                        T.C. Memo. 2002-29



                      UNITED STATES TAX COURT



    ORIN F. FARNSWORTH AND MARY L. FARNSWORTH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14460-99.            Filed January 28, 2002.


     Orin F. Farnsworth and Mary L. Farnsworth, pro sese.

     Paul K. Webb, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     BEGHE, Judge:   Respondent determined a deficiency of

$111,808 in petitioners’ joint Federal income tax for 1995.

     After concessions by the parties, there are two issues for

decision:   (1) Whether petitioners are entitled to exclude from

income, as a recovery of basis, any portion of the “contract

value” termination payments received in 1995 by petitioner Orin
                               - 2 -

F. Farnsworth under his District Manager’s Appointment Agreement

(DMAA) with Farmers Insurance Group, and (2) whether petitioners

are liable for self-employment tax under section 14011 on the

DMAA “contract value” termination payments.

     We hold that petitioners are not entitled to exclude from

income any portion of the DMAA “contract value” termination

payments because petitioners failed to prove that Mr. Farnsworth

had any basis in the DMAA contract.    We further hold that the

DMAA “contract value” termination payments included in

petitioners’ income are subject to self-employment tax under

section 1401.

                         FINDINGS OF FACT

     Most of the facts have been stipulated and are so found.

The stipulation of facts and related exhibits are incorporated by

this reference.

     Petitioners were residents of Redding, California, when they

filed their petition.   Petitioners are married and filed a joint

Federal income tax return, Form 1040, U.S. Individual Income Tax

Return for the taxable year 1995.




     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                 - 3 -

     On April 18, 1954, petitioner Orin F. Farnsworth (Mr.

Farnsworth), formerly known as Jose Farnsworth, married Gloria

Farnsworth, from whom he is now divorced.

     From 1956 through part of 1962, Mr. Farnsworth was employed

as an agent of Farmers Insurance Group2 (Farmers) in El Paso,

Texas, selling home, commercial casualty and life insurance.

     In 1962, Mr. Farnsworth, Gloria Farnsworth, and their family

moved to Chico, California.   From 1962 through part of 1966, Mr.

Farnsworth worked as a division agency manager for Farmers in the

Chico, California, area.

     On September 30, 1966, Mr. Farnsworth applied to become a

district manager with Farmers.    On November 1, 1966, Farmers and

Mr. Farnsworth entered into the DMAA, under which he was

appointed district manager for district number 98-26, in Redding,

California.   The DMAA between Mr. Farnsworth and Farmers was

effective, including addenda, from its execution on November 1,

1966 through Mr. Farnsworth’s retirement on January 31, 1995.

     Under the DMAA, Farmers agreed to pay Mr. Farnsworth an

“overwrite” on all business produced by agents of Farmers within

district number 98-26.   An “overwrite” is a percentage of the

commissions earned by the sales agents supervised by the district



     2
      Farmers Insurance Group (Farmers) is a collection of
companies which, during 1966, included Farmers Insurance
Exchange, Truck Insurance Exchange, Fire Insurance Exchange, Mid-
Century Insurance Co., and Farmers New World Life Insurance Co.
                               - 4 -

manager.   Under the DMAA, Farmers also provided certain benefits

to Mr. Farnsworth, including life and health insurance, in

accordance with Farmers’s rules.    Mr. Farnsworth, in return,

agreed to recruit and train as many agents acceptable to Farmers

as might be required to produce sales in accordance with the

goals and objectives established by Farmers; to actively

represent only Farmers; to conform to Farmers’s regulations and

operating principles; to maintain in full force and effect any

required licenses; to provide service to policyholders through

the agents; to maintain and make available for audit by Farmers

adequate records, including profit and loss statements; and to

surrender on cancellation or termination of the DMAA agreement

all records, levy lists, cards, books, manuals, papers, forms, or

other material of whatsoever kind, and all copies thereof, having

to do with the business of Farmers.    Farmers had the exclusive

right to decrease or otherwise change overwrite rates, schedules

or classifications.

