## F I L E D United States Court of Appeals Tenth Circuit 

### NOV 26 1997 

### PATRICK FISHER Clerk PUBLISH UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

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

Appeal from the United States Tax Court (Tax Court No. 12747-93)
Richard Clark, Fort Collins, Colorado, for Petition ers-Appellants. Regina S. Moriarty (Bruce R. Ellisen with her on th e brief), Department of Justice, Washington, D.C. for Respondent-Appellee. Oren L. Connaway, Austin, Texas, filed briefs for amicus curiae Coalition of Exclusive Agent Associations, Inc.

Before BRORBY, McWILLIAMS and KELLY , Circuit Judges.

BRORBY , Circuit Judge.1 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 r emainder of the opinion will refer to Mr. Schelble only. -2- The sole issue in this case is whether "extended earnings" payments received by Mr. Schelble are subject to self-employ ment tax under 26 U.S.C. § 1401. The Tax Court concluded the payments were subject to self-employment tax. Robert Schelble and Susan Schelble 1 appeal the Tax Court's order upholding the Commissioner of Internal Revenue's determinatio n 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. § 7482(a)(1). We affirm.

BACKGROUND Mr. Schelble was an independent insurance agent forAmerican 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 A gent's Agreement ("the Agreement") with each of the Companies. The Agreem ent defined the relationship between and obligations of Mr. Schelbl e and the Companies.2The commissions are also referred to as a "sales fee" for new policies and

a "service fee" for renewal policies written by an agent. -3- Pursuant to the Agreement, Mr. Schelble sold and se rviced insurance policies on behalf of the Companies. The Agreement specified M r. Schelble was an independent contractor for the Companies. The Comp anies agreed to pay insurance commissions 2 to Mr. Schelble based on percentages of premiums o n new and renewal policies sold by him. The commissi ons 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 Agr eement by giving written notice.

The Agreement provided, when terminated, the agent became entitled to "extended earnings" payments if all of the followin g conditions were met: (1) the agent represented the Companies for not less than f ive consecutive years immediately preceding termination; (2) the agent ha d 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 Comp anies all policies and policy records, manuals, materials, advertising, supplies or other property of the Companies; and (4) the agent did not associate hims elf in "any sales or sales3 For American Family Mutual, the amount of extende d earnings was

computed based on a percentage of renewal service f ees paid to the agent during the twelve months preceding the month of terminatio n. 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 te n 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 earni ngs was computed based on a percentage of renewal service fees paid to the agent during the six months preceding the month the agreement was termin ated. The percentage of renewal service fees was also based on the total nu mber 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. -4- management capacity with another insurer engaged in writing any of the kinds of insurance written by the company ...." The formulaused to compute extended earnings payments varied slightly among each of the Companies. 3 In general, the extended earnings payments were calculated based ona 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 imm ediately preceding termination of the Agreement. The extended earning s were to be paid in equal monthly installments over twelve to sixty months de pending on the total extended earnings.

On March 31, 1988, Mr. Schelble terminated his Agre ement with the-5-

Companies. Mr. Schelble met the extended earnings' requirements and elected to receive his extended earnings over thirty-six month s. 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 FamilyMutual during the twelvemonth period preceding the month the Agreement was terminated, and 100% of his renewal service fees paid to him by American St andard during the six-month period preceding the month of termination. Thus, M r. 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 receiv ed 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 Sche dule D, Capital Gains and Losses, as proceeds from the sale of an insuran ce agency in his Federal income tax returns for 1989, 1990 and 1991. The Commissioner of Internal Revenue (the Commissio ner) determined the extended earnings were self-employment income subje ct to self-employment tax under § 1401 of the Internal Revenue Code. On Marc h 17, 1993, the4The notice of deficiency made other adjustments t o the Schelble's Federal

income tax relating to and resulting from the addit ional self-employment tax assessed, not relevant to this opinion. -6- Commissioner issued a notice of deficiency for the Schelble's Federal income tax for the taxable years 1989, 1990 and 1991. 4

On June 21, 1993, the Schelbles filed a petition in the Tax Court seeking a redetermination of deficiencies issued by the Commi ssioner for taxable years 1989, 1990 and 1991. The case was submitted with the facts fully stipulated.

