Newberry v. Comm'r of Internal Revenue

• Decision Date: 17 March 1981
• Docket Number: Docket No. 8322-79.
• Citation: 76 T.C. 441
• Parties: MAX G. NEWBERRY and TINA F. NEWBERRY, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

76 T.C. 441

MAX G. NEWBERRY and TINA F. NEWBERRY, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 8322-79.

United States Tax Court

Filed March 17, 1981.

During 1975, petitioners received business interruption proceeds under two insurance policies. These proceeds were intended to compensate for earnings lost as a result of a fire which suspended operation of petitioner's grocery store business. Held, the business interruption proceeds are not derived from “a trade or business carried on,” and thus do not constitute earnings from self-employment within the meaning of sec. 1402(a), I.R.C. 1954. Ronnie Joe Lane, for the petitioners.

Albert L. Sandlin, Jr., for the respondent.

OPINION

NIMS , Judge:

Respondent determined a deficiency in petitioners' income tax for the year 1975 in the amount of $810. The issue for decision is whether amounts petitioners received during 1975 as business interruption insurance proceeds constitute “net earnings from self-employment” as defined in section 1402(a).¹

All of the facts in this case have been stipulated. The stipulation and attached exhibits are incorporated herein by reference.

At the time the petition herein was filed, petitioners resided in Donalsonville, Ga.

During the year 1974, petitioner Max G. Newberry (petitioner) owned and operated a grocery store known as Seminole Grocery, d.b.a. Piggly Wiggly, 209 S/S College (Crawford) Street, Colquitt, Ga. On November 10, 1974, this grocery store was destroyed by fire. From that date until June of 1975, petitioner did not operate the grocery store.

During 1975, petitioner was insured by two insurance policies issued by Southern Guaranty & Insurance Co. Montgomery, Ala., and Southern Trust Insurance Co. Macon, Ga., respectively. Both of these policies contained a loss of earnings endorsement, the purpose of which was to insure petitioner against the interruption of business and loss of earnings caused by any one of the insured perils. From January 1, 1975, through mid-June, 1975, petitioner received $11,000 from these policies as amounts representing petitioner's lost earnings. The amounts paid by the insurance companies under the policies were based on petitioner's profits (defined as net profit after normal operating expenses).

Petitioners reported the $11,000 as income on their return for 1975 and designated that amount as “Business Interruption Insurance.” Petitioners did not report self-employment tax due on this income.

In the notice of deficiency, respondent made the following determination:

(a) It is determined that the $11,000.00 which you received as business interruption insurance proceeds represents net earnings from self-employment. Accordingly, your self-employment tax is $810.00 computed as shown below.

+-----------------------------------------------------------------------------+
                ¦Net earnings from self-employment                                    ¦$11,000¦
                +---------------------------------------------------------------------+-------¦
                ¦Largest amount of wages and self-employment earnings subject to      ¦14,000 ¦
                ¦social security tax                                                  ¦       ¦
                +---------------------------------------------------------------------+-------¦
                ¦Less: FICA wages                                                     ¦3,850  ¦
                +---------------------------------------------------------------------+-------¦
                ¦Balance                                                              ¦10,250 ¦
                +---------------------------------------------------------------------+-------¦
                ¦Self-employment income—lesser of net earnings from self-employment or¦10,250 ¦
                ¦balance above                                                        ¦       ¦
                +---------------------------------------------------------------------+-------¦
                ¦Rate                                                                 ¦7.9%   ¦
                +---------------------------------------------------------------------+-------¦
                ¦Self-employment tax                                                  ¦810    ¦
                +-----------------------------------------------------------------------------+
                

The issue presented in this case is whether the $11,000 which petitioners received in 1975 as business interruption insurance proceeds is subject to self-employment tax.² Resolution of this issue depends on the construction to be accorded section 1402(a), which section generally defines net earnings from self-employment as “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.”

