Rev. Rul. 83-12

Rev. Rul. 83-12 [FN1]

                       Internal Revenue Service
                                 Revenue Ruling

           ADVANCE INSURANCE COMMISSIONS;  TAXABLE YEAR OF INCLUSION

                          Published: January 17, 1983

SECTION 451. - -GENERAL RULE FOR TAXABLE YEAR OF INCLUSION, 26 CFR 1.451-1: General rule for taxable year of inclusion

(Also Sections 446, 481; 1.446-1, 1.481-1.)

  Advance insurance commissions;  taxable year of inclusion. Advances made against unearned commissions to an independent cash-basis insurance agent that the agent is legally obligated to repay, but for which repayment is customarily forgiven, are includible in gross income in the taxable year of receipt.  Any change from not including to including such advances constitutes a change in accounting method.

ISSUE

  Are advances received by a cash-basis, commissioned insurance agent income in the taxable year of receipt under the circumstances described below?

FACTS

  A, an individual, is a self-employed, commissioned insurance agent that uses the cash receipts and disbursements method of accounting.

  IC, an insurance company, underwrites life insurance and health care insurance policies that are offered for sale by its independent sales agents, including A.  A entered into a written contract with IC that specified the rights and obligations of A and IC concerning the sales of IC's policies.

  Under the terms of the contract and the "Schedule of Commissions," which is expressly made a part of the contract, A is entitled to receive "as full compensation for services" certain commissions on the sale and renewal of IC policies.  The amount of these commissions is determined by reference to the type of policy sold (life or health care), the type of coverage selected (individual or family) and the mode of premium payment (monthly, etc.).  The contract provides that commissions on policies are "earned" by A only as premiums are earned by IC in the due course of business and that advances will be made against "unearned commissions."  The contract also states that the advances create a liability to IC on the part of A, payable on demand.

  Each month A receives a statement from IC reflecting transactions during the month, including cash advances made by IC to A.  The amount of the advance is generally the commission that would be earned by A on premiums on new business if the policy remained in force for the full term for which the initial premium is paid and is entered on the monthly statement as a charge (debit).  Earned

commissions (as defined in the agreement) are entered on the monthly statement as credit amounts.

  If the charges exceed the earned commissions, the monthly statement shows a debit balance (amount due IC).  If the amount of the debit balance is allowed to remain outstanding, IC imposes an interest surcharge of 0.5 percent per month, in accordance with the agreement.  Some agents prefer to pay off their debit balance promptly in order to avoid the surcharge, while others allow them to be carried over to succeeding months, to be offset by earned commissions. No surcharge is imposed if the debit balance is offset by commissions earned during the following month.

  No demand for payment is made by IC unless the agent terminates the contract with IC, in which case the agent's final statement is stamped PLEASE REMIT.  However, historically IC has made no attempt to enforce payment, except in a few cases involving large sums representing advances fraudulently obtained.  Moreover, IC customarily forgives repayment of advances relating to policies that remain in force six or more months.

  In 1980, A received advances from IC, a portion of which remained "unearned" under the terms of the agreement at A's taxable year end.  For federal income tax purposes, A did not report the portion that was deemed to be unearned under the agreement at A's taxable year end;  instead, A deferred the reporting of such amounts until 1981.

LAW AND ANALYSIS

  Section 61(a)(1) of the Code provides that, except as otherwise provided, gross income means all income from whatever source derived, including, but not limited to, compensation for services, including fees, commissions, and similar items.

  Section 451(a) of the Code provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.  Section 1.451-1(a) of the Income Tax Regulations provides that under the cash receipts and disbursements method of accounting, such an amount is includible in gross income when actually or constructively received.

  Rev. Rul. 68-239, 1968-1 C.B. 414, concerns a company that makes advance payments to its sales employees against unearned salary, commissions, or other remuneration for services.  The advances are charged to each employee's account, and any advance in excess of the salary, commissions, or other remuneration earned later is carried as an account due from the employee.  If an employee's services are terminated, the excess is charged to profit and loss.  Rev. Rul. 68-239 concludes that under these circumstances the advances are "wages," for federal employment tax purposes, at the time of payment.

  In George Blood Enterprises v. Commissioner, T.C.M. 1976-102, the taxpayer acted as general agent for an insurance company (the "company") under an "Associate's Agreement" (the "agreement").  The agreement authorized the taxpayer to solicit and procure applications for insurance, in return for which the company agreed to pay commissions based on the amount of premiums received on insurance applications submitted by the taxpayer and accepted by the company.

  Because there was a lag time between the date an agent began to sell insurance on behalf of the company and the date on which the commissions would be "earned" under the terms of the agreement, it was the policy of the company to make advances to the agents.  The amount of the advance was the commission that would be earned by the taxpayer on premiums on new business if the policy remained in force for the full term for which the initial premium was paid. During the years in issue the company made advances to the taxpayer with the understanding that the balances of these advances would be reduced as the commissions became "earned" under the terms of the agreement.  After making the advances to the taxpayer, the company would establish a "debt account" in the taxpayer's name, reflecting the amount of advances made.  When premiums were earned by the company by the policy remaining in effect for the premium period, the taxpayer's "debt account" would be credited by the amount of commissions earned.  If a policyholder were to cancel the policy before the end of the premium period, a portion of the premium would be refunded and the taxpayer's commission would be proportionately reduced.

