Federal Income Tax
Houston Tax Attorney
In Lendard v. Commissioner, T.C. Summary Opinion 2009-165, the U.S. Tax Court concluded that contract payment to an independent insurance agent to terminate his agent contract was ordinary income to the agent. This case is an example of how advanced tax planning could have produced a more favorable outcome.
Facts & Procedural History
Mr. Lendard was in the insurance industry.
He was a property and casualty insurance agent for Farmers.
Mr. Lendard signed a revised agreement (the 32-1106 contract) in 1987.
The 32-1106 contract, the “Agent’s Appointment Agreement,” appointed Mr. Lendard as “agent” for Farmers.
The 32-1106 contract obligated Farmers to: (1) Pay Mr. Lendard as an agent “new business and service commissions or any other commission” according to established schedules and (2) provide approved manuals, forms, and policyholder records necessary to carry out the provisions of the agreement.
It also obligated Mr. Lendard to (1) to sell insurance for Farmers in accordance with their rules and manuals; (2) to provide facilities necessary to furnish insurance services, including collecting and remitting money, receiving and adjusting claims, notifying the company of claims, and servicing all policyholders of Farmers; and (3) to permit the authorized representatives of Farmers to review and examine agency records.
On June 30, 2005, Mr. Lendard and Farmers terminated the 32-1106 contract. The contract value of the 32-1106 contract was $60,596 as of the termination date.
Mr. Lendard received $51,009.56 of the $60,596 in 2005.
Mr. Lendard did not report the $51,009.56 contract payment on his 2005 Federal income tax return.
Mr. Lendard agreed that the $51,009.56 contract payment was income that should have been reported in 2005, but he believed that it was capital in nature and not ordinary income. Mr. Lendard argued that he “sold” the agency, including goodwill of the business, to Farmers. According to Mr. Lendard, Farmers’ payment of the contract value was in exchange for the agency, “including the files, data, phone lines, etc.” and the “contractual non-compete clause.” Thus, Mr. Lendard asserted that the proceeds qualify for capital gain treatment.
The IRS argued that Mr. Lendard did not sell any property to Farmers; there was no transfer of title, so there could be no sale of a capital asset. Because Mr. Lendard sold no assets to Farmers, he could not have sold Farmers any goodwill.
So the issue was whether Mr. Lendard sold his business or simply went out of business. The tax consequences differ based for each, which is why taxpayers spend so much time and energy structuring the sale and termination of businesses. This is one area where tax advice is well worth the cost.
Mr. Lendard cited a prior court case in which the agent involved could terminate the agency, refuse to accept contract value, retain possession of policyholder files and records, and compete against Farmers for policyholder business. The court distinguished the facts in the current case on these grounds.
As such, the court upheld the IRS’s determination. It held that the contract payments were ordinary income for Mr. Lendard.Previous post: Deere & Company v. Commissioner: Foreign Branch Income is Gross Receipts for Research Tax Credit
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