652 / How are the commissions, including insurance commissions, of a sales representative taxed?
Commissions are generally taxable as ordinary income in the year received, regardless of whether the taxpayer is on a cash or accrual method of accounting, or whether the taxpayer has a contingent obligation to repay them. Commissions on insurance premiums, however, are subject to special rules. (See Q 3519 regarding the limitation on certain employers’ deductions.)
General rule for insurance commissions. First year and renewal commissions are taxable to the agent as ordinary income in the year received. If the agent works on commission with a drawing account, the amount the agent reports depends upon the contract with the company. In a technical advice memorandum, the IRS determined that cash advances made to an insurance sales agent were income in the year of receipt where there was no unconditional obligation to repay the advances, and any excess in advances over commissions earned were recoverable by the insurance company only by crediting earned commissions and renewals against such advances.1 This position is consistent with other IRS rulings and prior case law.2
On the other hand, if the drawing account is a loan repayable by the agent (or upon which the agent remains personally liable) if the agent leaves, only commissions actually received are treated as income. To this point, in a Tax Court memorandum opinion, the Tax Court held that advance commissions received by an agent that were repayable on demand, bore interest and were secured by earned commissions, as well as by the personal liability of the agent, were not taxable compensation to the agent.3