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Milligan Case
(CITE AS: 3a P.3D 1094)
Robert B. MILLIGAN,
Petitioner-Appellant,
V.
COMMISSIONER OF INTERNAL
REVENUE, Respondent-Appellee.
No. 93-70273.
United States Court of
Appeals, Ninth Circuit.
Argued and Submitted June
15, 1994.
Decided Oct. 25, 1994.
Commissioner of internal
Revenue Service (IRS) issued taxpayer notice of
deficiency for unpaid self-employment tax. The United
States Tax Court upheld determination of deficiency, and
taxpayer appealed. The Court of Appeals, Pregerson.
Circuit Judge, held that termination payments did not
'derive' from taxpayer's insurance sales business and,
therefore, were not subject to self employment tax.
Reversed.
> Ill
> 22Ok4381 k.
Self-employment.
C.A.9,1994.
Term 'derive' within meaning
of self-employment tax statute stating that income must
be derived from trade or business requires nexus between
income received and trade or business that was actually
carried on. > 26 U.S.C.A.
1401
> [2]
> 22Ok4361 k.
Self-employment.
C.A.9,1994.
Payment's 'derived' from
cessation of taxpayer's business activity were not
subject to self-employment
tax. > 26 U.S.C.A. s 1401.
> [3]
> 22Ok4381 k.
Self-employment.
C.A.9,1994.
Self-employment tax did not
apply to payments received by independent contractor
under non-competition agreement he entered with insurer
when he terminated his business relationship with
insurer. > 26 U.S.C.A. s 1401.
> [4]
> 22Ok4381 k.
Self-employment.
C.A.9,1994.
Termination payments
taxpayer received did not derive from his insurance
sales business and, therefore, payments were not subject
to self-employment tax, where payments were linked only
to taxpayer's previous status as two year-plus
independent contractor for insurer, where taxpayer had
already been compensated for his services, and where
termination payments were subject to adjustments
unrelated to any business activity on taxpayer's part
for insurer. > 26
U.S.C.A. n 1401.
> [5]
> 22Ok4361 k.
Self-employment.
C.A.9,1994.
To be taxable as
self-employment income, earnings must be tied to
quantity or quality of taxpayer's p7r or labor, rather
than mere fact that taxpayer worked or works for payor.
> 26 U.S.C.A. s 1401.
> [6]
> 22Ok43Bl k.
Self-employment.
C.A.9,1994.
In determining whether
disputed payments are subject to self-employment tax, it
is not enough that, had taxpayer not performed certain
services, taxpayer never would have received disputed
payments. > 26 U.S.C.A. a 1401.
*1095 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.
1Alice 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. s
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 *1096 commissions on
State Farm-Fire and State Farm-General policies
previously written by him.
(ER 53: s 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 %hall be paid as soon an
ascertainable and shall
constitute the final payment under the schedule of
compensation payments.); (ER
69: 11/16/90 letter to Milligan).
Milligan reti d on August
13, 1983, by providing written notice of
termination of the Agent's
Agreement (see ER 54: 9 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 34: s IV.A). The section of the
Agent's Agreement entitled
"Compensation" (a 11) did not include or refer to
the section entitled
"Termination Payments' (s IV).
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 200 of
the income generated by
personally-produced policies in that year), (ER 54-
55: a IV.A.1-2), 'less any
deductions for commission charge-backs CFN1]....'
(Id. a IV.A). [FN2] 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. a IV.A.1-2), less commission
charge-backs. [FN3] 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.
FNI. Commission charge-backs
are commissions paid on cancelled policies,
meaning that Milligan had
received commissions in excess of those he
actually earned. In effect,
State Farm was entitled to offset monies owed
by Milligan against monies
owed to Milligan as Termination Payments.
20
FN2. In particular, State
Farm-Auto would pay Milligan a percentage of his
prior service compensation
on person2lly-produoed policies. (Id. a
IV.A.1(2)). And, State
Farm-Fire and State Farm-General would pay him the
lesser of a percentage of
the commissions he had been paid on personally-
produced policies, or the
commissions he would have been paid on
person2lly-produced renewal
premiums had the Agent's Agreement not been
terminated. (Id. > s IV. >
2(a)).
