Court Opinion

ID: 4472799
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:34:55.614714+00
Date Added: 2024-06-11T07:54:32.182500
License: Public Domain

Halpern, J., dissenting: The majority holds that certain termination payments received by petitioner after his retirement as an independent insurance agent are not subject to self-employment tax pursuant to sections 1401 and 1402 because such payments were not “ ‘derived’ from the carrying on of petitioner’s insurance business”. Majority op. p. 140. The majority is persuaded by the reasoning of the Court of Appeals for the Ninth Circuit (the Ninth Circuit) set forth in Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994), revg. T.C. Memo. 1992-655. In Milligan, the Ninth Circuit recognized that, to be taxable as self-employment income under the Self-Employment Contributions Act of 1954 (SECA), sections 1401-1403, an individual’s income must be (1) derived (2) from a trade or business (3) carried on by that individual. Id. at 1097. In Milligan, the taxpayer disputed only whether the termination payments there in question (which the majority implies were “indistinguishable” from the payments here in question) were “derived” from the trade or business carried on by him. Relying on our opinion in Newberry v. Commissioner, 76 T.C. 441, 444 (1981), the Ninth Circuit stated: “The term ‘derive’ requires ‘a nexus between the income received and a trade or business that is, or was, actually carried on.’” Milligan v. Commissioner, supra at 1098. The Ninth Circuit continued: By nexus, we mean that the “trade or business activity by the taxpayer gives rise to the income. . . .” Id. [Newberry v. Commissioner, supra] (emphasis added). The income is sufficiently related to the taxpayer’s trade or business activity when the business activity is its source. Id. at 446 (“Any income must arise from some actual . . . income-producing activity of the taxpayer before such income becomes subject to . . . self-employment taxes. . . .”). [Id.] The Ninth Circuit found it unnecessary to characterize the precise relationship between the termination payments and the taxpayer’s prior business activity because it was obvious to the court that the termination payments did not “‘derive’ from Milligan’s prior business activity within the meaning of the self-employment tax.” Id. The Ninth Circuit laid down the following general rule: “To be taxable as self-employment income, earnings must be tied to the quantity or quality of the taxpayer’s prior labor, rather than the mere fact that the taxpayer worked or works for the payor.” Id. Because Milligan already had been fully compensated for his services, the Ninth Circuit concluded that the termination payments were linked only to Milligan’s previous status as a 2-year-plus independent contractor for State Farm, and, thus, “none of his business activity was the ‘source’ of the Termination Payments.” Id. at 1098-1099. The Ninth Circuit supported its holding that previous independent contractor status alone was not a sufficient nexus by analogizing to a wage tax situation in which employer-provided supplemental unemployment benefits were held not to be wages because the benefits, although the result of employment status at some previous time, were ‘“[I]n no way * * * a function of the employee’s providing services for his employer. Those benefits are not derived from any employment carried on.’” Id. at 1099 (quoting Newberry v. Commissioner, 76 T.C. at 445). I dissent because I am not persuaded by the reasoning of the Ninth Circuit in Milligan v. Commissioner, supra. I do not agree with the quantity-or-quality-of-labor test adopted by the Ninth Circuit. I believe that the Ninth Circuit has overemphasized parallels between the wage tax acts (the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA)) and SECA, forgetting that seca, unlike fica and futa, does not impose a levy solely against labor, but, rather, imposes a levy against certain trade or business income of an individual. Compare secs. 3121(a) and 3306(b) with sec. 1402(a). Properly, the Ninth Circuit looks for a connection (nexus) between the gross income in question and the taxpayer’s business “activity”. Improperly, however, the Ninth Circuit uses the word “activity” in a limited sense, a sense that encompasses only physical or mental exertions: e.g., “Because Milligan already had been fully compensated for his services, none of his business activity was the ‘source’ of the Termination Payments.” Milligan v. Commissioner, supra at 1099 (emphasis added). Such a restrictive interpretation may be appropriate for a wage tax analysis, in which the question is whether the payment is remuneration for employment (labor), see secs. 3121(a), 3306(b), but it is too narrow a frame of reference to determine whether the taxpayer’s trade or business is the source of an item of gross income. The statutory phrase in question is “net earnings from self-employment”, which is defined in section 1402(a) as “gross income derived by an individual from any trade or business carried on by such individual [less certain deductions]”. The only term that suggests that less than all of the trade or business income of an individual is subject to tax is the term “carried on”. S. Rept. 1669, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 302, is the report of the Committee on Finance that accompanied H.R. 6000, which was enacted as the Social Security Act Amendments of 1950, ch. 809, 64 Stat. 477, which included the