Paul L. Caron

Wednesday, January 9, 2008

9th Circuit: Insurance Contract Termination Payments Constitute Ordinary Income, Not Capital Gain

The Ninth Circuit yesterday, in Trantina v. United States, No. CV-03-02579-SRB, (9th Cir. 1/9/08), affirmed a district court's holding that insurance contract termination payments received by an insurance agent constituted ordinary income and not long-term capital gains, following Baker v. Commissioner, 338 F.3d 789 (7th Cir. 2003).

[T]he better view of the termination payments is that they were made pursuant to, not in exchange for, the Corporate Agreement. As the government points out, the Corporate Agreement obligated Trantina to perform certain services, such as soliciting and servicing insurance policies. Trantina was compensated for these services through commission payments under the agreement, and he was permitted to continue as State Farm's agent as long as the agreement remained in effect. Trantina only became entitled to the contractual termination payments after he complied with two additional conditions in the agreement: He was required to return all of State Farm's property and he was required to comply with a twelvemonth non-compete agreement. The Seventh Circuit reached a similar conclusion in Baker, finding that the termination payments were made at least in part for the non-compete agreement, which is taxed as ordinary income. ...

Trantina asserts that the rights he possessed under the Corporate Agreement are the type of property that Congress intended to tax at the capital gains rate because he made a "substantial economic investment in the Agreement" that "increased over the years." The basis for this investment, Trantina argues, is the economic opportunity cost that he incurred when he decided to pursue a career as an insurance agent instead of something else. This argument sweeps far too broadly. Every individual incurs an opportunity cost when he or she decides to take one course of action instead of another. To use opportunity cost as the basis for a capital investment would render not only every employment contract, but also every economic exchange, a capital asset.

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