|
NASFA
Home l Contact NASFA
Schelble Case
80 A.F.T.R.2d 97-8226, 97-2
USTC P 50,944, Unempl.Ins.Rep. (CCH) P 15808B
Robert SCHELBLE and Susan Schelble,
Petitioners-Appellants,
v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
The Coalition of Exclusive Agent Associations, Inc.,
Amicus Curiae.
No. 96-9010.
United States Court of
Appeals, Tenth Circuit. Nov. 26, 1997.
Taxpayers challenged
self-employment tax deficiency determination. The United
States Tax Court, > 1996 WL 315728, upheld
determination, and taxpayers appealed. The Court of
Appeals, Brorby, Circuit Judge, held that extended
earnings payments received when taxpayer terminated
independent insurance agency agreement were subject to
self-employment tax.
Affirmed.
Schelble v. C.I.R.
> [1] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XXI Assessment of Taxes
> 220XXI(E) Review by Tax
Court
> 220k4657 k. Presumptions
and burden of proof as to findings of commissioner.
C.A.10,1997.
Taxpayers who challenged
self-employment tax deficiency determination in tax
court had burden of proving Commissioner of Internal
Revenue's determination was incorrect.
Schelble v. C.I.R.
> [2] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4351 k. In general.
C.A.10,1997.
Federal self-employment tax
is designed to finance social security benefits paid to
self-employed individuals. > 26 U.S.C.A. S 1401.
Schelble v. C.I.R.
> [3] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
Independent insurance agent
generally is subject to federal self-employment tax on
self-employment income. > 26 U.S.C.A. S 1401.
Schelble v. C.I.R.
> [4] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
For income to be
'self-employment income,' subject to federal self-
employment tax, there must be nexus between income
received and trade or business that is, or was, actually
carried on; income must arise from some actual, whether
present, past or future, income-producing activity. > 26
U.S.C.A. S 1402(b).
See publication Words and
Phrases for other judicial constructions and
definitions.
Schelble v. C.I.R.
> [5] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
'Self-employment income,'
subject to federal self-employment tax, is determined by
source of income, not taxpayer's status at time the
income is realized. > 26 U.S.C.A. S 1402(b).
See publication Words and
Phrases for other judicial constructions and
definitions.
Schelble v. C.I.R.
> [6] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
Capital gains or losses are
not subject to federal self-employment tax. > 26 U.S.C.A.
S 1402(a)(3)(A).
Schelble v. C.I.R.
> [7] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
Extended earnings payments
received by independent insurance agent when he
terminated agency agreement were sufficiently derived
from trade or business to qualify as 'self-employment
income,' subject to federal self-employment tax under
law then in effect, where payments were tied to quantity
and quality of services performed; agent had to have 400
outstanding policies at termination to be eligible for
payments, and amount of payments was based on length of
service and fees paid before termination. > 26 U.S.C.A.
SS 1401, > 1402(b).
See publication Words and
Phrases for other judicial constructions and
definitions.
Schelble v. C.I.R.
> [8] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220XIV Taxes on Specific
Articles, Transactions and Employment
> 220XIV(D) Employment Taxes
> 220k4381 k.
Self-employment.
C.A.10,1997.
Extended earnings payments
received by independent insurance agent when he
terminated agency agreement were not proceeds from sale
of business goodwill, which would be excluded from
federal self-employment tax, absent any evidence of sale
of agent's business or any other asset. > 26 U.S.C.A. S
1402(a)(3)(A).
Schelble v. C.I.R.
> [9] > KeyCite this
headnote
> 220 INTERNAL REVENUE
> 220V Income Taxes
> 220V(G) Gains and Losses
from Sales and Exchanges in General
> 220k3181 k. Goodwill.
C.A.10,1997.
Sale of goodwill, treated as
capital asset for tax purposes, takes place only when
business or part of it, to which goodwill attaches, is
sold. > 26 U.S.C.A. S 1221.
*1389 Richard Clark, Fort
Collins, CO, for Petitioners-Appellants.
Regina S. Moriarty (Bruce R.
Ellisen with her on the brief), Department of Justice,
Washington, DC, for Respondent-Appellee.
Oren L. Connaway, Austin,
TX, filed briefs for amicus curiae Coalition of
Exclusive Agent Associations, Inc.
Before BRORBY, McWILLIAMS
and KELLY, Circuit Judges.
BRORBY, Circuit Judge.
The sole issue in this case
is whether 'extended earnings' payments received by Mr.