Self-Employment Contributions Act. That report indicates that Congress used the verbal phrase “carried on” in a relational sense, to describe a business conducted or operated by the individual subject to the tax (as opposed to someone else): The trade or business must be “carried on” by the individual either personally or through agents or employees, in order for the income to be included in his “net earnings from self-employment.” Accordingly, gross income derived by an individual from a trade or business carried on by him does not include income derived by a beneficiary from an estate or trust even though such income is derived from a trade or business carried on by the estate or trust. [S. Rept. 1669, supra, 1950-2 C.B. at 354.] See also H. Rept. 1300, 81st Cong., 1st Sess. (1949), 1950-2 C.B. 255, 294. Clearly, the trade or business need not currently be carried on by the individual; a past carrying on will do. See Shumaker v. Commissioner, 648 F.2d 1198, 1200 (9th Cir. 1981) (affirming self-employment tax on sale proceeds from wheat that the taxpayer grew in the past: “self-employment income is determined by the source of the income, not the taxpayer’s status at the time the income is realized” (emphasis added)), affg. in part and revg. in part T.C. Memo. 1979-71; sec. 1.1402(a)-1(c), Income Tax Regs. Thus, the only relevant question is whether the item of gross income in question is derived from the taxpayer’s trade or business or from some other source. It seems safe to conclude that petitioner was in the business of selling insurance as an independent agent of State Farm Insurance Co. (State Farm). His relationship with State Farm, including the terms under which he would earn gross income from State Farm, were governed by his written agency agreements with State Farm. The termination payments were made pursuant to the State Farm agent’s agreement, form AA3 (the agreement). The agreement appoints petitioner an agent of State Farm for an indefinite period. The agreement contains a preamble and six numbered sections: (1) Mutual Conditions and Duties (2) Compensation (3) Termination of Agreement (4) Termination Payments (5) Extended Termination Payments (6) General Provisions The section entitled “Termination of Agreement” provides, in pertinent part, that the agreement terminates upon the agent’s death or upon written notice by either party. That section also contains a prohibition against competition by the terminated agent. Termination payments are provided for in the section entitled “Termination Payments” and are as described by the majority. The agreement provides that it is the sole and entire agreement between the parties. No part of the agreement has to do with anything other than the beginning, middle, and end of petitioner’s business relationship with State Farm. The termination payments were conditioned on petitioner’s returning to State Farm all of its property and not competing with State Farm for 1 year, and those payments were a product of both petitioner’s performance during his last year with State Farm and the staying power of petitioner’s performance for State Farm. The payments were not otherwise identified as being in consideration for any particular contractual obligation of petitioner’s under the agreement. Some portion of the termination payments may have been in consideration for petitioner’s promise not to compete for 1 year. The majority’s report does not contain sufficient information from which to make an allocation. Moreover, I am not convinced that, even if such information were available, an allocation would be required. In Barrett v. Commissioner, 58 T.C. 284, 289 (1972) (rejected sub silentio with respect to its focus on the “goods-and-services test” in Groetzinger v. Commissioner, 82 T.C. 793 (1984), affd. 771 F.2d 269 (7th Cir. 1985), affd. 480 U.S. 23 (1987)), we accepted the parties’ agreement “that noncompetition does not constitute the carrying on of a trade or business.” In addition, in Ohio Farm Bureau Fedn., Inc. v. Commissioner, 106 T.C. 222, 236 (1996), we suggested that the rationale in Newberry v. Commissioner, 76 T.C. 441 (1981), supported the holding that income from a nonsponsorship and noncompetition agreement does not constitute “unrelated business income” under the definition of that term in section 512(a). Those cases, however, do not mandate the conclusion that income received from a covenant not to compete is per se excluded from the reach of SECA. I think that the law on that point still may be uncertain. Since that point is not crucial to my disagreement with the Ninth Circuit, I shall not pursue it any further. It is sufficient to me that, on the facts as I understand them, the payments were made pursuant to a business contract that served no purpose other than to define both the consideration for and other aspects of the business relationship between petitioner and State Farm. Lastly, the termination payments in this case are fundamentally unlike the insurance proceeds in Newberry v. Commissioner, supra. The payments in Newberry were derived from an insurance policy that was purchased by the taxpayer in order to provide him with a substitute for his trade or business income in the event of a business interruption, such as the catastrophic fire in that case. The payments took the place of income from the trade or business and were not themselves income from that business. In this case, the termination payments were derived from a trade or business carried on by petitioner.