Jackson v. Comm'r of Internal Revenue, 23558-94.

• Decision Date: 31 March 1997
• Docket Number: No. 23558-94.,23558-94.
• Citation: 108 T.C. 130,108 T.C. No. 10
• Parties: William R. and Muriel G. JACKSON, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

108 T.C. 130

108 T.C. No. 10

William R. and Muriel G. JACKSON, Petitioners,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 23558-94.

United States Tax Court.

March 31, 1997.

William R. Jackson, pro se.

John F. Driscoll, for respondent.

OPINION

DAWSON, Judge:

Respondent determined deficiencies in petitioners' Federal income taxes for the taxable years 1990 and 1991 in the amounts of $2,837 and $2,837.48, respectively.

At issue is whether termination payments received by William R. Jackson, a former independent agent for State Farm Insurance Companies, are subject to self-employment tax pursuant to sections 1401 and 1402.¹

This case was submitted fully stipulated under Rule 122. The stipulation of facts and attached exhibits are incorporated herein by this reference. The pertinent facts are summarized below.

Petitioners resided in Lakeshore, Mississippi, at the time they filed their petition in this case.

On April 15, 1954, William R. Jackson (petitioner) was appointed as an exclusive agent of State Farm Insurance Companies (State Farm), which consisted of the following four subcompanies: (1) State Farm Mutual Automobile Insurance Co.; (2) State Farm Life Insurance Co.; (3) State Farm Fire & Casualty Co.; and (4) State Farm General Insurance Co.

While serving as an agent for State Farm, petitioner's duties included soliciting applications for insurance, collecting payments, and generally assisting State Farm policyholders. His compensation for his State Farm duties consisted of commissions on new policies and renewals on existing policies.

From April 15, 1954, to May 31, 1959, and from January 1, 1972, until his retirement on December 31, 1987, petitioner served as an agent of State Farm under a series of three separate State Farm Agent's Agreements. During these periods of time both petitioner and State Farm considered their association to be an independent contractor relationship. From June 1, 1959, to December 31, 1971, petitioner served State Farm as District Agency Manager, and he operated under a District Agency Manager Agreement. During that period both he and State Farm considered their relationship to be that of an employer and an employee.

Petitioner was 63 years of age when he retired. Being an independent contractor operating pursuant to the provisions of a previously executed State Farm Agent's Agreement, Form AA3 (the Agreement), petitioner closed his office on December 31, 1987, and did not thereafter engage in further insurance business of any kind. At that time his agency relationship with State Farm ended and he became eligible for “Termination Payments” under Section IV of the Agreement. In 1990 and 1991 petitioner received termination payments from State Farm of $21,885 and $21,837, respectively. On his Federal income tax returns for 1990 and 1991, he reported the amounts received as termination payments as income, but not for purposes of self-employment tax.

Because the Agreement was terminated more than 2 years after its effective date, the termination made petitioner eligible to receive 5 years of monthly termination payments from State Farm. Section II of the Agreement entitled “Compensation” did not include or refer to Section IV entitled “Termination Payments”.

For the first post-termination year, Section IV of the Agreement required each of the State Farm companies to compute termination payments based on a percentage of petitioner's compensation during the previous 12 months, which was generally 20 percent of the income generated by personally produced policies in that year, less any deductions for commission charge-backs. For the subsequent 4 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, less commission charge-backs. None of the termination payments depended upon the length of petitioner's service for State Farm and overall earnings.

Petitioner had no vested right to receive any termination payments. The Agreement conditioned such payments upon two contractual requirements; i.e., (1) returning all of State Farm's property within 10 days of termination entitled petitioner to 2 months of termination payments, and (2) refraining from competing with all of the State Farm companies for a period of 1 year entitled petitioner to subsequent termination payments.

The Agreement also conditioned the termination payments upon certain adjustments to reflect: (1) The amount of income the State Farm companies received on petitioner's book of business during the first post-termination year, and (2) the number of his personally produced policies canceled during that year.

On Forms 1099-Misc sent to petitioner and the Internal Revenue Service for 1990 and 1991, State Farm reported the amounts of termination payments as nonemployee compensation attributable to service rendered by petitioner prior to his retirement.

In the notice of deficiency respondent determined that the amounts petitioner received from State Farm as termination payments constituted income from self-employment within the meaning of section 1401, and, therefore, were subject to self-employment tax.

We begin by pointing out that this case is indistinguishable from Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994), revg. T.C. Memo. 1992-655. Both cases involve former State Farm insurance agents who received termination payments under precisely the same provisions of Section IV of the State Farm Agent's Agreement. However, our opinion in Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), is not applicable here because an appeal of our decision in this case would be to the United States Court of Appeals for the Fifth Circuit. Consequently, we must decide whether to follow the rationale of our Milligan opinion or the decision of the Court of Appeals for the Ninth Circuit that reversed us.

Petitioner, of course, urges us to follow the Court of Appeals' decision in Milligan and hold that the income he received as termination payments is not subject to self-employment tax. To the contrary, respondent asserts that we should adhere to our Milligan opinion and conclude that petitioner is liable for self-employment tax on the termination payments.

Section 1401 imposes a tax upon each individual's “self-employment income”.² “Self-employment income” is defined in section 1402(b) as “net earnings from self-employment” with certain exceptions not relevant to this case. “Net earnings from self-employment” is defined in section 1402(a) as “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”. It is well established that the earnings of an insurance agent who is an independent contractor are “self-employment income” subject to self-employment tax. Simpson v. Commissioner, 64 T.C. 974 (1975); Erickson v. Commissioner, T.C. Memo. 1992-585, affd. without published opinion 1 F.3d 1231 (1st Cir. 1993).

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 our 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 tax. Id. at 446. And section 1.1402(a)-1(c), Income Tax Regs., provides that gross income derived from an individual's trade or business may be subject to self-employment tax even when it is attributable in whole or in part to services rendered in a prior taxable year. This Court and others have repeatedly applied the “nexus” test.³

In applying the statutory definition of self-employment income, we must decide whether the income from the termination payments satisfies three requirements: that it was (1) derived, (2) from a trade or business, (3) carried on by petitioner. Here, as in Milligan v. Commissioner, supra, petitioner agrees that he formerly carried on a trade or business as a State Farm insurance agent. Thus, the narrow question presented is whether the termination payments were “derived”, pursuant to the terms and conditions of the Agreement, from the carrying on of petitioner's previous work as a State Farm insurance agent.

This Court found in Milligan v. Commissioner, T.C. Memo. 1992-655, that the termination payments were the equivalent of deferred compensation which a State Farm agent, active or retired, would receive from policies sold in prior years. On that basis, we held that the payments were “derived” from self-employment even though they were received in years subsequent to the business activity which generated them. In other words, we found that there was a sufficient nexus between the income received and Mr. Milligan's trade or business to render the termination payments self-employment income. We stated that termination payments were analogous to the renewal commission payments in Becker v. Tomlinson, 9 AFTR 2d 1408, 62-1 USTC par. 9446 (S.D. Fla. 1962), because they constituted the payment of previously earned commissions, similar to the deferred commissions that an active insurance agent would receive.

The Court of Appeals for the Ninth Circuit reversed our Milligan decision. In doing so, it 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. But the Court of Appeals stated 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. The Court of Appeals concluded that Mr. Milligan had...