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Residual commission income is self employment income?

Technical topics regarding tax preparation.
#1
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Client is an insurance agent who separated from his agency, but his contract provided a residual commission to be paid to him for five years based on the ongoing earnings of his book of business in place at the time he left. He has since opened his own agency targeting a non-competitive client base. Would the residual payments received be considered self-employment income?
 

#2
HowardS  
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Check 1402(k)
Not SE if all conditions are met.
I suffer from depreciation.
 

#3
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**A Challenge** So I read Code Section 1402(k) but I got so totally distracted by the frequent repetitive insistent machine-gun-like use [overuse?] of the word "such" that I couldn't focus on the substance of the provision.

Here's the challenge: Can anyone here locate a definition of the word "such" as it is being used in this Code section? I don't want an example, I want a definition. I have done my homework, looking up the word and its use in dictionaries and grammar and usage manuals and similar such resources, but I have found only one "definition" for this use of the word and such definition wasn't really a definition, it was more an example.

(1) such amount is received after termination of such individual’s agreement to perform such services for such company,
(2) such individual performs no services for such company after such termination and before the close of such taxable year,
(3) such individual enters into a covenant not to compete against such company which [Why not "and such covenant"] applies to at least the 1-year period beginning on the date of such termination, and....

A similar use of "such" is also found in IRC Section 163(h)(3)(C)(i)(II) in the definition of what needs to be the security for a borrowing for interest on such borrowing to be considered home mortgage interest or something like that. And, as I recall, we did not resolve it when it was brought up in this forum in that context... :shock: :x :shock:
 

#4
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Spell Czech wrote:Can anyone here locate a definition of the word "such" as it is being used in this Code section? I don't want an example, I want a definition.


Such. Of that kind, having particular quality or character specified. Identical with, being the same as what has been mentioned. Alike, similar, of the like kind. "Such" represents the object as already particularized in terms which are not mentioned, and is a descriptive and relative word, referring to the last antecedent.


Black's Law Dictionary
 

#5
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I am not sure if Rev. Rul. 54-309 is still good law, but it says: "the commissions (including deferred or renewal commissions) paid to [a life insurance salesman] constitute earnings from self-employment for purposes of the self-employment tax."
 

#6
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Thanks, tb, but in Section 1402(k) I think "such" is being used to mean *that one* rather than "Of that kind, having particular quality or character specified. Identical with, being the same as what has been mentioned. Alike, similar, of the like kind" as it's described in Black's Law. See the difference?

IRC 1402(k) could just as easily have used "the" "that" or "those" rather than "such" and avoided the ambiguity, IMO, that's introduced by using "such" in most of those places...

Maybe the Section 163(h) use of the word can be used to illustrate:
(i) In general
The term “acquisition indebtedness” means any indebtedness which—
(I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and
(II) is secured by such that residence.


If 163(h) said "that residence" rather than "such residence" do you see how a possible ambiguity might be avoided?

Try it in Section 1402, just for fun:
(1) that amount is received after termination of that individual’s agreement to perform those services for that company,
(2) that individual performs no services for that company after the termination and before the close of the taxable year,
(3) such individual enters into a covenant not to compete against that company which applies to at least the 1-year period beginning on the date of the termination, and
Last edited by Spell Czech on 10-Oct-2019 4:36pm, edited 4 times in total.
 

#7
HowardS  
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Rev. Rul. 54-309 addresses a currently employed insurance salesman, a statutory employee. OP is asking about residuals earned from his previous employment.
I suffer from depreciation.
 

#8
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Thank you HowardS, that's what I was looking at too, just wanted to make sure I was reading it correctly.
 

#9
Dennis2  
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SSA looks to origin. SSR 71-22: SECTION 203 https://www.ssa.gov/OP_Home/rulings/oas ... si-29.html
 

#10
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Is SSA's SSR 71-22 (the ruling linked just above) even relevant in determining whether the earnings in the OP are subject to IRC Section 1401's self-employment tax?
 

#11
dave829  
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Schelble, T.C. Memo. 1996-269, aff’d. 130 F.3d 1388 (10th Cir. 1997), ruled that residual commissions paid to a former insurance agent were subject to SE tax, but that was before 1402(k) was enacted. HowardS referred to this section in #2, above.

