Opinion ID: 316607
Heading Depth: 1
Heading Rank: 3

Heading: Agents' Commissions

Text: 14 Finally, the company contends that, if required to accrue the gross deferred and uncollected premiums, it should at least be allowed to accrue the agents' commissions on those premiums and take corresponding deductions. The government responds that these expenses are not accruable, since the liability for them is not fixed and definite. The company will be liable to pay the commissions only if the premiums are in fact paid. As noted before, there is no assurance that they will ever be paid, although the policies will lapse if they are not. 15 There is no doubt that the government is entirely correct when it asserts that these agents' commissions are not accruable under generally accepted accounting principles. Treasury Regulation 1.461-1(a)(2) provides that 16 under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy . . .. No accrual shall be made in any case in which all of the events have not occurred which fix the liability . . .. 17 Accrual of deductions has consistently been denied where not all the events necessary to fix the taxpayer's liability have occurred. Brown v. Helvering, 1934, 291 U.S. 193, 54 S.Ct. 356, 78 L.Ed. 725; Trinity Construction Co. v. United States, 5 Cir. 1970, 424 F.2d 302; Commissioner of Internal Revenue v. H. B. Ives Co., 2 Cir. 1961, 297 F.2d 229; Pierce Estates v. Commissioner of Internal Revenue, 3 Cir. 1952, 195 F.2d 475. Under these authorities the commission expenses clearly are not properly accruable. 18 In our view, however, this is not the end of the question. We must not forget that we are, in Judge Drennan's colorful phrase, in the 'fantasy world of life insurance company accounting and taxation.' Western Mational Life Insurance Co., 51 T.C. 824, 830. It is no answer to say that the commissions are not properly accruable. The premiums themselves are not properly accruable, either, but the company must report them as though they were. Unavoidably, then, the company's income has already been distorted by that requirement. It would only distort that income yet further not to permit the company to accrue the commission expense deductions, which are only contingent to the same extent that receipt of the premiums themselves is contingent. The company cannot receive premiums without incurring corresponding commission liabilities. We therefore hold that the district court should have permitted the company to accrue deductions for commissions on the deferred and uncollected premiums, and we remand for a determination of those commissions. 19 In reaching this result we are aided by few of the authorities cited by the parties. Great Commonwealth asserts that a rule allowing the accrual of commissions in the year of accrual of the associated income is established by Ohmer Register Co. v. Commissioner of Internal Revenue, 6 Cir. 1942, 131 F.2d 682; Air-Way Electric Appliance Corp. v. Guitteau, 6 Cir. 1941, 123 F.2d 20; Central Cuba Sugar Co. v. Commissioner of Internal Revenue, 2 Cir. 1952, 198 F.2d 214; and The Warren Co., 1942, 46 B.T.A. 897, aff'd on other grounds, 5 Cir. 1943, 135 F.2d 679. In support of its position that accrual of deductions is permissible only when the liability therefore is fixed and definite, even if the associated income is accruable in an earlier year, the United States cites American Automobile Association v. United States, 1961, 367 U.S. 687, 81 S.Ct. 1727, 6 L.Ed.2d 1109; Schlude v. Commissioner of Unternal Revenue, 1963, 372 U.S. 128, 83 S.Ct. 601, 9 L.Ed.2d 603; ABKCO Industries, Inc. v. Commissioner of Internal Revenue, 3 Cir. 1973, 482 F.2d 150; and W. S. Badcock Corp., 1972, 59 T.C. 272, which is presently pending on appeal in this court. All of these cases deal with properly accrued income items, and the issue in them is whether the associated expenses are properly accruable. In this case, however, it is agreed that neither the premium income nor the associated commission expenses are properly accruable, in the sense that neither the right to receive nor the obligation to pay is fixed and definite. The company's cases do no more than follow the usual rule that expenses are deductible in the year in which the liability becomes fixed and definite, while the government's cases merely establish that the goal of matching income and its related expenses in the same taxable year, so as to clearly reflect income, does not override the necessity of following normal accrual rules, so long as those rules have not already been violated in the treatment of income items. The issue before us is whether to permit accrual of the commission deductions to the same extent accrual of the premium income is required, in view of the fact that both items are subject to precisely the same contingencies. 20 This particular issue seems to have been presented to only two courts. In Occidental Life Insurance Co. v. United States, C.D.Cal.1970, 25 Am.Fed.Tax R.2d 796, the commission deduction was denied, but an opposite result was reached in United Life and Accident Insurance Co. v. United States, D.N.H. 1971, 329 F.Supp. 765. We think the New Hampshire district court reached the sounder result, although we disagree with its conclusion that the expenses associated with the deferred and uncollected premiums are properly accruable under generally accepted accrual accounting principles. We base our holding on the need to avoid undue distortion of income. 21 The Commissioner's power to require a change in the treatment of items in computing taxable income is grounded on 446(b), which provides in part that 'if the method (of accounting) used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.' In the exercise of the discretion granted him, the Commissioner could reasonably feel that the company's income would not be clearly reflected by accrual of only the net valuation portion of the deferred and uncollected premiums, and he has been consistently upheld in requiring accrual of the gross amount. The statutory objective of clear reflection of income will be hindered, however, if the expenses necessarily associated with that gross premium income are not also taken into account. This does no further violence to the usual accrual rules, which would not permit accrual of either the premiums or the commissions. In fact, it tends to mitigate the distortion of income caused by the Commissioner's deviation from those rules in requiring the accrual of the gross amount of the premiums. 22 Not only would disallowal of commission deductions create an inconsistency in the treatment of income and its associated expenses, it would also create an inconsistency in the treatment of these deductions and the deduction for net increases in life insurance reserves under 809(d)(2). The company's reserve liability with regard to the net valuation portion of the deferred and uncollected premiums will not in fact accrue until the premiums themselves accrue. Yet the Commissioner has not merely allowed the company to accrue this item, which generates the 809(d)(2) deduction, he has used that very accrual as the sole basis for requiring accrual of the gross amount of the deferred and uncollected premiums. Since the Commissioner does not challenge the deduction under 809(d)(2), we see no basis for allowing a challenge to the deduction for agents' commissions, which are no more contingent than the reserve liability. 23 In requiring accrual of the gross amount of the deferred and uncollected premiums, the Seventh Circuit explained the need to use consistent accrual assumptions. 24 The District Court would permit the taxpayer to accrue a full year's liability without a corresponding accrual of the related year's asset in point of time. Such a result would attribute to Congress an intention that in the same statutory equations, exclusions and deductions attributable to reserves are to be based on the assumption that the annual premium is fully paid up and yet the amounts in the same equation from which these figures are to be subtracted are to be determined on the assumption that the annual premium is not fully paid up. This is, in effect, saying that Congress, when it specified accrual accounting, must have meant one rule to apply to reserve deductions and exclusions and another different accrual rule to apply to determining the amount from which the former are to be subtracted. We perceive nothing from which intent to impose such a dual standard of tax accounting can be presumed. 25 Franklin Life Insurance Co. v. United States, supra, 399 F.2d at 761. We think the same reasoning applies with equal force here. We do not think that Congress meant for one standard to apply to reserve deductions and a different rule to apply to commission deductions.