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 sel f-employment income; and (2) the payments were proceeds from the sale of his ins urance business, a capital asset not subject to self-employment tax.

On June 12, 1996, the Tax Court issued its decisionholding the extended earnings payments were self-employment income subje ct to self-employment tax. See Schelble v. Commissioner , 71 T.C.M. (CCH) 3166 (1996). The court reasoned the extended earnings payments were suffic iently connected with Mr. Schelble's prior insurance business to constitute i ncome "derived from a trade or-7-

business" within the meaning self-employment income under 26 U.S.C. § 1402. Id. In addition, the court rejected Mr. Schelble's ar gument that the termination payments were payments for the sale of his insuranc e business because there was no express sales agreement nor evidence of vendible business assets. Id. Mr. Schelble appeals.

STANDARD OF REVIEW We review Tax Court decisions "in the same manner a nd to the same extent as decisions of the district courts in civil action s tried without a jury." 26 U.S.C. § 7482(a)(1). We review purely factual questions f or 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 th e Tax Court's conclusions after applying the law to the undisputed facts. Therefor e, we review the Tax Court's application of the law de novo, since we are "'equa lly as able as the tax court to draw conclusions from the undisputed facts presente d.'" Anderson v. Commissioner , 62 F.3d 1266, 1270 (10th Cir. 1995) (citations om itted). The Schelbles have the burden of proving the Commission er's determination is incorrect. See Tax Ct. R. Prac. & Proc. 142(a); Welch v. Helvering , 290 U.S. 111, 115 (1933).5 All section references are to the Internal Revenu e Code in effect for the

years in issue. -8- DISCUSSION Section 1401 of the Internal Revenue Code imposes atax on selfemployment income of every individual, in addition to income tax. 26 U.S.C. § 1401. 5 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
. N O . 81-1669, at 153-163 (1950), reprinted in 1950 U.S.C.C.A.N. 3287. An independent insurance agent generally is subject to selfemployment 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 se lf-employment tax on commission income); Simpson v. Commissioner , 64 T.C. 974, 983, 989 (1975) (insurance agent was independent contractor subjectto self-employment tax).

The issue is whether Mr. Schelble's extended earnin gs constitute "selfemployment income." "Self-employment income" means "net earnings from selfemployment." 26 U.S.C. § 1402(b). "Net earnings f rom self-employment" is "gross income derived ... from any trade or busines s carried on by such6Under recently enacted 26 U.S.C. § 1402(k), termi nation payments

received by former insurance salespersons from insu rance companies after December 31, 1997 are excluded from self-employmentincome if certain requirements are met, including that the amount of such payment "does not depend to any extent on length of service or overal l earnings from services performed for such company (without regard to wheth er eligibility for payments depends on length of service)." Taxpayer Relief Ac t of 1997, Pub. L. No. 105-34, § 922, 111 Stat. 788, 879-880 (codified as 26 U.S.C . § 1402(k)(4)(B)). However, because Mr. Schelble's payments were received priorto December 31, 1997, this section does not apply. -9- individual," less allowable deductions. 26 U.S.C. § 1402(a). 6 For income to be self-employment income, "there must be a nexus betw een the income received and a trade or business that is, or was, actually carri ed on." Newberry v. Commissioner , 76 T.C. 441, 444 (1981). The "income must arise from some actual (whether present, past or future) income-pro ducing activity." Id . at 446. "[S]elf-employment income is determined by the sour ce of the income, not the taxpayer's status at the time the income is realize d." Shumaker v. Commissioner , 648 F.2d 1198, 1200 (9th Cir. 1981); see Treas. Reg. § 1.1402(a)-1(c) (selfemployment income may include payments received fro m services provided in a prior taxable year). Capital gains or losses are e xcluded from self-employment income. See 26 U.S.C. § 1402(a)(3)(A).

