T.C. Memo. 2002-305

UNITED STATES TAX COURT

EDGAR L. AND JOAN H. PARKER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5732-01. Filed December 16, 2002.

P, self-employed, worked under contract as a

district manager for F, a group of insurance companies. 

F canceled P’s contract and paid P an amount designated

“Contract Value”, based on the quantity (length of

service) and quality (final 6 months’ earnings) of the

services rendered by P to F. P failed to pay selfemployment tax with respect to the Contract Value,

claiming that it constituted a capital gain.

Held: The contract value is subject to the tax on

self-employment income and is not capital gain.

Robert B. Alexander, for petitioners.

Donna M. Palmer, for respondent.
- 2 -

MEMORANDUM OPINION

HALPERN, Judge: By notice of deficiency dated February 22,

2001 (the notice), respondent determined deficiencies in

petitioners’ Federal income taxes of $58,127, $22,433, and

$11,221 for their taxable (calendar) years 1996, 1997, and 1998,

respectively.

The issue for decision is whether certain payments received

by petitioner Edgar L. Parker (petitioner) are ordinary income

subject to self-employment taxation or are capital gains income,

which is not subject to self-employment taxation. We conclude

that the payments are ordinary income subject to self-employment

taxation.

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years at issue.

Some facts have been stipulated and are so found. The

stipulation of facts, with accompanying exhibits, is incorporated

herein by this reference. We need find few facts in addition to

those stipulated and shall not, therefore, separately set forth

our findings of fact. We shall make additional findings of fact

as we proceed.

Background

At the time the petition was filed, petitioners resided in

Kingwood, Texas. 
- 3 -

On September 1, 1985, petitioner, previously an insurance

agent, was appointed a district manager by a group of insurance

companies, Farmers Insurance Companies (the companies). To

accomplish the appointment, petitioner and the companies executed

a document entitled “District Manager’s Appointment Agreement”

(the agreement). As a district manager, petitioner could not

personally sell insurance policies but recruited, trained, and

supervised agents within his district to do so. As a district

manager, petitioner was not treated as an employee by the

companies.

Pursuant to the agreement, petitioner received a service

commission overwrite on all business produced by the companies’

agents within his district. A service commission overwrite is a

specified commission paid to a district manager based on each

insurance policy sold and on renewals of policies sold by the

supervised agents. The agreement states that either the

companies or petitioner can cancel it on 30 days’ written notice,

and any service commission overwrites unpaid as of the date of

cancellation are deemed unearned, with petitioner’s rights with

respect to such commissions being deemed waived. 

Petitioner had completed 11 years of service as a district

manager when he received written notice that the companies were

canceling the agreement. The agreement was canceled as of
- 4 -

September 16, 1996. In part, the agreement provides the

following with respect to cancellation:

E. In the event of cancellation * * * of the agency

created hereby for any reason whatsoever, * * *

(1) the Companies may at their option elect to pay

“Contract Value”, as hereinafter defined, to the

District Manager, his/her personal representative

or heirs, or (2) the Companies agree to give

consideration to a written nomination of his/her

successor by the District Manager, or in case of

the District Manager’s death, by his/her heirs or

personal representative, provided such nominee is

in all respects acceptable to the Companies.

If the Companies do not elect to pay “Contract

Value” it is agreed that the District Manager, or

his/her heirs or personal representative, may

negotiate with such nominee for compensation in an

amount not exceeding “Contract Value” for the

nomination and the District Manager’s interest

under his/her Appointment Agreement. * * *

* * * * * * * 

CONTRACT VALUE

“Contract Value” will be based upon (1) the service

commission overwrite paid to the District Manager

during the six months immediately preceding

termination, and (2) the number of years of service as

District Manager for the Companies in this district all

in accordance with the following schedule:

SCHEDULE

* * * * * * *

7. 10 or more years as a District Manager-–5 times

the last 6 months’ service commission overwrite.

* * * * * * *

Payment of “Contract Value” by either the Companies or

the nominee will be based on the following schedule:
- 5 -

* * * * * * *

E (7) Above – Four equal semi-annual installments.

* * * * * * *

The District Manager agrees to transfer and assign all

of his/her interest under the District Manager

Appointment Agreement and his/her agency to the nominee

acceptable to the Companies, or to the Companies

themselves in the event they elect to pay the “Contract

Value” as hereinabove provided, and further agrees that

for a period of three years from date of said

cancellation * * * he/she will neither directly nor

indirectly in any manner solicit, accept or service,

for or on behalf of himself/herself or any insurer or

broker, the insurance business of any policyholder of

any of the Companies within the County or Counties in

which the district is located and all Counties

immediately adjoining.