Schelble are subject to self-employment tax under > 26
U.S.C. S 1401. The Tax Court concluded the payments were
subject to self- employment tax. Robert Schelble and
Susan Schelble [FN1] appeal the Tax Court's order
upholding the Commissioner of Internal Revenue's
determination of deficiencies in the Schelble's Federal
income tax for the taxable years 1989, 1990 and 1991 in
the amounts of $4,334, $4,489 and $1,362, respectively.
We have jurisdiction under > 26 U.S.C. S 7482(a)(1). We
affirm.
FN1. Susan Schelble is a
party to this action because she filed joint tax returns
for the years in question with her husband, Robert
Schelble. Since only Robert Schelble's income is
disputed in this appeal, the remainder of
the opinion will refer to
Mr. Schelble only.
BACKGROUND
Mr. Schelble was an
independent insurance agent for American Family Life
Insurance Co., American Family Mutual Insurance Co., and
American Standard Insurance Co. of Wisconsin
(collectively 'the Companies') from 1973 to 1988. On
March 13, 1973, Mr. Schelble executed a Career Agent's
Agreement ('the Agreement') with each of the Companies.
The Agreement defined the relationship between and
obligations of Mr. Schelble and the Companies. Pursuant
to the Agreement, Mr. Schelble sold and serviced
insurance policies on behalf of the Companies. The
Agreement specified Mr. Schelble was an independent
contractor for the Companies. The Companies agreed to
pay insurance commissions [FN2] to Mr. Schelble based on
percentages of premiums on new and renewal policies sold
by him. The commissions were 'to be in full payment for
all services rendered by the agent and to be made as
soon as practicable.' Either party could terminate the
Agreement by giving written notice.
FN2. The commissions are
also referred to as a 'sales fee' for new policies and a
'service fee' for renewal policies written by an agent.
The Agreement provided, when
terminated, the agent became entitled to
'extended *1390 earnings'
payments if all of the following conditions were met:
(1) the agent represented the Companies for not less
than five consecutive years immediately preceding
termination; (2) the agent had no less than 400 American
Family Mutual Casualty Fire and Health policies in force
at termination, and no less than fifty American Standard
policies in force at termination; (3) within ten days of
termination, the agent returned to the Companies all
policies and policy records, manuals, materials,
advertising, supplies or other property of the
Companies; and (4) the agent did not associate himself
in 'any sales or sales management capacity with another
insurer engaged in writing any of the kinds of insurance
written by the company....' The formula used to compute
extended earnings payments varied slightly among each of
the Companies. [FN3] In general, the extended earnings
payments were calculated based on a percentage of the
renewal service fees paid to the agent during the six-
or twelve-month period preceding the month the Agreement
terminated. The percentage was based upon the agent's
length of consecutive service for the Companies
immediately preceding termination of the Agreement. The
extended earnings were to be paid in equal monthly
installments over twelve to sixty months depending on
the total extended earnings.
FN3. For American Family
Mutual, the amount of extended earnings was computed
based on a percentage of renewal service fees paid to
the agent
during the twelve months
preceding the month of termination. The percentage of
renewal service fees was based on the agent's total
number of consecutive years of service prior to
termination as follows: (1) 50% for at least five years
but less than ten years of service; (2) 100% for at
least ten years but less than fifteen years of service;
and (3) 150% for fifteen years or more of service.
For American Standard, the
amount of extended earnings was computed based on a
percentage of renewal service fees paid to the agent
during the six months preceding the month the agreement
was terminated. The percentage of renewal service fees
was also based on the total number of consecutive years
of service but as follows: (1) 50% for at least five
years but less than ten years of service; and (2) 100%
for at least ten years of service.
On March 31, 1988, Mr.
Schelble terminated his Agreement with the Companies.
Mr. Schelble met the extended earnings' requirements and
elected to receive his extended earnings over thirty-six
months. Because he worked for the Companies for over
fifteen years, Mr. Schelble was entitled to 150% of his
renewal service fees paid to him by American Family
Mutual during the twelve- month period preceding the
month the Agreement was terminated, and 100% of his
renewal service fees paid to him by American Standard
during the six-month period preceding the month of
termination. Thus, Mr. Schelble was entitled to
receive $93,345.89, payable
in thirty-five monthly installments of $2,592.95 and a
last installment of $2,592.64. Mr. Schelble received
extended earnings payments from the Companies as
follows:
1988 $20,743.60
1989 31,115.40
1990 31,115.40
1991 10,371.49
----------
Total $93,345.89
Mr. Schelble reported the
extended earnings on Schedule D, Capital Gains and
Losses, as proceeds from the sale of an insurance agency
in his Federal income tax returns for 1989, 1990 and
1991.