Mr. Schelble makes two alternative arguments why hi s extended earnings payments are not self-employment income: (1) the p ayments are not sufficiently7The Commissioner in Mr. Schelble's case also call s our attention to

Jackson v. Commissioner , 108 T.C.130 (1997). In a set of facts indistingu ishable from Milligan , the Tax Court found the Ninth Circuit Court of Ap peal's reasoning in Milligan persuasive and concluded termination payments rece ived by Mr. Jackson did not constitute self-employment income s ubject to self-employment tax. Id. -10- derived from his prior insurance business because h e 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 Mr. Schelble argues his extended earnings payments did not "derive" from a trade or business within the definition of self-e mployment income. Mr. Schelble relies on two recent federal appellate dec isions, Milligan v. Commissioner , 38 F.3d 1094 (9th Cir. 1994), 7 nonacq . 1995-2 C.B. 1, and Gump v. United States , 86 F.3d 1126 (Fed. Cir. 1996), addressing similarissues of whether termination or extended earnings payments r eceived by insurance agents after their termination "derive" from a trade or bu siness. In Milligan , the Court of Appeals for the Ninth Circuit reversed the Tax Court's decision, holding termination payments did not "derive" from the agen t's prior insurance business so-11-

as to constitute self-employment income. See Milligian , 38 F.3d at 1098-99. Similarly, the Court of Appeals for the Federal Cir cuit in Gump reversed the Court of Federal Claims, also holding extended earn ings 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 wheth er this circuit would follow Milligan and Gump

.

In Milligan , Mr. Milligan was an independent contractor who so ld 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 St ate Farm and complied with the conditions to receive termination payments. See id. For the first posttermination year, the payments were calculated base d 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 percentage8Commission charge-backs are commissions paid on p olicies subsequently

canceled. The effect of the charge-back is to retr oactively reduce commissions paid but unearned. -12- 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 ona fraction of the amount payable in the first post-te rmination year, less commission charge-backs. 8 See id. Although the Tax Court found a sufficient nexus t o characterize Mr. Milligan's termination payments as self-employment income, the Ninth Circuit Court of Appeals reversed. See id. at 1097-1100.

The Ninth Circuit Court of Appeals concluded Mr. Mi lligan's termination payments did not derive from his prior insurance bu siness 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, th e 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 work s 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 pay ments were not deferred compensation because Mr. Milligan was fully paid fo r commissions earned in-13-

prior years. See id. at 1099. The amount of termination payments did n ot 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 b usiness activity because the Termination Payments were subject to tw o adjustments unrelated

to any business activity on Milligan's part for St ate Farm. The State Farm companies adjusted the Termination P ayments to reflect the amount of income received on Milligan's book of business during the first post-termination year, and the num ber of his personally-produced policies cancelled during that year. If all of Milligan's customers had cancelled their State Farmnon-life policies during the first post-termination year, then Millig an would have received nothing. The adjusted payment amount depe nded notupon Milligan's past business activity, but upon the suc cessor agent's future business efforts to retain Milligan's custom ers 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 t o the quantity or quality" of Mr. Milligan's prior trade or business so as to con stitute 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 eligibili ty requirements such as (1) a minimum service requirem ent; (2) relinquishment of-14-

company records and policies; and (3) a covenant no t 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 exte nded 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 t he payments in Milligan , Mr. Schelble's extended earnings payments were calculat ed solely on the percentage applied to service fees paid to him during the twel ve 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 su fficiently derived from his prior insurance business to constitute self-employm ent income subject to selfemployment tax under 26 U.S.C. § 1401.

Mr. Schelble also relies on Gump , in which the Federal Circuit Court of Appeals held extended earnings payments received bya Nationwide insurance agent were not taxable as self-employment income. See 86 F.3d 1126. However,9If this were the only consideration, then the pay ments derived from the

cessation of Mr. Schelble's business activity wouldprobably not be subject to self-employment tax. See Newberry , 76 T.C. at 446 (deciding insurance proceeds compensating taxpayer for inability to operate dest royed grocery were not selfemployment income). -15- the payment scheme in Gump is nearly identical to that in Milligan and distinguishable from Mr. Schelble's payment 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 extendedearnings payments arises from the cancellation of his relationship wi th the Companies, 9 not from his prior business. Nevertheless, the right to and amo unt of payments are tied to the quantity of policies sold for the Companies, the le ngth of Mr. Schelble's prior service and the amount of his prior commissions. Applying Newberryto 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.