     The DMAA was terminable by either Farmers or Mr. Farnsworth

without cause on 30 days’ notice.    The DMAA was also terminable

immediately by Farmers for cause on specified grounds.

     The DMAA provided that upon cancellation by either party

without cause or as a result of Mr. Farnsworth’s death, Farmers

would have the right to pay Mr. Farnsworth the “contract value”

and terminate the contract.   If Farmers did not exercise its
                               - 5 -

right to pay “contract value”, Mr. Farnsworth or his estate could

attempt to sell his district manager position to a successor

nominee acceptable to Farmers for an amount not exceeding

"contract value".

     The amount of the "contract value" referred to in the DMAA

was based upon a schedule that took into account (1) the service

commission overwrite paid to the district manager during the 6

months immediately preceding termination, and (2) the number of

years of service completed by the district manager.   In the case

of Mr. Farnsworth, who had worked for more than 20 years as a

district manager at the time of termination, the DMAA provided

for a “contract value” of seven times the last 6 months’ service

commission overwrite.

     The DMAA specified that all lists and records of any kind

pertaining to policyholders or expirations, and also the

information contained therein, were the secret and confidential

property of Farmers and were never to be used or divulged by Mr.

Farnsworth.   All policy rights remained the property of Farmers.

Mr. Farnsworth had no rights or privileges in the continuing

effectiveness of the policies produced for Farmers.   Mr.

Farnsworth had no interest, assignable or otherwise, in the

district or in the DMAA, except as to the “contract value”

payments upon termination without cause.
                               - 6 -

     On November 1, 1966, Mr. Farnsworth and Farmers signed an

addendum to the DMAA, amending his concurrently signed DMAA.

The November 1, 1966, addendum to the DMAA reduced Mr.

Farnsworth’s overwrite commissions to the portion of the

overwrite in excess of $935 per month.   The monthly reduction in

the overwrite payable to Mr. Farnsworth is commonly referred to

as the “retention amount”.   Under the terms of the addendum, the

retention amount was to be withheld for the first 120 months of

the contract (10 years).   Commencing with the 121st month, the

retention would be reduced or eliminated if Farmers, in its

discretion, determined that Mr. Farnsworth’s performance

warranted the reduction.

     A second addendum to the DMAA, entered into by Farmers and

Mr. Farnsworth on February 6, 1968, reduced the “retention

amount” from $935 per month to $605 per month, but extended the

term of the retentions to the 178th month of the contract

(approximately 15 years from inception of the contract).

Commencing with the 178th month, the retention would be reduced

or eliminated if Farmers, in its discretion, determined that Mr.

Farnsworth’s performance warranted the reduction.3


     3
      The stipulation of facts between petitioner and respondent
mischaracterized the retention amounts as commencing, rather than
terminating or being reduced, on the 121st and 178th month of the
DMAA, respectively. The addenda make clear, however, that the
retention amounts were to be withheld commencing immediately, and
were to continue until the 121st and 178th month, respectively,
                                                   (continued...)
                              - 7 -

     In order to reimburse itself for the cost of paying

“contract value” to retiring district managers (rather than

requiring the retiring managers to sell their interests to the

replacement managers), Farmers began in 1965 to impose retention

amounts on its new district managers.   The retention amounts

withheld by Farmers from the compensation it paid to a new

district manager were not used to fund deferred compensation to

the new district manager upon retirement.   Instead Farmers used

the retention amounts to reimburse itself for the cost of paying

“contract value” retirement benefits to the retiring manager.

Farmers conditioned the new district manager’s right to receive

“contract value” benefits from Farmers at retirement on his

agreement to have retention amounts withheld.

     In issuing a Form 1099 reporting income to a district

manager, Farmers would take the commission overwrite earned by

the district manager and then deduct any “retention amount”

withheld from the district manager’s earnings to arrive at the

gross income of the district manager.   During the entire time



     3
      (...continued)
and we so find. See Cal-Maine Foods, Inc. v. Commissioner, 93
T.C. 181, 195 (1989). The total payments under both addenda
would have been approximately equal. The first addendum called
for retentions of $935 per month for 120 months, totaling
approximately $112,200. Assuming the retentions called for under
the first addendum were withheld until the effective date of the
second addendum, there would have been retentions of $935 per
month for 17 months, followed by retentions of $605 per month for
the remaining 160 months, totaling $112,695.
                               - 8 -

that Mr. Farnsworth worked as a district manager, Farmers

maintained standard accounting practices nationwide, under which

it did not report any “retention amounts” as income to its

district managers.

