Peterson v. Comm'r

• Decision Date: 08 July 2016
• Docket Number: Nos. 14–15773,14–15774,s. 14–15773
• Citation: Peterson v. Comm'r, 827 F.3d 968 (11th Cir. 2016)
• Parties: Christine C. Peterson, Roger V. Peterson, Petitioners–Appellants, v. Commissioner of IRS, Respondent–Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

827 F.3d 968

Christine C. Peterson, Roger V. Peterson, Petitioners–Appellants

v.Commissioner of IRS, Respondent–Appellee.

Nos. 14–15773

14–15774

United States Court of Appeals, Eleventh Circuit.

July 8, 2016

Hala A. Sandridge, Mitchell I. Horowitz, Buchanan Ingersoll & Rooney PC, Tampa, FL, for Petitioners–Appellants.

Clint A. Carpenter, Thomas J. Clark, Gilbert Steven Rothenberg, U.S. Department of Justice, William J. Wilkins, Chief Counsel—IRS, Washington, DC, for Respondent–Appellee.

John Clancy Wilson, Henderson Caverly Pum & Charney LLP, San Diego, CA, for Play Shortstop, LLC, Amicus Curiae.

Before ROSENBAUM and FAY, Circuit Judges, and MIDDLEBROOKS,^* District Judge.

FAY, Circuit Judge:

Christine C. Peterson and Roger V. Peterson¹ appeal the decision of the United States Tax Court, determining deferred compensation payments under corporate plans made after Peterson's retirement from Mary Kay, Inc. (“Mary Kay”), in tax year 2009 were derived from her former Mary Kay association, making them subject to self-employment tax. We affirm in part and dismiss in part.

I. FACTUAL AND PROCEDURAL BACKGROUND

A. Mary Kay Sales Structure and Commission Compensation

Mary Kay is a manufacturer and seller of cosmetics, toiletries, skin care, and related products. Mary Kay has prospered in the United States and internationally, because of its indigenous, highly incentivized levels of independent sellers, who are commission compensated. A Mary Kay seller can progress rapidly according to her sales and commissions; each advancement is more lucrative to the seller and financially beneficial to Mary Kay. Unique to Mary Kay are its post-retirement, deferred-compensation programs, the ultimate financial incentive for Mary Kay sellers, who have risen through the seller ranks to earn the opportunity to participate in them.

All of Mary Kay's sellers are independent contractors. The entry level is an independent Beauty Consultant (“BC”), each of whom enters into a written agreement with Mary Kay and commits to develop a customer base to whom they sell Mary Kay products. BCs buy Mary Kay products wholesale and sell them retail to public customers. BCs have two responsibilities: (1) to build a customer base and (2) to recruit new BCs, from whom a BC earns commissions on purchases made by their recruited BCs.

When a BC has recruited 24 independent BCs, she can become a Sales Director (“SD”), which involves signing a SD Agreement with Mary Kay. Her 24 BCs constitute a personal sales unit, from all of whom she earns commissions. A SD has additional responsibilities: she oversees the BCs under her by educating and inspiring them to excel in selling Mary Kay products. She also continues to acquire additional personal units, from which she earns a percentage of their sales commissions. BCs within a SD's sales unit may become SDs, resulting in an offspring sales unit, from which the SD continues to earn a percentage of their sales commissions.

A SD is eligible to advance to National Sales Director (“NSD”), the highest level of the Mary Kay sales network, when she has acquired 20 offspring units and is approved for the position by a Mary Kay committee. An NSD is the only appointed Mary Kay sales position; each is required to sign an NSD Agreement, which states the contingent relationship between an NSD's responsibilities and her commission compensation:

NSD recognizes that NSD's earnings as a National Sales Director are contingent upon the results of NSD's efforts in promoting the sale of Mary Kay cosmetics and in inspiring, motivating, counselling and aiding others to become successful sellers of Mary Kay cosmetics and successful Unit Sales Directors. NSD agrees to assume responsibility for offering effective, conscientious advice and assistance to Beauty Consultants and Unit Sales Directors wishing to avail themselves of NSD's experience and suggestions for building successful Mary Kay businesses of their own.

....

In consideration of the commission compensation provided under this Agreement and the other rights and benefits provided hereunder, NSD agrees to continuously and faithfully employ NSD's best efforts to promote the sale of Mary Kay cosmetics throughout the market area served by Director's Sales Group during the period this Agreement is in effect.