The agreement also obligates petitioner to surrender to the

companies on cancellation of the agreement all records and other

materials having to do in any manner with the business of the

companies. It states petitioner’s agreement that all lists and

records pertaining to policyholders are the property of the

companies and that petitioner has no interest, assignable or

otherwise, in the “Agency” created by the agreement, except as

provided in paragraph E of the agreement (quoted in part above). 

It further states that, in the event of cancellation, petitioner

will not interfere with the agency contracts of the agents or

district managers of the companies. 

No provision of the agreement provides for any change in

“Contract Value”, once determined, on account of any subsequent
- 6 -

1 Notwithstanding that the agreement appears to contemplate

that contract value would be paid in four equal semi annual

installments, the parties appear to agree that the payments (in

their varying amounts) constitute the installment payments of

contract value. We shall proceed based on that assumption.

event, such as policy cancellations or failures to collect

premiums.

Following cancellation of the agreement, petitioner received

payments from the companies of $439,656, $212,466, and $106,233,

in 1996, 1997, and 1998, respectively (collectively, the

payments). Petitioners reported the payments as income from an

installment sale, from the sale of “Insurance Agency”, subject to

the favorable long-term capital gains rates. 

Discussion

The principal adjustments giving rise to the deficiencies in

question are respondent’s reclassifications of the payments,

reported by petitioners as installment sale gains (subject to the

favorable long-term capital gains rates), as ordinary income

subject to self-employment taxation.1 Other adjustments made by

respondent are derivative of those adjustments and are not a

matter of dispute between the parties. We have addressed

adjustments similar to the principal adjustments on other

occasions, e.g., Farnsworth v. Commissioner, T.C. Memo. 2002-29;

Schelble v. Commissioner, T.C. Memo. 1996-269, affd. 130 F.3d

1388 (10th Cir. 1997), and the rules are relatively clear. We
- 7 -

need not engage in an extended discussion to dispose of this

case.

Section 1401 imposes a tax on “the self-employment income of

every individual”. Section 1402(b) defines self-employment

income as “the net earnings from self-employment”. Section

1402(a) defines self-employment earnings as “gross income derived

by an individual from any trade or business carried on by such

individual, less the deductions * * * which are attributable to

such trade or business”. Gain or loss from the sale or exchange

of capital assets or from the disposition of other property

(except for stock in trade, inventory, or property held primarily

for sale to customers in the ordinary course of business) is

excluded from the computation of net earnings from selfemployment. Sec. 1402(a)(3)(A), (C).

In Newberry v. Commissioner, 76 T.C. 441, 444 (1981), we

held that, for income to be taxable as self-employment income,

“there must be a nexus between the income received and a trade or

business that is, or was, actually carried on.” In order to

satisfy the nexus standard, the “income must arise from some

actual (whether present, past, or future) income-producing

activity”. Id. at 446.

During the 11-plus years that petitioner was a district

manager for the companies, his business consisted principally of

recruiting, training, and supervising insurance agents, and he
- 8 -

was compensated exclusively by commissions based on the business

produced by those agents. Petitioner’s relationship with the

companies was governed by the agreement, and once the agreement

was canceled, petitioner had no right to any further commissions. 

He was, however, paid an amount denominated “Contract Value”

(contract value), which was based on the commissions paid him

during the 6 months immediately preceding the cancellation of the

agreement and the number of years of his service as district

manager. That amount was not subject to any change once

determined. Petitioners do not dispute that, during petitioner’s

tenure as a district manager, he was a self-employed individual

engaged in the business of managing a district for the companies. 

They do argue that the contract value paid to petitioner

following cancellation of the agreement is excluded from the

computation of net earnings from self-employment since it is a

capital gain or other gain described in section 1402(a)(3)(A) or

(C).