FN3. The above discussion
describes the payment calculations made by State
Farm-Auto, State Farm-Fire,
and State Farm-General. The Agent's Agreement
created a different payment
structure for payments from State Farm-Life.
State Farm-Life was required
to compute all five years of Termination
Payments based on 100% of
the amount Milligan would have received during
the post-termination years
on personally-produced and assigned policies had
the Agent's Agreement not
been terminated, (ER 56: > a IV.A.3; 71-72),
less commission
charge-backs. Milligan conceded that the $345.00 in
Termination Payments he
received in 1987 from State Farm-Life were taxable
as self-employment income,
meaning that the character of those payments is
not at issue on appeal. But
see note 8 infra (significant differences
between the payments from
State Farm-Life and the disputed payments might
justify disparate tax
treatment).
Milligan had no vested right
to receive any Termination Payments. The
Agent's Agreement
conditioned the Termination Payments upon two
contractual
requirements, (ER 54, > a
IV.A): (1) returning State Fm- 's property within
ten days of termination
entitled an agent to two months of Termination
Payments, (ER 36, > 9
3:V.B.l), 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. a IV.B). After retiring in 1983,
Milligan returned state
F2rM'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
*1097 during that year. See
ER 54-55: > ss IV.A.l(o), 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].').
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.
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 Fm--Auto, State Farm-
Fire, and State
Farm-General. [FN4]
FN4. In 1987. Milligan
received $15,354.00 from State Farm-Auto. $8,450.00
from State Farm-Fire, and
$972.00 from State Farm-General.
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 14illigan'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
an individual
self-employment income. We review the tax court's
findings of
law de navo, > Paci First
Fed. Sav. Bank v. Commissioner, 961 P.2d 800,
803 (9th Cir.), cert.
denied, > 506 U.S. 873, 113 S.Ct. 209, 121 L.Ed.2d 150
(1992), and findings of fact
for clear error, > Vukanovich 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'), > as 1401- > 1403 of
the Internal Revenue Code,
imposes a separate tax on the annual self-employment
income of every individual.
> 26 U.S.C. s 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. a
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. s 1402(a) (defining
"net earnings from self-employment' as "the gross
income (minus exclusions
from gross income[ CFN311] derived by an individual
from any trade or business
carried on by such individual').
FN5. "[T]here shall be
excluded any gain or loss--(A) which is considered
as gain or loss from the
sale or exchange of a capital asset E i.e. , capital
gain or lose] ... or (C)
from the sale, exchange ... or other disposition
of property if such property
is neither (includible in inventory nor
property held for sale to
customers in the ordinary course of business].'
> 26 U.S.C. a 1402(a)(3)(A),
(C). Gain or loss from 'sale, exchange, or
other disposition of
property' includes a disposition that creates ordinary
gain or loss, as opposed to
capital gain or loss. Treas.Reg.
a 1.1402(a)-6(a) (as amended
in 1965).
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.
> *1096 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, an an
independent contractor); > Erickson v. Commissioner,
64 T.C.M. (CCH) 963, 966,
1992 WL 245517 (1992), aff'd without op.. > 1 P.3d
1231 (lst Cir.1993)
(self-employment tax on deferred payments of unpaid
commissions and renewal
commissions to former insurance agent). It in
immaterial that Milligan was
no longer self-employed in 1987 when he received
the Termination Payments.
Treas.Reg. s 1.402(a)- > l(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 P.2d 1196, 1200 (9th
Cir.1981) (affirming
self-employment tax on sale proceeds from wheat taxpayer
grew in the past:
"[Self-employment income is determined by the source of
the
income, not the taxpayer's
status at the time the income is realized.')
(Emphasis added.) -
> [1] 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 between
the
income received and a trade
or business that is, or was, actually carried
on.' > Newberry v.
Commissioner, 76 T.C. 441, 444, 1981 WL 11375 (1981). BY
nexus, we mean that the
'trade or business activity by the taxpayer gives rise
to the income.... 0 > Id.
(emphasis added). The income in sufficiently
related to the taxp2yer's
trade or business activity when the business activity
is its source. > Id. at 446
('Any income must arise from some actual ...
income-producing activity of
the taxpayer before such income becomes subject
to'... self-employment
taxes.... 1). See, e.g., > Shumaker, 648 P.2d at 1200
(income derived from selling
wheat from prior farming activity).