NSD Agreement §§ 8.1, 8.10 (emphasis added). NSDs generally no longer solicit new Mary Kay customers; instead, they provide training, direction, and motivation through telephone calls, regular meetings, and workshops for Mary Kay sales personnel, especially those in their networks whose wholesale purchases generate their commissions. The NSD Agreement details an NSD's status, obligations, and compensation relative to commissions from her sales units, based on monthly wholesale purchase volume.² The percentage for calculating an NSD's commissions decreases as the offspring units become farther removed from the NSD's original sales unit.³

At the sole discretion of Mary Kay, NSDs, who had maintained a personal sales unit prior to July 1, 1991, were eligible for a Director Unit Volume Bonus based on the NSD's personal sales unit's Monthly Unit Wholesale Purchase Volume, while concurrently serving as an NSD as designated under Annex II of the NSD Agreement. Based on the Monthly Unit Wholesale Purchase Volume, an NSD's bonus ranged from $300 for her sales unit's sales of $4,000 to $5,999 to $3,500 for sales of $40,000 or more. NSD Agreement, Annex II, at ii. A Senior NSD also receives a 5% commission, payable on the Wholesale Purchase Volume of the Personal Sales Unit of a First–Line Offspring Director, who becomes an NSD; 3% for a Second–Line Offspring Director, who becomes an NSD; and 2% for a Third–Line Offspring Director, who becomes an NSD. Id. The NSD Agreement also subjects the NSD to a noncompetition agreement for two years after termination of her NSD Agreement.⁴

Relevant to this case, the NSD Agreement clearly provides the status of an NSD is that of an independent contractor, who files state and federal tax returns as a self-employed individual :

The relationship created and intended to be created is that NSD acts as an independent contractor for commission compensation measured by the results achieved, the measurement of those results being the Wholesale Purchase Volume of NSD's Sales Group . It is recognized that NSD is not a joint venturer with, or partner, agent or employee of [Mary Kay] . Nothing in this Agreement shall be deemed to permit or empower NSD to conduct business in the name of, or on account of [Mary Kay], or to incur or assume any expense, debt, obligation, liability, tax or responsibility in behalf of, or in the name of [Mary Kay] or to act in [Mary Kay's] behalf or to bind [Mary Kay] in any way whatsoever. [Mary Kay] shall have and reserves no right of power to determine or control the manner, means, modes or methods by which NSD performs NSD's activities or accomplishes NSD's objectives hereunder and shall only look to NSD for results achieved, as measured by the Wholesale Purchase Volume of NSD's Sales Group .

As an independent contractor, NSD shall have the obligation to file all necessary income tax returns to reflect self-employment income in a manner required by any applicable state or Federal laws or governmental regulations and, in connection therewith, [Mary Kay] shall furnish NSD with a statement in the form prescribed by law reflecting all compensation including all commissions, prizes, awards, or other compensation paid by [Mary Kay] to NSD or on NSD's behalf during the year or other legally prescribed reporting period.

The independent NSD will not be treated as an employee with respect to any services for state or Federal tax purposes, or otherwise .

Id. §§ 11.1, 11.3, 11.4 (emphasis added).

The NSD Agreement clarifies NSDs are compensated by commissions for sales of their sales units. They are not salaried employees but independent contractors , whose incentive to increase their income is based on commissions from sales of their sales units. It is to the financial benefit of an NSD and her sales units working under her to maximize sales of Mary Kay products. Significantly, the NSD Agreement provides: “[Mary Kay] reserves the right to alter, modify or change any discount, commission and bonus provision of this Agreement from time to time by not less than sixty (60) days' prior written notice to NSD to be effective on or after the commencement of any annual renewal term of this Agreement.”⁵ NSD Agreement § 3.4 (emphasis added). While Mary Kay has a sales network of approximately 2.7 million worldwide, there are only 200 NSDs and approximately 155 “emeritus” or retired NSDs.⁶

B. Mary Kay Post–Retirement, Deferred–Compensation Programs for NSDs

Mary Kay offers two post-retirement, deferred-compensation programs for which only NSDs are eligible as part of their pay package: (1) the Family Security Program (“Family Program”) and (2) the Great Futures Program (“Futures Program”). Jill Wedding, Mary Kay Director of Consultant Marketing, testified at trial in the Tax Court: “I don't know another direct selling company that offers anything like [these Programs].” Trial Tr. 176. While the retirement Programs are voluntary, if an NSD participates in either Program, she must sever her NSD Agreement with Mary Kay at age 65, when the Programs become effective. Wedding testified that she had “never seen [an eligible NSD] decline” either program, since they are incentive for an NSD to maximize the sales of her area, because the Programs are “so financially lucrative,” when she enters emeritus status; this incentive also means “more revenue” for Mary Kay. Id.

1. Family Program

The preamble of the Family Program, adopted effective July 1, 1991, “recognizes the valuable contribution made by those select group of independent contractors who have attained the coveted position of ‘National Sales Director,’ ” and Mary Kay “desires to establish a program which will offer financial security and...