654 / How are an insurance agent’s commissions taxed if they are received pursuant to a deferred income plan?

If, before retiring, an insurance agent enters into an irrevocable agreement with the insurance company to receive renewal commissions in level installments over a period of years, only the amount of the annual installment will be taxable each year – instead of the full amount of commissions as they accrue.¹ Although the Oates case and Revenue Ruling 60-31 concern deferred compensation arrangements during retirement years, the same principle should apply if the agent, during the agent’s lifetime, elects a level commission arrangement for payments after death.

In a private letter ruling, the IRS determined that an insurance agent’s contributions of commissions to his company’s nonqualified deferred compensation plan will not be includable in the agent’s gross income or subject to self-employment tax until actually distributed.² In Olmsted, the insurance company, by agreement with the agent, substituted an annuity contract for its obligation to pay future renewal commissions. The Tax Court and the U.S. Court of Appeals for the Eighth Circuit held that the agreement was effective to defer tax until payments were received under the annuity.³ The IRS did not acquiesce to the Olmsted decision.⁴

However, since 2005, IRC Section 409A specifically covers commission compensation of agents as employees and brokers as independent contractors (both of which are referred to as “service providers”) if there is a “deferral of compensation” with the creation of a “nonqualified deferred compensation plan” (even for a single individual). Although additive constructive receipt income tax law that does not replace prior income law and doctrines, Section 409A requires nearly all mandatory and voluntary deferral arrangements for commissions to comply with both the Section 409A written form and operational requirements to achieve and defer income taxation of commissions and other compensation connected to the sale and placement of life insurance and other investments.

Under the regulations to Section 409A, the initial elections to defer such compensation must specifically be made irrevocable prior to January 1 of the calendar year in which bona fide sales/renewal commissions are earned in the case of sales commissions. In the case of investment commissions based upon the value of assets under management, an irrevocable initial election must be made prior to January 1 of the calendar year in which the date for each 12-month measuring period begins.⁵

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1. Commissioner v. Oates, 207 F.2d 711 (7th Cir. 1953); Rev. Rul. 60-31, 1960-1 CB 174; Let. Ruls. 9540033, 9245015.