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

Just because common law classifications would allow for compensation as an independent contractor, doesn’t mean Congress agrees. An individual who meets the legal definition of an independent contractor may still be considered an “employee” for tax purposes.  Generally, these “independent contractors” that are treated as “employees” are given the name “Statutory Employees”.  As the name implies, Congress created a law that states some individuals who would normally be considered under common law as independent contractors are treated as employees for tax purposes.  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.

What does it mean to be a statutory employee?  As has been discussed earlier this week, the tax treatment of the two dissimilar arrangements is significantly different.  On the one hand, an employee, including statutory employees, will file for withholding of federal income taxes on wages as well as withholding for Medicare and Social Security taxes.  Employees also are not considered to be in a trade or business.  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 tax structure.

Other examples of statutory employees include:[6]

• “A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is [an] agent or is paid on commission.

• “A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson’s principal business activity.

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?

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

[2] 26 C.F.R. § 31.3121(d)-1

[3] Id.

[4] Id.

[5] Id.

[6] Internal Revenue Service Publication 15-A (2010).  Page 4.

Valuation discounts are increasingly challenged by the IRS. Gone are the days when assets could be dropped into a family limited partnership with some transfer restrictions and forgotten about until a valuation discount was needed to reduce a gift or estate tax bill.  A recent U.S. District Court case, Fisher v. U.S., reminds us that times have changed.  Often, placing assets in a business entity is no longer enough to justify a valuation discount—the entity must be run like a business to justify the discount.   Read the analysis by our experts Robert Bloink and William Byrnes located at AdvisorFX Journal Valuation Discounts: Only for a Bona Fide Business

For some good news about valuation discounts, see our article in AdvisorFX Advisor’s Journal on the Jensen case.

From a tax perspective see Tax Facts Q 613. How is a closely held business interest valued for federal estate tax purposes?

After reading the analysis, we invite your questions and comments by posting them below, or by calling the Panel of Experts.

Hybrid income annuity products can be a great way to provide clients with a stream of income during retirement, especially when they offer guaranteed lifetime withdrawal benefits (GLWB). Despite this, there are a number of reasons why clients may continue to resist locking their funds into an annuity. Typically, they worry about losing control of their retirement savings, or an insurance company’s failure to continue annuity payments should they die earlier than expected. The market turmoil of the past few years has generated an additional concern about the financial stability of the companies issuing annuity contracts. A recent National Association of Insurance Commissioners (NAIC) Life Insurance and Annuities Committee meeting should lead to new regulations that will clarify and conform hybrid income annuities in order to make them much easier to sell.

What Is a Hybrid Income Annuity?

Hybrid income annuity products are annuities that are combined with a different type of annuity within the same annuity contract. For example, a contingent deferred annuity (CDA) is an annuity that guarantees lifetime payments based on the value of the assets in the annuity account. Income payments are conditional upon the owner’s survival and the depletion of the assets in the account. Often, a GLWB rider is attached to the annuity to provide lifetime income payments that begin if there is a depletion or change in value of the annuity account’s assets. The addition of the GLWB rider is what makes the annuity a hybrid.

Synthetic hybrid income annuities, which are hybrid income annuities where the assets in the account are not owned by the insurer, are also being investigated, and would be subject to any new regulation.

For previous coverage of the guaranteed lifetime withdrawal benefits in Advisor’s Journal, see More Consumers Buy Guaranteed Living Benefits Rider.

For in-depth analysis of the different types of annuity product, see Advisor’s Main Library: E—Annuities.

Why is this Topic Important to Financial Professionals:  A general understanding of classification of employees versus independent contractors will not only save your client aggravation, but could also avoid additional taxes and penalties.  In addition, the tax consequences of this determination can be far reaching, and an understanding of the concepts of income and types of allowable deductions can help enable more comprehensive planning for the Financial professional and clients.    

As a general rule, independent contractors compensation is reported through Form 1099-MISC.  In determining net income of the sole proprietor or corporation, one will usually factor income and 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”.[1] 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”.[2]

Some expenses that the trade or business may incur include, but are not limited to: [3]

• 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 using income and percentage charts provided by the Internal Revenue Service.

The IRS states “Self-Employed” individuals or those who carry “on a trade or business as a sole proprietor or an independent contractor”, are required to pay self employment taxes.[4] The rate for this tax is 15.4% which equals the Social Security and Medicare taxes paid by traditional employees and employers.  This tax is in addition to the federal income tax.  Self employed individuals are normally required to make estimated quarterly tax payments, based on estimated quarterly net taxable income.  In 2009 only the first $106,800 of “combined wages” was subject to the self employment tax, which means after this amount, self employment taxes are not levied on any additional “combined wages.” [5]

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

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

[2] 26 U.S.C.A. 162(a)

[3] 2009 Internal Revenue Service Form 1120S

[4] “Self Employment Tax Article”.  Internal Revenue Service.  May 20, 2010. http://www.irs.gov/businesses/small/article/0,,id=98846,00.html Last Accessed 8/18/2010.

[5] Id.

Seven Tax Tips for Job Seekers – Edited by G. Mentz, JD, MBA, CWM®