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Illegally waived or rebated commissions not taxable to agent.

In 1982, insurance agent Mickey Worden sold six life insurance policies through the Federal Home Life Insurance Co. Worden's contracts with the cleints who brought Federal Home Life insurance provided that he would act as their "insurance consultant." In return for a fee, Worden would, among othher things, search the market for the "most reasonable rates available."

Worden provided his cleints with their first year's coverage at cost by waiving his first-year commission--chargingX the clients a "consulting fee" equal to the net first-year premium due the insurance company (after deducting the "basic commission" to which he normally would have been entitled). Worden then remitted the net premium to the company. Worden's contract with Federal Home Life allowed him to remit only the net premium (that is, the gross premium normally paid by the client, less the basic commission allowed to the agent).

Such rebating of insurance commissions was and is illegal in Worden's home state, Oklahoma. (The practice is illegal in all states with the exception of California and Florida. Further, even where rebating is legal, many insurance companies do not allow it.)

orden did not report the basic ccommissions as gross income, since he had not received them. However, Federal Home Life, assuming he had kept the difference between the net premium and the usual retail cost to the client, reported to the Internal Revenue Service that he had received basic commissions on the sixx contracts, and a tax dispute ensued.

The IRS, recasting Worden's exclusion as a deduction, claimed the basic commissions could not be deducted because Internal Revenue Code section 162(c)(2) prohibits deductions for illegal payments.

The Tax Court agreed with the IRS, and the case was appealed to the 10th Circuit Court of Appeals.

Result: For Worden. Worden never had a right to the basic commissions under the the contract, nor was he ever in actual or constructive receipt of them. Therefore, he need not include them in income. This was not a case of illegal deductions, since Worden never received the commission amounts. (Had Worden been required to remit to Federal Home Life the gross premium, the court said it might have reached a different conclusion.)

The court distinguished a similar case that had reached the opposite conclusion (Alex, 9th Cir., 1980). In Alex, clients actually paid the agent's commission to the insurance company or to the agent, and the agent separately reimbursed the client for the amount of the commission.

* Worden (10th Cir., 1993).

Note: Another recent decision by the federal district court in North Dakota dealt with the taxation of the insured when illegal rebates are involved. In that case, an agent illegally rebated 100% of the first-year premium to the purchasers of a universal life ploicy. The North Dakota district court held that the insureds had to pay tax on the rebated amount. (Woodbury (DC N.Dak., 1993).
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Nov 1, 1993
Words:478
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