The Commissioner of Internal
Revenue (the Commissioner) determined the extended
earnings were self-employment income subject to
self-employment tax under S> 1401 of the Internal
Revenue Code. On March 17, 1993, the Commissioner issued
a notice of deficiency for the Schelble's Federal income
tax for the taxable years 1989, 1990 and 1991. [FN4]
FN4. The notice of
deficiency made other adjustments to the Schelble's
Federal income tax relating
to and resulting from the additional self- employment
tax assessed, not relevant to this opinion.
On June 21, 1993, the
Schelbles filed a petition in the Tax Court seeking a
redetermination of deficiencies issued by the
Commissioner for taxable years 1989, 1990 and 1991. The
case was submitted with the facts fully stipulated.
*1391 Mr. Schelble contended
his extended earnings payments were not subject to
self-employment tax because: (1) the payments were not
sufficiently derived from his prior insurance business
to constitute self-employment income; and (2) the
payments were proceeds from the sale of his insurance
business, a capital asset not subject to self-employment
tax.
On June 12, 1996, the Tax
Court issued its decision holding the extended earnings
payments were self-employment income subject to
self-employment tax. See > Schelble v. Commissioner, 71
T.C.M. (CCH) 3166 (1996). The court reasoned the
extended earnings payments were sufficiently connected
with Mr. Schelble's prior insurance business to
constitute income 'derived from a trade or business'
within the meaning self-employment income under > 26
U.S.C. S 1402. > Id. In addition, the court rejected Mr.
Schelble's argument that the termination payments were
payments for the sale of his insurance business because
there was no express sales agreement nor evidence of
vendible business assets. > Id. Mr. Schelble appeals.
STANDARD OF REVIEW
> [1] We review Tax Court
decisions 'in the same manner and to the same extent as
decisions of the district courts in civil actions tried
without a jury.' > 26 U.S.C. S 7482(a)(1). We review
purely factual questions for clear error and purely
legal questions de novo. See > Hawkins v. Commissioner,
86 F.3d 982, 986 (10th Cir.1996). In the present case,
the parties dispute the Tax Court's conclusions after
applying the law to the undisputed facts. Therefore, we
review the Tax Court's application of the law de novo,
since we are ' 'equally as able as the tax court to draw
conclusions from the undisputed facts presented.' ' >
Anderson v. Commissioner, 62 F.3d 1266, 1270 (10th
Cir.1995) (citations omitted). The Schelbles have the
burden of proving the Commissioner's determination is
incorrect. See Tax Ct. R. Prac. & Proc. 142(a); > Welch
v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed.
212 (1933).
DISCUSSION
> [2][3] > Section 1401 of
the Internal Revenue Code imposes a tax on
self-employment income of every individual, in addition
to income tax. > 26 U.S.C. S 1401. [FN5] Self-employment
tax is designed to finance social security benefits paid
to self-employed individuals. See > Patterson v.
Commissioner, 740 F.2d 927, 929 (11th Cir.1984); S.REP.
NO. 81-1669, at 153- 163 (1950), reprinted in 1950
U.S.C.C.A.N. 3287. An independent insurance
agent generally is subject
to self-employment tax on self-employment income. See >
Erickson v. Commissioner, 64 T.C.M. (CCH) 963 (1992),
aff'd > 1 F.3d 1231 (1st Cir.1993) (unpublished table
opinion) (independent insurance agent subject to
self-employment tax on commission income); > Simpson v.
Commissioner, 64 T.C. 974, 983, 989, 1975 WL 3150 (1975)
(insurance agent was independent contractor subject to
self-employment tax).
FN5. All section references
are to the Internal Revenue Code in effect for the years
in issue.
> [4][5][6] The issue is
whether Mr. Schelble's extended earnings constitute
'self-employment income.' 'Self-employment income' means
'net earnings from self-employment.' > 26 U.S.C. S
1402(b). 'Net earnings from self-employment' is 'gross
income derived ... from any trade or business carried on
by such individual,' less allowable deductions. > 26
U.S.C. S 1402(a). [FN6] For income to be self-employment
income, 'there must be a nexus *1392 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). The 'income must arise
from some actual (whether present, past or future)
income-producing activity.' > Id. at 446. '[S]elf-employment
income is determined by the source of the income, not
the taxpayer's status at the time
the income is realized.' >
Shumaker v. Commissioner, 648 F.2d 1198, 1200 (9th
Cir.1981); see Treas. Reg. S 1.1402(a)-1(c)
(self-employment income may include payments received
from services provided in a prior taxable year). Capital
gains or losses are excluded from self-employment
income. See > 26 U.S.C. S 1402(a)(3)(A).