> [2][3][4][5] We are not
prepared to characterize the precise
relationship between the
Termination Payments and Milligan's prior business
activity. Ambiguities in the
Agent's Agreement prevent us from doing so.
CFN6] But, despite the
ambiguities, we can see that the Termination Payments
did not 'derive, from
14illigan's prior business activity within the meaning
of
the self-employment tax. To
be taxable as self-employment income, earnings
must be tied to the quantity
or quality of the taxpayer's prior labor, rather
than the mere fact that the
taxpayer worked or works for the payor.
FN6. It would appear that
Milligan received the Termination Payments
because he stopped working
for State Farm and did not compete with State
Farm. The payments derived
from termination of the Agent's Agreement
(termination of Milligan's
business activity for State Farm), and
Milligan's compliance with
the contractual covenant not to compete (and
return of State Farm
property). Payments derived from the cessation of
Milligan's business activity
are not subject to self-employment tax. See
> Newberry, 76 T.C. at 446
(holding that-insurance proceeds were not
taxable self-employment
income where taxpayer's inability to operate a
destroyed grocery store,
rather than the carrying on of a business, gave
rise to the proceeds). Nor
does the self-employment tax apply to payments
derived from non-competition
with State Farm. > Barrett v. Commissioner,
58 T.C. 284, 289, 1972 WL
2450 (1972) ('Noncompetition does not constitute
the carrying on of a trade
or business.').
Here, the Termination
Payments were linked only to Milligan's previous status
as a two year-plus
independent contractor for State Farm. Had Milligan not
worked for State Farm, he
never would have received the Termination Payments.
And, had he worked for State
Farm for less than two years, or had he not
generated any policies that
produced commissions (or service compensation with
respect to State Farm Auto,
see ER 54-55: > a IV.A.I(a)) in the final pre-
termination year, he would
have received nothing.
> [6] Without more, this
link between the disputed payments and any business
activity carried on by
Milligan does not satisfy the derive' requirement. It
is not enough that, had the
taxpayer not performed certain services (that were
fully compensated for)--not
been an independent contractor, for example--the
taxpayer never would have
received the disputed payments. See > Newberry, 76
T.C. at 445 (harmonizing
self-employment *1099 tax-with the Federal
Unemployment Tax Act and the
Federal Insurance Contributions Act: CFN7] An
Individual who becomes
eligible for benefits as a -result of the individual's
employment status at some
previous time' has not received wages subject to
social security tax. I[I]n
no way are the benefits a function of the
employee's providing
services for his employer. Those benefits are not
derived
from any employment carried
on.').
20
FN7. The self-employment tax
on self-employed individuals is the
counterpart to the tax on
employees, wages under the Federal Unemployment
Tax Act (IFUTAII) and the
Federal Insurance Contributions Act ("FICA').
> Steffens v. Commissioner,
707 F.2d 478, 481 (llth Cir.1983) (citing
> Newberry v. Commissioner,
76 T.C. 441, 443, 1981 WL 11375 (1981)). The
wage tax under both PUTA and
FICA attaches to 'all remuneration for
employment.' See > 26 U.S.C.
s 3121(a) (FICA wage definition), id.
> s 3306(b) (PUTA wage
definition). . 'Employment' [under FICA] means any
service, of whatever nature,
performed ... by an employee for the person
employing him....' > 26
U.S.C. s 3121(b) (emphasis -added); id.
> 9 3306(c) (same under FUTA).
Because Milligan already had
been fully compensated for his services, none of
his business activity was
the 'source" of the Termination Payments. The
payments did not represent
deferred compensation of previously-earned
commissions, cf. > Erickson,
supra, because none of Milligan's earnings were
deferred, i-e., he had no
vested right to payment of an identifiable money
amount. Nor were they
renewal commissions on previously-generated policies,
cf. > id.; Becker v.
Tomlinson, > 9 A.F.T.R.2d 1407, 1409-10 (S.D.Fla.1962),
or retirement income tied to
Milligan's years of service and overall earnings.