Proceeds From the Sale of Goodwill As an alternative argument, Mr. Schelble contends h is extended earnings payments are proceeds from the sale of business goo dwill, a capital asset under 26 U.S.C. § 1221. Proceeds from the sale of a capital asset are excluded from selfemployment tax. See 26 U.S.C. § 1402(a)(3)(A). By transferring policyrecords10The disputed payments in Killian were made pursuant to an express sale

of Mr. Killian's personal insurance business. 314 F.3d at 853-54. Kenney addressed payments under "An Agency Termination andBusiness Purchase -16- to the Companies pursuant to the Agreement, Mr. Sch elble maintains he transferred insurance business goodwill developed b y him. Policy records and expiration lists containing clients' names, policy expiration dates and types of policies are generally treated as goodwill in the i nsurance business because of their value to an agent in continuing an establishe d 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).

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. '" Elliott v. United States , 431 F.2d 1149, 1154 (10th Cir. 1970) (citations omitted ). Mr. Schelble cites Commissioner v. Killian , 314 F.2d 852 (5th Cir. 1963), and Kenney v. Commissioner , 37 T.C. 1161 (1962), to support his theory the "e xtended earnings" payments constitute proceeds from the sale of goodw ill. These cases do not assist Mr. Schelble. Unlike Mr. Schelble's situation, the facts in both cases involved an express sales agreement and evidence of vendible as sets. 10 Although this courtAgreement" expressly referring to payments for the purchase of Mr. Kenney's

insurance business along with a covenant not to compete. 37 T.C. at 1164-65. -17- may view "the substance, not the form, of the trans action," Commissioner v. Hansen , 360 U.S. 446, 461 (1959), there is no evidence in the record of vendible assets to support the sale of Mr. Schelble's insurance business, nor does Mr. Schelble's Agreement's contain any language referen cing a contract of sale. In addition, at oral argument, Mr. Schelble could not provide a basis in the record to allocate extended earnings payments under the Agree ment as proceeds for the sale of goodwill. We agree with the Tax Court; Mr. Sche lble failed to meet his burden of proof.

In Erickson v. Commissioner , 64 T.C.M. (CCH) 963 (1992), aff'd 1 F.3d 1231 (1st Cir. 1993) (unpublished table opinion), the Tax Court rejected a similar argument that payments received under a settlement agreement represented a sale because the record "contain[ed] no express sales ag reement, nor [did] it contain evidence of vendible business assets." Id. We find the reasoning in Erickson persuasive.

The word "sale" means "'a transfer of property for a fixed price in money or its equivalent,' Iowa v. McFarland, 110 U.S. 487, 478 [1885]; it is a contract 'to-18-

pass rights of property for money, -- which the buy er pays or promises to pay to the seller [for the thing bought and sold].' Williamson v. Berry , [49 U.S. 495], 8 How. 495, 544 [1850]." Commissioner v. Brown , 380 U.S. 563, 571 (1965). Mr. Schelble's Agreement contained no language indicati ng it was a contract for the purchase of his business. The Agreement does not r efer to a seller, buyer or specific property to be sold. The Agreement provid es "all copies of policies, endorsements, and policy records, manuals, material s, and supplies furnished by the agent by the Company shall be and shall remain the property of the Company and the agent shall be deemed the bailee thereof fo r the use and benefit of the company." This language does not in any way refer to a sale. The Agreement does not refer to a definite purchase price nor doe s it provide a basis of allocation of payments to a purchase price of assets. There i s no indication the parties intended to treat the payments as a sale of an asse t.

Although Mr. Schelble may have intended to treat so me or all of the payments as a purchase of his insurance business, o nce having accepted the Agreement in its form, he "must accept the tax cons equences of his choice, whether contemplated or not, ... and may not enjoy the benefit of some other route he might have chosen to follow but did not." Commissioner v. National Alfalfa Dehydrating & Milling Co. , 417 U.S. 134, 149 (1974) (citations omitted); see also-19-

McCoy Enters., Inc. v. Commissioner , 58 F.3d 557, 561-62 (10th Cir. 1995). Despite Mr. Schelble's claim that goodwill was deve loped by his work and transferred to the Companies, the evidence in the r ecord fails to support the sale of an asset. We affirm the Tax Court's ruling the extended earnings payments were not proceeds from the sale of goodwill.

CONCLUSION Accordingly, the judgment of the United States Tax Court is AFFIRMED

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