FN6. Under recently enacted
> 26 U.S.C. S 1402(k), termination payments received by
former insurance salespersons from insurance companies
after December 31, 1997 are excluded from
self-employment income if certain requirements are met,
including that the amount of such payment 'does not
depend to any extent on length of service or overall
earnings from services performed for such company
(without regard to whether eligibility for payments
depends on length of service).' Taxpayer Relief Act of
1997, Pub.L. No. 105-34, S 922, 111 Stat. 788, 879-880
(codified as > 26 U.S.C. S 1402(k)(4)(B)). However,
because Mr. Schelble's payments were received prior to
December 31, 1997, this section does not apply.
Mr. Schelble makes two
alternative arguments why his extended earnings payments
are not self-employment income: (1) the payments are not
sufficiently derived from his prior insurance business
because he received the payments for terminating his
relationship with the Companies; or (2) the payments are
for
sale of his insurance
business, generating capital gain excluded from self-
employment income. These are the same arguments Mr.
Schelble made to the Tax Court. We review each argument
in turn.
Payments Derived From Prior
Trade or Business
> [7] Mr. Schelble argues
his extended earnings payments did not 'derive' from a
trade or business within the definition of
self-employment income. Mr. Schelble relies on two
recent federal appellate decisions, > Milligan v.
Commissioner, 38 F.3d 1094 (9th Cir.1994), [FN7] nonacq.
1995-2 C.B. 1, and > Gump v. United States, 86 F.3d 1126
(Fed.Cir.1996), addressing similar issues of whether
termination or extended earnings payments received by
insurance agents after their termination 'derive' from a
trade or business. In > Milligan, the Court of Appeals
for the Ninth Circuit reversed the Tax Court's decision,
holding termination payments did not 'derive' from the
agent's prior insurance business so as to constitute
self-employment income. See > Milligan, 38 F.3d at
1098-99. Similarly, the Court of Appeals for the Federal
Circuit in > Gump reversed the Court of Federal Claims,
also holding extended earnings payments did not 'derive'
from the agent's insurance business. See > 86 F.3d at
1130. The Tax Court in Mr. Schelble's case refused to
apply > Milligan and > Gump because the payment schemes
in those cases are distinguishable from Mr. Schelble's
payment scheme. We agree and therefore do not decide
whether this circuit would follow > Milligan and
> Gump.
FN7. The Commissioner in Mr.
Schelble's case also calls our attention to > Jackson v.
Commissioner, 108 T.C. 130, 1997 WL 143922 (1997). In a
set of facts indistinguishable from > Milligan, the Tax
Court found the Ninth Circuit Court of Appeal's
reasoning in > Milligan persuasive and concluded
termination payments received by Mr. Jackson did not
constitute self- employment income subject to
self-employment tax. > Id.
In > Milligan, Mr. Milligan
was an independent contractor who sold insurance for
State Farm for thirty years. See > 38 F.3d at 1095-96.
Pursuant to his Agent's Agreement with State Farm, Mr.
Milligan was eligible to receive 'termination payments'
following his termination if he: (1) had two or more
years of service with the company; (2) returned all
State Farm property; and (3) refrained from competing
with State Farm companies for one year. See > id. at
1096. Mr. Milligan terminated his contract with State
Farm and complied with the conditions to receive
termination payments. See > id. For the first
post-termination year, the payments were calculated
based on a percentage of Mr. Milligan's commission
income generated during the twelve- month period
preceding the month the agreement was terminated. See >
id. The percentage applied to Mr. Milligan's commission
income had no relation to Mr.
Milligan's length of
service. See > id. The subsequent four years' payments
were based on a fraction of the amount payable in the
first post-termination year, less commission
charge-backs. [FN8] See > id. Although the Tax Court
*1393 found a sufficient nexus to characterize Mr.
Milligan's termination payments as self-employment
income, the Ninth Circuit Court of Appeals reversed. See
> id. at 1097-1100.
FN8. Commission charge-backs
are commissions paid on policies subsequently canceled.
The effect of the charge-back is to retroactively reduce
commissions paid but unearned.