Now, the challenge is to satisfy 1402(k)(4)(B), which requires the amount of the payment not to “depend to any extent on the individual's length of service or overall earnings from services” that the insurance salesman performed for the company. For renewal commissions, this is virtually impossible, and a few Tax Court cases have said so:

Geneser, T.C. Memo. 2017-110
https://www.ustaxcourt.gov/UstcInOp/Opi ... x?ID=11277

Lenard, T.C. Summary Opinion 2009-165
https://www.ustaxcourt.gov/UstcInOp/Opi ... px?ID=8791

Gilbert, T.C. Summary Opinion 2005-176
https://www.ustaxcourt.gov/UstcInOp/Opi ... px?ID=6664
 

#12
Dennis2  
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Is SSA's SSR 71-22 (the ruling linked just above) even relevant in determining whether the earnings in the OP are subject to IRC Section 1401's self-employment tax?


Looking to origin is a consistent IRC position. Considering the residual commissions as effectively earned when the original policies were sold and the resulting income in later years of the same nature as it would have been then makes a lot of sense to me. Can't see SSA adopting a position contrary to IRS but who knows?
 

#13
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Seems to me that the *purpose* of the SSA definition has nothing to do with the taxation of the income, while IRS's definition is all about its taxation. I think they're two different definitions for two different purposes. Whaddya think?
 

#14
Dennis2  
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Your assumption is wrong. SSA is saying residual commissions earned as wages are treated as wages and those earned as a self employed individual are considered self employment income. My point essentially is that this determination is unlikely to have been taken in a vacuum and totally consistent with fundamental IRC positions.

"For purpose of work deductions" seems taxation related, no?
 

#15
HowardS  
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For renewal commissions, this is virtually impossible, and a few Tax Court cases have said so:

Totally agree, 1402(k)(4)(B) should make it very difficult to escape FICA where the commissions have the same character as the original and are not severance-like payments as in the Milligan appeal.
I suffer from depreciation.
 

#16
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Dennis2 pointed out, somewhat rhetorically,
"For purpose of work deductions" seems taxation related, no?
to which I would say "No, it doesn't seem taxation related" and I would point out that upon reading SSA's Ruling SSR 71-22, I discovered that by its own terms the SSA Ruling asserts that it is "For purposes of work deductions under section 203 [of the Social Security Act]...." And I know that Section 203 of the Social Security Act has *nothing whatsoever* to do with determining whether income is self-employment income for purposes of Internal Revenue Code Section 1401.

And as pointed out somewhere above in this thread, IRC Section 1402(g) is relatively recent [1996, thank you Dave829] compared to SSA's Ruling 71-22 [1971, I would guess]. Maybe it, the SSA ruling, was written in a vacuum, and then 25 years later, along came IRC Section 1402(g) which … let oxygen (or whatever) into the vacuum! ;)

[Afterthought: I believe the "work deductions" referred to in the SSA Ruling are the reductions in the amount of money a Social Security retiree is entitled to receive during "retirement" when he or she makes money by working. These aren't "deductions" in the IRS sense, these are *reductions* in the actual Social Security benefits-to-be-paid sense. I sure hope I haven't assumed anything here. :lol: ]
 

#17
Dennis2  
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Actually the referred deductions relate to the net amount of income on which the tax is computed. Essentially work related expense does not reduce gross wages.

Look...I realize that the SSA ruling is not completely on point...but it does emphasize Arrowsmith. The continuation of the character of income is fundamental to the why of the tax code

(4)the amount of such payment—
(A)depends primarily on policies sold by or credited to the account of such individual during the last year of such agreement or the extent to which such policies remain in force for some period after such termination, or both, and
(B)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 payment depends on length of service).

Not sure of the why the significance of the "last year", and I would like to know the reason behind the specificity, but at best it would affect a small portion of the self employed salesman's residual earnings and any relief from self employment tax would not change the character of his income or the fact that the right to that (or such if you prefer) income is earned when the policy is sold.
 

#18
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Subtle, nuanced asides such as yours give such a rush to a person such as I. ;)
And what's more (but not "once more"), on top of that, nobody's given me crap about my mistaken reference (twice) to Section 1402(g) of the IRC, which references should have been to 1402(k)...
 

#19
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In SSA's Ruling SSR 71-22, isn't there a typo in the very first paragraph, where it says

"The purpose of this ruling is to update SSR 64-57, C.B. 1964, p. 68, restating the position set forth therein under the current provisions of section 302 of the Social Security Act (42 U.S.C. 403)."
...shouldn't that be "section 203" rather than "section 302"?

And then, also, in a later paragraph [5 or 6], where the ruling says

"...the last act required to entitle him to fist-year commissions."
...is that just another typo?

:o :lol: :o
 


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