The Ninth Circuit has affirmed a district court and held that termination payments received by a retiring insurance agent were not capital gain but were taxable as ordinary income. The court thus joins the Seventh Circuit in so ruling on similar facts. See Warren L. Baker Jr. v. Commissioner, 92 AFTR2d 2003-5640.
Charles Trantina retired after working 38 years as a State Farm agent in Phoenix. Under his agency’s contract, the insurer provided forms, manuals and records and assisted Trantina with some advertising costs. In return, the agency solicited and serviced insurance policies, which also belonged to State Farm. State Farm paid Trantina commissions and, upon his retirement and the dissolution of the agency’s corporation, termination payments.
Trantina originally reported these termination payments as ordinary income on his individual tax return but later amended his return to recharacterize them as long-term capital gain. He claimed they resulted from the sale or exchange of a capital asset—the agreement with State Farm—that was held longer than one year. The IRS denied the refund, and Trantina sued in district court. The court granted summary judgment for the IRS, finding that the agreement was not a capital asset and that no exchange or sale of it had occurred. Trantina appealed.
The Ninth Circuit reasoned that to realize a capital gain, there must be ownership of a capital asset. However, under the terms of the agreement with State Farm, Trantina had no property that could be sold or exchanged. All manuals, forms, records and policies were the property of State Farm. Trantina countered that the agreement itself was a capital asset that he exchanged with State Farm for the termination payments. The court responded that the termination payments were made pursuant to, not in exchange for, the agreement. Trantina was not entitled to the termination payments unless he complied with two requirements—that he return all State Farm property and that he not compete with State Farm for 12 months.
Taxpayers will not have success in achieving capital gain treatment unless the asset in question meets the definition of a capital asset. Under IRC § 1222(3), to classify income as a long-term capital gain, the payments must arise from the sale or exchange of a capital asset held longer than one year and must be given in consideration of this sale or exchange.
n Charles E. Trantina v. U.S, 101 AFTR2d 2008-443
Prepared by Karen M. Cooley, CPA, MPA, instructor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.