Opinion ID: 381453
Heading Depth: 1
Heading Rank: 2

Heading: Discount Method

Text: 11 Alex used the discount method to finance the premiums of insureds who bought a certain kind of policy which had a large first-year cash value. In such cases, Jefferson did not require direct payment; instead, it permitted an insured to write a check to Alex in the amount of the premium (less the cash value). Alex was then to send his personal check to Jefferson for the small amount equal to the premium less Alex's commission (and the cash value). In fact, the insured never gave Alex any check; Alex financed out of his own pocket his check to Jefferson. Alex's allowances and bonuses, which he received later, more than covered this expenditure . 2
12 The discount method had the same substantive economic effect as the reimbursement method, so the Tax Court treated the two the same. However, the fact that under the discount method Alex did not actually receive commissions in cash (or pay out in cash the amount of the commissions) warrants some discussion. Alex was a cash-basis taxpayer, and it must be shown that his gross income itself was not phantom. 13 In Ostheimer v. United States, 264 F.2d 789 (3rd Cir.), cert. denied, 361 U.S. 818, 80 S.Ct. 61, 4 L.Ed.2d 64 (1959), an insurance agent bought policies on the lives of his co-workers and children. Rather than take his commissions on those policies in cash, he accepted a discount on the premiums in that amount from the insurance company. The commissions were held includable in his gross and taxable income, and were not considered an adjustment of the price of the insurance. Accord, Williams v. Commissioner, 64 T.C. 1085 (1975) (15-0 vote) (real estate commissions). The only apparent difference between the clearly correct Ostheimer case and the present case is that Ostheimer used his credit for commissions to reduce the premium balance owed on policies owned by him, whereas Alex used his credit to reduce the premium balance owed on policies owned by third parties. 3 14 Alex's situation can be fairly analogized to that of a manufacturer's representative. When a customer (the insured) orders a widget (insurance) through the representative, it pays him the retail price (the premium). He transmits the order and the wholesale price (the difference between the premium and the commission) to the manufacturer (Jefferson), retaining the markup (commission) in consideration of his selling services, and the manufacturer sends a widget directly to the customer. 15 If the representative wants to provide a customer with a free widget, he might certify falsely that the customer has paid him the retail price, and pay from his own pocket the wholesale price to the manufacturer, which then would ship the widget to the customer. Tax law would treat the transaction as if the representative himself had bought the widget, using an Ostheimer credit, and then transferred the widget to the customer. The representative would have income in the amount of the markup (but not in the amount of the wholesale price), and would have no tax benefit other than a potential deduction for the value of the widget. 16 Similarly, Alex's commissions were gross income to him, even though he never received them in cash. The full premium amount (less the cash value)-the value of the policy-might conceivably have been deductible, were it not for § 162(c) (2), but his transactions surely provided him no other tax benefit.