The Ninth Circuit Court of
Appeals concluded Mr. Milligan's termination payments
did not derive from his prior insurance business because
the payments 'linked only to Milligan's previous status
as a two year-plus independent contractor for State
Farm.' > Id. at 1098. To be 'derived' from a trade or
business within the definition of self-employment
income, the Ninth Circuit required the earnings 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.' > Id. The court found no
other relevant connection between Mr. Milligan's
payments and his prior labor for State Farm other than
his status as two-year plus contractor. See > id. at
1098-99. Specifically, the court
noted the payments were not
deferred compensation because Mr. Milligan was fully
paid for commissions earned in prior years. See > id. at
1099. The amount of termination payments did not depend
on Mr. Milligan's length of service for State Farm,
other than the two-year service requirement to qualify.
See > id. at 1096. In addition, the court noted the
termination payments
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.
> Id. at 1099 (emphasis in
original). Thus, for all of these reasons, the court
concluded the termination payments were not 'tied to the
quantity or quality' of Mr. Milligan's prior trade or
business so as to constitute self- employment income.
See > id. at 1098.
In contrast to > Milligan,
Mr. Schelble's payments are tied to the quantity and
quality of his prior services performed for the
Companies. Although the payments in > Milligan and Mr.
Schelble's payments have similar eligibility
requirements such as (1) a minimum service requirement;
(2) relinquishment of company records and policies; and
(3) a covenant not to compete, Mr. Schelble's payments
have distinguishing features related to Mr. Schelble's
prior services. For example, unlike the plan in >
Milligan, Mr. Schelble must have 400 outstanding
policies at his termination to be eligible for extended
earnings payments. In addition, in contrast to >
Milligan, the amount of Mr. Schelble's payments was
computed based on Mr. Schelble's length of service for
the Companies. As an agent for the Companies for over
fifteen years, Mr. Schelble's extended earnings payments
were calculated using a higher percentage than if he had
only been an agent for five or ten years. Furthermore,
unlike the payments in > Milligan, Mr. Schelble's
extended earnings payments were calculated solely on the
percentage applied to service fees paid to him during
the twelve months preceding the Agreement's termination.
No adjustments unrelated to Mr. Schelble's prior
services were made in calculating these payments. Based
on these distinguishing factors, we conclude Mr.
Schelble's payments are sufficiently derived from his
prior insurance business to constitute self-employment
income subject to self-employment tax under > 26 U.S.C.
S 1401.
Mr. Schelble also relies on
> Gump, in which the Federal Circuit Court of Appeals
held extended earnings payments received by a Nationwide
insurance agent were not taxable as self-employment
income. See > 86 F.3d 1126. However, the payment scheme
in > Gump is nearly identical to that in > Milligan and
distinguishable from Mr. Schelble's payment *1394
scheme. For the same reasons we reject > Milligan, we
also find > Gump does not apply Mr. Schelble's case.
Mr. Schelble further
contends the right to extended earnings payments arises
from the cancellation of his relationship with the
Companies, [FN9] not from his prior business.
Nevertheless, the right to and amount of payments are
tied to the quantity of policies sold for the Companies,
the length of Mr. Schelble's prior service and the
amount of his prior commissions. Applying > Newberry to
these facts, we find there is a 'nexus between the
income received and a trade or business that is, or was,
actually carried on.' > 76 T.C. at 444.
FN9. If this were the only
consideration, then the payments derived from the
cessation of Mr. Schelble's business activity would
probably not be subject to self-employment tax. See >
Newberry, 76 T.C. at 446 (deciding insurance proceeds
compensating taxpayer for inability to operate destroyed
grocery were not self-employment income).
Proceeds From the Sale of
Goodwill
> [8] As an alternative
argument, Mr. Schelble contends his extended earnings
payments are proceeds from the sale of business
goodwill, a capital asset under > 26 U.S.C. S 1221.
Proceeds from the sale of a capital asset are excluded
from self-employment tax. See > 26 U.S.C. S
1402(a)(3)(A). By transferring policy records to the
Companies pursuant to the Agreement, Mr. Schelble
maintains he transferred insurance business goodwill
developed by him. Policy records and expiration lists
containing clients' names, policy expiration dates and
types of policies are generally treated as goodwill in
the insurance business because of their value to an
agent in continuing an established business and securing
renewals on existing policies. See > Marsh & McLennan,
Inc. v. Commissioner, 420 F.2d 667, 668 (3d Cir.1969); >
Morris v. Commissioner, 27 T.C.M. (CCH) 1558 (1968).
> [9] Mr. Schelble has
failed, however, to show a sale of assets occurred. 'A
sale of good will, for tax purposes, takes place '...
only when the business or a part of it, to which the
goodwill attaches is sold.' ' > Ellio |
