Insurance agency termination payments were ordinary income.

• Author: Trantina, Charles E.

P was employed as an independent insurance agent of Y life insurance company, first in his individual capacity and later on behalf of T Agency, Inc., which he wholly owned. P wished to retire and so advised Y. T became entitled to termination payments under its agreement with Y; Y made the payments from 1996 to 1999.

When T liquidated in 1997, P exchanged his stock for T's assets, including the right to collect the termination payments. Y began making termination payments to P rather than T.

P first reported the termination payments as ordinary income, but subsequently amended his 1997 and 1998 returns to report them as long-term capital gains, rather than ordinary income. The IRS accepted the 1997 and 1998 amendments and granted the refund. However, when P amended his 1999 return, the IRS denied the refund claim.

Legal Standards

P maintains that the termination payments are long-term capital gains under Sec. 1222(3), because the termination of the corporate agreement was a "sale" of the agency back to Y. Sec. 1222(3) defines long-term capital gain as "gain from the sale or exchange of a capital asset held for more than one year.... "To treat the termination payments as long-term capital gain, P must prove both that he owned a capital asset and sold it in exchange for the termination payments; see Baker, 338 F3d 789 (7th Cir. 2003).

P does not argue that policyholder information, policy manuals, drafting tools or other implements of the insurance trade are the capital assets at issue here. Such an argument would fail, as Y owned all such property under the corporate agreement's terms; see Baker, 338 F3d at 793 (finding that taxpayer owned no capital assets under a nearly identical insurance agent agreement). Instead, P asserts that the agreement itself constituted the capital asset sold in exchange for the termination payments.

However, it is difficult to see how a contract declaring that P owns no assets may itself he an asset. Although P possessed certain rights under the agreement (e.g., the right to solicit customers, submit applications for insurance and collect...