Insurance Agent Termination Payments

Posted by Lee Reams Sr., BSME, EA on

A frequent question: what is the tax treatment of termination payments made to a retiring insurance agent?

Where there was no sale or exchange where assets used by an insurance agent in the conduct of his business, including a computer, customer lists, and books and records, were returned to the insurance company. The assets weren't his to sell because his agreement with the insurance company specified that the assets were the insurance company's property. And while the agent developed goodwill during his tenure (the sale of which would generally produce capital gain), the goodwill, too, belonged to the company and wasn't he agent’s to sell. So, termination payments received by the agent were ordinary income. (Baker, Warren L. Jr. v. Com., (2003, CA7)).

SE Tax - Net earnings from self-employment do not include any amount received during the tax year from an insurance company on account of services performed by an individual as an insurance salesman for the company if:

(1)  the amount is received after termination of the individual's agreement to perform services for the company (Sec 1402(k)(1);

(2)  the individual performs no services for the company after the agreement ends and before the close of the tax year (Sec 1402(k)(2);

(3)  the payments are conditioned on the salesman's agreeing not to compete with the company for at least one year following termination of the agreement (Sec 1402(k)(3); and

(4)  the amount of the payment depends primarily on:

(a) policies sold by, or credited to the account of, the individual during the last year of the agreement, and/or

(b) the extent to which the policies remain in force for some period after the agreement ends (Sec 1402(k)(4)(A)).

The amount of the payment cannot depend on the length of service or overall earnings from services performed for the company. However, eligibility for payment can depend on length of service and/or overall earnings (Sec 1402(k)(4)(A)).