In Schelble v. Commissioner, supra, the taxpayer was an

insurance agent (not a manager), and, on termination of his

agency agreement, he was paid “extended earnings”, which amount

was determined based on renewal commissions paid to him during

the last 6 or 12 months of his service and the number of his

years of service. Because the record showed that there was no

express agreement for the sale of any assets or any evidence of
- 9 -

vendible business assets, we concluded that the taxpayer had

failed to prove that the extended earnings constituted gain from

the sale of any capital asset. We found that, because the

extended earnings “were tied to the quantity, quality, and

duration” of the taxpayer’s prior labor as an insurance agent,

there was a nexus between the payments and that business, and the

payments constituted net earnings from self-employment, subject

to the tax on self-employment income provided for in section

1401. The Court of Appeals for the Tenth Circuit affirmed,

recognizing that the extended payments were in consideration of

the taxpayer’s return of records and a covenant not to compete,

but emphasizing that the extended payments were “tied to the

quantity and quality of his prior services performed for [the

insurance companies in question]” and were not subject to

adjustment on account of any factor unrelated to his prior

service. Schelble v. Commissioner, 130 F.3d 1388, 1393 (10th

Cir. 1997). The Court of Appeals concluded: “Based on these

distinguishing factors, we conclude that Mr. Schelble’s payments

are sufficiently derived from his prior insurance business to

constitute self-employment income subject to self-employment tax

under 26 U.S.C. § 1401.” Id. The Court of Appeals dismissed the

taxpayer’s argument that he had sold a capital asset for the same

reason as the Tax Court; i.e., no evidence of vendible assets nor

any language referencing a contract of sale. Id. at 1394. 
- 10 -

Recently, in Farnsworth v. Commissioner, T.C. Memo. 2002-29,

we addressed cancellation payments made to a former district

manager of Farmers Insurance Group (a group of insurance

companies consisting of many of the same insurance companies that

constitute the companies). The district manager’s agreement in

that case provided for the payment of “contract value” similar to

the payment of contract value at issue here, except that, during

the taxpayer’s tenure as a district manager, “retention amounts”

were retained from commissions to reimburse Farmers Insurance

Group for payments of “Contract Value” to the district manager’s

predecessor. In Farnsworth, as in Schelble, we determined that

the payment in question was subject to self-employment tax

because it was based on the quantity (length of service) and

quality (final 6 months’ earnings without reduction for posttermination events) of the services rendered by the taxpayer. We

found that the retention amount device provided an “additional

nexus” between the cancellation payments and the taxpayer’s prior

position as a district manager. We analyzed the provision of the

agreement in question that dealt with business property used by

the taxpayer (identical to a provision in the agreement), and

found: “The payments Mr. Farnsworth received were expressly in

consideration for the termination of the * * * contract, the

payments were not made in return for the transfer of specific

property owned by him. Neither in form nor substance was the
- 11 -

2 Sec. 1253(b)(1) provides: “The term ‘franchise’ includes

an agreement which gives one of the parties to the agreement the

right to distribute, sell, or provide goods, services, or

facilities, within a specified area.”

transaction at issue a sale of property by Mr. Farnsworth.” 

Farnsworth v. Commissioner, supra; see also Baker v.

Commissioner, 118 T.C. 452, 461-465 (2002) (termination payment

made to insurance agent not received for sale of capital assets).

The payments by the companies of contract value are subject

to the tax on self-employment income since they constitute net

earnings from self-employment. We reach that conclusion because

contract value was determined based on the quantity (length of

service) and quality (final 6 months’ earnings without reduction

for posttermination events) of the services rendered by

petitioner to the companies. That establishes a nexus between

the contract value and petitioner’s business of being a district

manager. Petitioners argue that the agreement created a

franchise, which petitioner transferred back to the companies. 

The agreement contains no language establishing a franchise, nor

do we believe that the agreement, which gives petitioner the

right to render personal services as a district manager,

establishes a franchise within the meaning of section

1253(b)(1).2 See Clark v. Commissioner, T.C. Memo. 1994-278

(implicitly rejecting the argument that a district manager with

Farmers Insurance Companies relinquished a franchise in
- 12 -

consideration of the payment of a contract value amount). 

Petitioners have failed to introduce evidence of vendible assets

or show language referencing a contract of sale. That is

sufficient for us to conclude that petitioner received no payment

for any property. See Schelble v. Commissioner, T.C. Memo. 1996-

269, affd. 130 F.3d 1388 (10th Cir. 1997). We reach the same

conclusion that we reached in Farnsworth v. Commissioner, supra,

also involving a district manager’s agreement, that neither in

form nor in substance did the cancellation of the agreement give

rise to the sale of property by petitioner. See also Clark v.

Commissioner, supra.

We sustain in full the deficiencies in tax determined by

respondent.

Decision will be entered

for respondent.