Why is this Topic Important to wealth managers? General classification and taxation of insurance professionals is governed by statute.  Therefore, a basic discussion of the law as it applies to wealth managers and tax is presented below.

Generally speaking common law classifications have determined under which circumstances an individual will be treated as an employee versus an independent contractor for tax purposes. Nevertheless, under statute, an individual who meets the legal common law definition of an independent contractor may still be considered an “employee” for tax purposes. “Independent contractors” who are classified statutorily as “employees” are usually referred to as “Statutory Employees”.  As the name implies, Congress created a law that states some individuals who would normally be considered independent contractors under common law are treated as employees for all purposes relating to the tax code.  Among the categorization of “Statutory Employees”, according to the Code is “full-time life insurance salesman.” [1]

A full-time life insurance salesman means “[a]n individual whose entire or principal business activity is devoted to the solicitation of life insurance or annuity contracts, or both, primarily for one life insurance company”. [2] The Treasury Regulations state that a full time life insurance salesman “ordinarily uses the office space provided by the company or its general agent, and stenographic assistance, telephone facilities, forms, rate books, and advertising materials are usually made available to him without cost.” [3]

On the contrary, an individual is not considered a full time life insurance salesman when he “is engaged in the general insurance business… the individual’s principal business activity” is not the, “solicitation of life insurance or annuity contracts, or both, for one company”.[4] Likewise, “any individual who devotes only part time to the solicitation of life insurance contracts, including annuity contracts, and is principally engaged in other endeavors, is not a full-time life insurance salesman.” [5] Also, some producer groups have contractual relationships with multiple insurance companies, so life-insurance salespeople are sometimes able to sell products for more than one company, generally excluding them from statutory employee definition.

So what’s the difference? Generally, the tax treatment of the two dissimilar arrangements is significantly different.  On the one hand employees are subject to withholding of federal income taxes on wages as well as withholding for Medicare and Social Security taxes. Generally, independent contractors operate as sole-proprietors or some incorporated or limited liability business structure.  Meeting the definition of a trade or business, generally, these individuals will have gain or loss treatment in relation to their income.

As a general rule, independent contractors will calculate taxable income by determining income minus expenses. Income in this context is included in Internal Revenue Code Section 61 “Gross Income” which includes “all income from whatever source derived,” including “compensation for services, [and] fees”. [6] Expenses or deductions from gross income for a trade or business are determined using Section 162 of the Code which states that a deduction may be taken for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”.[7]

Some expenses that the trade or business may incur include, but are not limited to:

• cost of goods sold
• compensation
• salaries and wages
• repairs and maintenance
• bad debts
• rents
• depreciation
• taxes
• travel
• interest, and
• advertising

To arrive at net taxable income, expenses are generally deducted from gross income.   The taxpayer can then determine the tax liability based on the tax rate found in IRC Section 1 or by using income and percentage charts provided by the Internal Revenue Service.

For a detailed analysis regarding independent contractors, see Tax Facts Q 814. How are business expenses reported for income tax purposes?

For a detailed analysis regarding the tax treatment of life insurance agent, see Tax Facts Q 361. Who is an owner-employee for purposes of the qualification requirements?

Tomorrow’s blogticle will continue to discuss issues related to wealth mangers and estate planning generally.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C.A. § 3121(d)(3)(b).

[2] 26 C.F.R. § 31.3121(d)-1.

[3] Id.

[4] Id.

[5] Id.

[6] 26 U.S.C.A. 61(a), 26 U.S.C.A. 61(a)(1).

[7] 26 U.S.C.A. 162(a)

Tags: Business, Employment, Federal Insurance Contributions Act tax, Financial services, independent contractor, insurance, Internal Revenue Code, Internal Revenue Service, IRS tax forms, life insurance, Self-employment, Tax

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