At most, the amount of the
Termination Payments, not the payments themselves,
actually arose from
Milligan's business activity. Milligan had a contingent
right to receive an
uncertain amount of money or nothing, depending upon the
level of his prior business
activity leading to compensation in his final year
as an agent. The payment
amount depended upon the level of his commissions
(and service compensation
from State Farm-Auto) on personally-produced
policies, i.e., his previous
value as a State Farm insurance agent.
However, in part, even the
payment amount did not depend upon the level
of Milligan's prior business
activity because the Termination Payments were
subject to two adjustments
unrelated to any business activity on Milligan's
part for State Farm. The
State Farm companies adjusted the Termination
Payments to reflect the
amount of income received on Milligan's book of
business during the first
post-termination year, and the number of his
personally-produced policies
cancelled during that year. If all of Milligan's
customers had cancelled
their State Farm non-life policies during the first
post-termination year, then
Milligan would have received nothing. The adjusted
payment amount depended not
upon Milligan's past business activity, but upon
the successor agent's future
business efforts to retain Milligan's customers
and to generate service
compensation for State Farm. In this way too, the
disputed Termination
Payments did not "derive" from Milligan's prior
services.
Therefore, the tax court
erred by characterizing the Termination Payments as
earnings derived from the
carrying on of Milligan's trade or business. As
stated in supra note 3, we
express no opinion on whether the Termination
Payments from State
Farm-Life are subject to self-employment tax. We
therefore
reject the Commissioner's
suggestion that the tax status of the State Farm-Life
payments affects that of the
disputed Termination Payments provided for in the
same Agent's Agreement.
Nonetheless, we note two
significant differences, which might justify
disparate tax treatment,
between the payments from State Farm-Life and the
disputed payments. First,
payments from State Farm-Life represent unpaid
earned income from
Milligan's prior life insurance sales. He received the
same compensation from those insurance policies that he
would have received had the agent's Agreement not been
terminated. In contrast, Termination Payments e other
three State Farm companies were monies that Milligan
would not have received had the Agent's Agreement not
been terminated. He received these
payments precisely because
he was no longer working for State Farm. These
payments were calculated
*1100 based on Milligan's past earnings, which had
been fully paid, and were
not made to compensate him for prior labor. Second,
Termination Payments from
State Farm-Life were not subject to adjustments
unrelated to Milligan?s
business activity. The Termination Payments are not
subject to self-employment
income tax. Because we conclude that the
Termination Payments are not
derived from the carrying on of Milligan's trade
or business, we need not
decide whether the payments are within the exclusion,
> 26 U.S.C. 3 1402(a)(2)(A):
(C), supra note 5, for capital gain and
ordinary gain from the sale
exchange or other disposition of property.
REVERSED.
END OF DOCUMENT
KEYCITE
> Milligan v. C.I.R., 36
P.3d 1094, 74 A.F.T.R.2d 94-6714, 94-2 USTC P 50,565,
Unempl.Ins.Rep. (CCH) P
15063B.12 (gth Cir., Oct 25, 1994)
(NO. 93-70273)
> Citations to the Case >
Table of Authorities
HISTORY & GUIDE Page 1 of 3
FULL HISTORY
DIRECT HISTORY
1 Milligan v. C. 1. R., T.C.
Memo. 1992-655, 1992 WL 321334,
64 T.C.M. (CCH) 1282,
Unempl.Ins.Rep. (CCH) P 16991A.54,
T.C.M. (@) 92,655 (U.S.Tax
Ct. Nov 09, 1992) (NO. 2694-91)
Reversed by
M> 2 MILLIGAN V. C.I.R., 36
P.3D 1094, 74 A.F.T.R.2D 94-6714,
94-2 USTC P 50,565,
UNEMPL.INS.REP. (CCH) P 15063B.12
(9TH CIR. OCT 25, 1994) (NO.
93-70273), NONACQ., 1995-2 C.B. 1
NEGATIVE INDIRECT HISTORY
DISTINGUISHED BY
3 schelble v. C.I.R., 130
P.3d 1388, 80 A.F.T.R.2d 97-8226,
97-2 USTC P 50,944, Un@l.Ins.Rep.
(CCH) P 15808B
(l0th Cir. Nov 26, 1997)
(NO. 96-9010)
( > Additional History)
T.C. Memo. 1992-655 1992 WL
321334 (U.S.Tax Ct.), 64 T.C.M. (CCH) 1282, |
