellate Section, and Jeffrey H. Skatoff, Attorney.

Oren L. Connaway, Rentea & Associates, Austin, Texas, represented the amici curiae, United Farmers Agents Association and The Coalition of Exclusive Agent Associations, Inc. With him on the brief was Bogdan Rentea.

Before MAYER, Circuit Judge, FRIEDMAN, Senior Circuit Judge, and MICHEL, Circuit Judge.

MAYER, Circuit Judge.

Herbert J. Gump and Marilyn Gump appeal a judgment entered by the Court of Federal Claims after denying their motion for summary judgment and granting the government's cross-motion. * The Court of Federal Claims held that Gump's monthly payments from the insurance company from which he retired were derived from his activities as an insurance sales agent and thus represented self-employment income. We reverse.

Background

Gump was an insurance agent with Nationwide Mutual Insurance Co. ("Nationwide") for over 35 years. He operated as an independent contractor under the name "Gump Insurance Agency" until he retired on December 31, 1989. Under Nationwide's Agency Security Compensation Plan, an agent who retires after at least five years is potentially entitled to two forms of additional payment: Deferred Compensation Incentive Credits (DCIC) and extended earnings. The DCIC amount represents compensation that the agent earned throughout the course of his affiliation with Nationwide, which Nationwide annually credited to his retirement account. The extended earnings are an amount calculated by reference to the agent's policy renewal fees for his last twelve months of service, subject to certain adjustments. The extended earnings are financed by decreasing the renewal commission rates of the agent who takes over the files of the departing agent by fifty percent for two years.

Gump met the requirements in the agreement and received $116,805.86 in DCIC and $101,267.06 in extended earnings in monthly installments of $3,750.85 over five years. In 1990 and 1991, the tax years in question, Gump reported both amounts as self-employment income.

On June 29, 1992, Gump requested a refund of self-employment taxes on the extended earnings portion of his monthly payments in the amount of $5,464.00 for 1990 and $5,095.00 for 1991. The IRS disallowed these claims on November 27, 1992, and Gump filed a refund suit on March 24, 1993. On March 9, 1995, the Court of Federal Claims granted the government's cross-motion for summary judgment.

Discussion

No relevant facts are in dispute. The sole issue is whether the Court of Federal Claims erred in holding that the extended earnings paid by Nationwide to Gump after his retirement are "derived from a trade or business carried on by him" within the meaning of the Self-Employment Contributions Act and thus are taxable as self-employment income. We review the summary judgment of the Court of Federal Claims, as well as its interpretation and application of the governing law, de novo. Lane Bryant, Inc. v. United States, 35 F.3d 1570, 1574 (Fed.Cir.1994).

Self-employment income is taxed "in order to fund social security benefits for self-employed individuals." Patterson v. Commissioner, 740 F.2d 927, 929 (11th Cir.1984). "[N]et earnings from self-employment derived by an individual ... during any taxable year" constitute "self-employment income." 26 U.S.C. § 1402(b) (1994). The Internal Revenue Code defines "net earnings from self-employment" as "gross income derived by an individual from any trade or business carried on by such individual," less allowable deductions. Id. § 1402(a); see also 26 C.F.R. § 1.1402(a)-1(a) (1996) (defining "net earnings from self-employment"). Self-employment income need not be earned in a year in which the taxpayer is subject to self-employment tax; under the applicable regulations, "[g]ross income derived by an individual from a trade or business includes gross income received ... or accrued ... in the taxable year from a trade or business even though such income may be attributable in whole or in part to services rendered or other acts performed in a prior taxable year as to which the individual was not subject to the tax on self-employment income." Id. § 1.1402(a)-1(c).

The Court of Federal Claims held that the extended earnings are necessarily derived from Gump's insurance business because they "represent a right to compensation established by the terms of the business relationship formalized in the Agent's Agreement." Slip Op. at 5-6, 1995 WL 864085. The court reasoned that the extended earnings are "part and parcel of the consideration promised by the company in return for the exclusive sales representation undertaken by the agent." Id. at 5. Having the same focus on overall "business relationship" as the trial court, the government argues that Gump's extended earnings are self-employment income because they are an "integral part of the overall relationship" between Gump and Nationwide and therefore must be seen as "part of the compensation paid to an insurance agent for selling Nationwide insurance."

We disagree. Rather than reasoning that the right to receive these funds arises from "the business arrangement," it is more accurate to say that the right to receive them arises from the qualified cancellation of that arrangement. Cf. Milligan v. Commissioner, 38 F.3d 1094, 1098 n. 6 (9th Cir.1994) ("Payments derived from the cessation of [the taxpayer]'s business are not subject to self-employment tax."). No right to extended earnings arises absent a qualified cancellation of the agreement. Thus, qualified cancellation is not just a condition that must be observed to preserve Gump's eligibility for these earnings; it is a precondition to receiving them. He would not have received these earnings at all if he had "induced or attempted to induce, either directly or indirectly, policyholders to lapse, cancel, or replace any insurance contract in force" with Nationwide, which would have made the cancellation "unqualified." Thus, it is improper to ignore the very conditions that give rise to the extended earnings and look only at the "big picture"--i.e., that all of the earnings are in a sense rooted in the Agent's Agreement. Cf. Newberry v. Commissioner, 76 T.C. 441, 446, 1981 WL 11375 (1981) (holding that insurance proceeds derived from the taxpayer's inability to operate his grocery store were not taxable as self-employment income). Whether or not the extended earnings are payable to Gump in some sense as "compensation" for "services rendered under this Agreement," they are not "part and parcel of the consideration promised by the company in return for the exclusive sales representation undertaken by the agent," Slip Op. at 5. Undertaking the exclusive sales representation does not give rise to an automatic right to receive the extended earnings.

Because the DCIC earnings are subject to the same conditions as the extended earnings--that Gump refrain from selling insurance for one year within 25 miles of his former office, and that he return all company records and supplies in good condition within ten days--the government argues that "[t]he far better reading is that Extended Earnings are a deferred compensation benefit." The character of the DCIC earnings is not before us, because the taxpayers concede that they are deferred compensation and as such are subject to self-employment tax. We cannot agree, however, that the extended earnings are equivalent to deferred compensation, because Gump was previously paid all renewal commissions to which he was entitled under paragraph 7 of the Agent's Agreement.

There are, moreover, significant differences between the two types of payment. First, unlike the DCIC earnings, the extended earnings are not derived by holding back a portion of Gump's salary--they are paid in essence by his replacement. Second, the extended earnings, unlike the DCIC payments, were subject to adjustments unrelated to Gump's business activities. Nationwide could make deductions from the payments if certain large...

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