8735 / Are there any circumstances where an insurance agent’s commissions may be taxable to a company rather than to the agent?

Where an individual agent owns or controls a corporation which is related to the agent’s insurance activities, questions may arise as to the proper allocation of income and deductions between the individual and his corporation.

Typically, income is taxed to the individual who earns it, and the income earner cannot avoid the result by assigning income or the right to receive it either before or after the income has been earned.¹

In one situation, a life insurance agent assigned his commissions to his wholly owned pension consulting corporation, for which he worked as an employee. He did not (could not, under the insurer’s rules) assign his agency contract. Since neither the corporation nor any of its other employees were authorized under the contract to submit applications, none of them had the right under the contract to earn commissions. All applications developed through the sales efforts of all employees were submitted through the agent and the insurance company paid the commissions under the assignment to the consulting firm. The IRS considered the arrangement an assignment of future income and ruled that the commissions were includable in the agent’s gross income.

However, the agent was allowed to deduct (as a business expense) a part of the assigned commissions. Since the services of other employees of the corporation helped produce the commissions, part of the assigned commissions was treated as compensation to the corporation for its services and taxed to the corporation. The balance of the assigned commissions was treated as contributions to capital instead of income.²

The IRS distinguished this situation from one in which the corporation was held to have earned the income,³ because there the agreements between the agent and insurance company were assigned to the corporation.

In another case, a corporate life insurance agency tried to assign a contract to service a group medical insurance plan to its subsidiary, also an insurance agency. The parent corporation assigned the insurance commissions and service fees to the subsidiary, as well. However, the parent agency continued to perform all services to the group plan under the agreement, used its own office facilities and employees and paid all operating expenses. The subsidiary was unable to perform the agreement because of lack of staff, equipment and financing.

The Tax Court held that the parent earned the fees and commissions since it performed the services, and the subsidiary was unable to perform them. The parent agency argued that the assignment was of the agreement, as distinguished from the income. The argument failed because the parent was unable to submit proof. However, the court suggested that it would be hard to show an actual assignment of the agreement in view of the nature of the agreement, since it was one calling for performance of future services which the alleged assignee would be unable to perform.⁴

In Davidson v. Commissioner, the taxpayer was a successful salesman who specialized in estate planning sales. He formed a corporation to which he sold his insurance business, including all assets and good will, and provided in the instrument of transfer that all business done by him thereafter would be done for the benefit of the corporation. The taxpayer was to turn over to the corporation all of his first year commissions, keep his renewal commissions and be paid a salary as general manager of the corporation. The corporation carried on estate planning services acting through agents and employees other than the taxpayer, though the taxpayer worked jointly with some of these agents and personally received all commissions not retained by the other agents. The taxpayer endorsed over to the corporation commissions received by him pursuant to his agreement with the corporation, and did not include the commissions in his gross income, but did include them in the corporation’s gross income in its return.⁵

Despite all these elaborate arrangements, the Tax Court held that all the commissions received by the taxpayer were taxable to him personally, not to the corporation. The court also rejected the taxpayer’s argument that the commissions endorsed over to the corporation should be considered payments for services rendered by the corporation, and thus deductible as a business expense. The court held that the only amount deductible on such a basis would be an amount considered reasonable payment for such services had the taxpayer and the corporation bargained at arm’s length.

In American Savings Bank v. Comm., two individuals formed an insurance partnership authorized to solicit mortgage and credit life insurance in connection with loans made by banks in which they had interests. Insurance was sold on the bank premises primarily by officers of the banks who were individually licensed as insurance agents. By agreement between the partnership and the agents, commissions were divided 50-50 between the agents and the partnership. Later, the insurance business which, to that point, had been conducted as a partnership, was transferred to a corporation formed by the two partners. Commissions thenceforth were divided between the corporation and the agents just as had been done between the partnership and the agents. The issue in the case was whether the commissions received by the corporation were taxable to the corporation or to the two individuals.⁶

The court examined all surrounding facts and circumstances, and concluded that control over the company’s earnings rested with the corporation. The court noted that nearly all commissions were generated by other agents of the company and the contracts authorizing sales of insurance were with the corporation rather than with the individuals. Therefore, the commissions were taxable to the corporation rather than to the two individuals.

In Shaw v. Comm., the taxpayer owned and managed two corporations. He was also licensed as an insurance agent to sell credit life and health insurance to customers of his companies. Insurance was sold by employees to the corporations and applications were submitted in the taxpayer’s name. Commissions on the insurance sold were paid to the taxpayer, who in turn endorsed the checks over to the corporations. In reaching its determination whether the commissions should be taxed to the taxpayer or to his corporations, the court first observed that the result would not be affected by the fact that, under state law, the corporations were prohibited from acting as insurance agents. Such a circumstance would not prevent the court from finding that the corporations should be taxed on the commissions if it determined that the corporations were actually in control of the insurance-selling enterprise. However, the court believed the facts of the case indicated that the taxpayer “was himself in the insurance business (admittedly to benefit his corporations) and used the corporations as his agents in the carrying out of the business of selling insurance.” The court found, therefore, that the taxpayer, not his corporations, had earned the commission income and was liable for the taxes associated with it. However, the court recognized the fact that the corporations had performed services and expended funds in producing the insurance, and so allowed the taxpayer to deduct a large part of the commissions turned over to the corporations as a business expense.⁷