Respondent notes that there is no dispute that petitioner's grocery business was a trade or business whose profits are subject to the self-employment tax. Such being the case, respondent insists that since the instant proceeds were merely a substitute for the loss of profits from petitioner's grocery business, they are similarly subject to the self-employment tax. Essentially, petitioners argue that since an interruption in business was the sine qua non for their entitlement to the proceeds, they were not “derived from any trade or business carried on” and thus are beyond the scope of section 1402(a).

This appears to be a case of first impression on this issue. Respondent has cited various cases concerning the question of whether various types of receipts constitute taxable income for income tax purposes,³ but for reasons hereafter stated, we do not perceive the immediate relevance of these cases to the self-employment tax. However, we feel that some insight can be drawn from an analysis of the purpose behind the self-employment tax and an examination of the “wage” definition as utilized under the Federal Unemployment Tax Act (FUTA) and the Federal Insurance Contributions Act (FICA). See secs. 3306(b) and 3121(a).

The self-employment tax was enacted by the Social Security Act Amendments of 1950, ch. 809, 64 Stat. 477, in order to assist in the administration of the Social Security system. In particular, it functions to finance the extension of Social Security benefits to self-employed individuals. S. Rept. 1669, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 302, 307-308, 352-353. For individuals who operate their own trades or businesses, it is the counterpart of the taxes imposed on the wages of employees by FUTA and FICA. Its constitutionality was upheld in Cain v. United States, 211 F.2d 375 (5th Cir. 1954), cert. denied 347 U.S. 1013 (1954), and also in numerous cases in this Court.⁴

In the employee context, liability for FUTA and FICA taxes is imposed only on the basis of wages received by employees. Secs. 3101(a), 3301. Non-wage income is simply not subject to either tax. The term wages, in general, is defined to include all remuneration for “employment.” Secs. 3121(a), 3306(b). Employment generally means any service an employee performs for the person employing him. Secs. 3121(b), 3306(c).

Section 1402(a) defines self-employment earnings as the “gross income derived by an individual from any trade or business carried on by such individual.” (Emphasis supplied.) Respondent's position requires a reading of “carried on” to mean carried on at some point: past, present, or future. In other words, there is no requirement that the income in question result from the operation of the taxpayer's trade or business. Thus, the individual's previous business activity would suffice to satisfy the “carried on” requirement of the statute.

We agree, however, with petitioner's position that there must be a nexus between the income received and a trade or business that is, or was, actually carried on. Put another way, the construction of the statute can be gleaned by reading the relevant language all in one breath: the income must be derived from a trade or business carried on. That there be some trade or business activity by the taxpayer which gives rise to the income is evidenced by the Senate report which accompanied the first enactment of the self-employment tax:

The trade or business must be “carried on” by the individual, either personally or through agents or employees, in order for the income to be included in his “net earnings from self-employment.” Accordingly, gross income derived by an individual from a trade or business carried on by him does not include income derived by a beneficiary from an estate or trust even though such income is derived from a trade or business carried on by the estate or trust. [S. Rept. 1669, supra, 1950-2 C.B. at 354.]

We note that this statutory construction is in keeping with respondent's interpretation of the wage definition under FICA and FUTA. In Rev. Rul. 56-110, 1956-1 C.B. 488, an employer established a plan to provide workers with unemployment benefits in addition to any State unemployment benefits they might receive, a context analogous to the instant case. In that ruling, the Commissioner held that benefits from such a plan, although income under section 61(a), are not wages for purposes of FUTA, FICA, or income tax withholding. The same result obtained in Rev. Rul. 60-330, 1960-2 C.B. 46.

Even though no rationale was contained in Rev. Rul. 56-110, supra, as to why such benefits did not constitute wages, the result appears to be compelled by virtue of the statutory definition. Because the unemployed worker performs no services there is no employment. Since the benefits are not remuneration for employment, they consequently cannot be considered wages. This construction of the statute is borne out by respondent's rulings which deal with strike and lockout benefits paid by unions to their members.

In Rev. Rul. 58-139, 1958-1 C.B. 14, and Rev. Rul. 68-424, 1968-2 C.B. 419, the Commissioner ruled that strike benefits includable in gross income are not wages for FICA and FUTA purposes. The latter ruling specifically states that the nonperformance of services provides the justification; strike...