  When the company made advances to agents, it was generally understood that it would not assert any personal liability for repayment on the part of the agent, other than through the crediting of commissions as they became earned under the terms of the agreement.  This was the case even when the taxpayer terminated its agreement with the company.

  The taxpayer received advances during the taxable years in issue.  The taxpayer had full control over the sums received by these advances and could use the sums in any manner it saw fit.  The issue was whether the advances were loans, rather than compensation for services.

  The court concluded that there was no expectation of repayment at the time the advances were made (other than through the crediting of commissions as they became earned under the terms of the agreement) and that the taxpayer had failed to show that it had an unconditional obligation to repay the advances made to it by the company.  In concluding that the advances were income to the taxpayer in the taxable year of receipt, the court indicated the following:

    Advances of commissions to a taxpayer under an agreement that places no personal liability of repayment on him but provides that any excess of the advances over commissions earned are to be recovered by the payor only by crediting earned commissions against the advances constitute income to the recipient when the advances are received.  L. L. Moorman, 26 T.C. 666, 674 (1956), 1956-2 C.B. 7;  Kenneth Drummond, 43 B.T.A. 529, 532-533 (1941). [T.C.M. 1976-102 at 76-443]

  In the present case, the advances are not made with the intent that they are presently an indebtedness.  Any amount that will eventually have to be repaid is contingent and indeterminate when the sums are advanced;  that is, there is no obligation of A to pay a sum certain at any fixed or other maturity date. Further indications that there is no unconditional obligation to repay the advances in the present case are IC's practice of forgiving the repayment of advances if the policy has remained in force a certain portion of the premium earning period and IC's practice of not pursuing the repayment of debit balances by some agents upon termination of their contract.

  A has complete control over the advances and can use these sums in any manner that A sees fit.  When advances are made, repayment is not expected by any means other than by "earned" commissions, which A is entitled to receive, pursuant to the agreement, as full compensation for services rendered.  Such advances constitute income to A in the taxable year in which the advances are received.  See George Blood Enterprises and L. L. Moorman.  See also Van Wagoner v. United States, 368 F.2d 95 (5th Cir. 1966), in which the court held that commissions are taken into income when received even though there is a possibility that some portion of the amount might have to be refunded to the insurance company if the policy is canceled.  Also see Beaver v. Commissioner, 55 T.C. 85 (1970), in which the court offered the following analysis:

    If the advances were loans, it is obvious that they did not constitute taxable income.  On the other hand [sic], if the advances were compensation for services, even though those services were to be performed in the future, they constituted taxable income in the years received.  ...  In either case, the recipient of the funds incurs an obligation which requires satisfaction at some point in the future.  In the case of a loan, satisfaction is to be made by making monetary repayment pursuant to the parties' agreement.  In such case a debtor-creditor relationship is established at the outset.  In the case of compensation for future services, satisfaction is to be made by actually performing such services. Only when such services are not rendered does there arise a debtor-creditor relationship requiring satisfaction by monetary repayment.

HOLDING

  Under the circumstances described above, advances received by a cash-basis, commissioned insurance agent constitute gross income in the taxable year of receipt.

  The holding herein is equally applicable to advances received under the facts described herein by a commissioned insurance agent who is an employee of the insurance company.

  Any change from not including to including such advances in gross income in the taxable year of receipt constitutes a change in method of accounting to which sections 446 and 481 of the Code apply.

  Section 446(e) of the Code and section 1.446-1(e)(2)(i) of the regulations state that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes.  Section 1.446-1(e)(3)(i) provides, in relevant part, that except as otherwise provided in subdivision (ii), in order to secure the Commissioner's consent, the taxpayer must file an application on Form 3115 with the National Office within 180 days after the beginning of the taxable year in which the taxpayer desires to make the change.  Subdivision (ii) provides that notwithstanding subdivision (i), the Commissioner may prescribe administrative procedures, subject to such limitations, terms, and conditions as he deems necessary to obtain his consent, to permit taxpayers to change their accounting methods to an acceptable method consistent with applicable regulations.  In Rev. Proc. 83-4, page 23, this Bulletin, the Commissioner has waived the 180 day rule and has granted advance consent for taxpayers to change their method of accounting for reporting advance commission income.  The change is from the method of including the advance commission in gross income in the taxable year in which it is "earned" pursuant to a contract with the insurance company to the method of including the advance commission in gross income in the taxable year in which it is received.  The advance consent has been granted for a taxable year ending on or before December 31, 1983.

FN1. Also released as News Release IR-82-150; dated December 23, 1982.

Rev. Rul. 83-12, 1983-1 C.B. 99.