     During that same time, Mr. Farnsworth did not treat the

retention amounts as income and did not pay income taxes on the

retention amounts.

     Mr. Farnsworth and Gloria Farnsworth were divorced on

November 8, 1988, pursuant to a marital settlement agreement

filed in the California Superior Court.   Gloria Farnsworth is not

a party to this proceeding.   Under the terms of the marital

settlement agreement, Mr. Farnsworth assigned to Gloria

Farnsworth 32.91 percent of his right to contract value under the

DMAA.

     In July 1989, the Farmers Insurance Group Federal Credit

Union approved a loan to Mr. Farnsworth of $25,001 secured by an

assignment of Mr. Farnsworth’s “contract value” in the DMAA.     In

May 1991, Mr. Farnsworth agreed to guarantee a loan by Farmers to

Fred Fourby, an agent of the company, secured by Mr. Farnsworth’s

right to “contract value” upon termination of the DMAA.   Mr.

Farnsworth retired from Farmers on January 31, 1995.   At Mr.

Farnsworth’s retirement, his “contract value” under the DMAA was

$761,740.   Farmers deducted from the full “contract value” of

$761,740 (1) the outstanding Credit Union loan balance of
                               - 9 -

$20,513.68, and (2) the remaining balance of $5,196.53 on the

Fredy Fourby loan guaranty, resulting in a net "contract value"

of $736,029.79.

     Pursuant to the DMAA and the divorce decree,

Farmers made the following “contract value” payments during

taxable years 1995 and 1996:

                       Orin           Gloria
                    Farnsworth      Farnsworth       Total
Mar. 2, 1995       $161,780.38      $83,562.88    $245,343.26
July 31, 1995       161,780.38       83,562.88      245,343.26
Jan. 31, 1996       161,780.39       83,562.88      245,343.27
  Total             485,341.15      250,688.64      736,029.79

     Petitioners reported a taxable gain of $263,156 on Form

4797, Sales of Business Property, and Form 6252, Installment Sale

Income, attached to their Form 1040 for taxable year 1995.

Petitioners reported the total gross “contract value”, amounting

to $761,740, which amount included:    (1) All payments made to Mr.

Farnsworth in taxable years 1995 and 1996; (2) all payments made

to Orin Farnsworth's former wife, Gloria Farnsworth; (3) the

canceled credit union loan valued at $20,513.68, which was offset

by Farmers; and (4) the Fred Fourby loan guaranty of $5,196.53,

which was also offset by Farmers.

     Petitioners reduced the gross “contract value” of $761,740

by $373,560 for “cost or other basis of property sold”.      The

“cost or other basis” claimed by petitioners consisted of the
                             - 10 -

entire $250,689 (rounded) which Farmers paid from the “contract

value” directly to Gloria Farnsworth during 1995 and 1996, and an

additional $122,871 in alleged basis, leaving a reported gross

profit of $388,180.

     Petitioners reported on Form 6252 receiving $516,397 in

“contract value” payments in 1995, consisting of:   (1) $323,560

of “contract value” received by Mr. Farnsworth; (2) $167,126 of

“contract value” received by Gloria Farnsworth; (3) the canceled

credit union loan of $20,514 (which was apparently repaid by

Farmers out of the contract value); and (4) the $5,197 Fred

Fourby loan guaranty (which was apparently also repaid or

withheld by Farmers).

     Using Mr. Farnsworth’s and Gloria Farnsworth’s relative

shares of total contract receipts, petitioners reported a gross

profit percentage of 50.96 on Form 6252.   For 1995, on the basis

of total payments reportedly received by Mr. Farnsworth and

Gloria Farnsworth of $516,397, petitioners reported taxable

installment sale income for the year of $263,156 (50.96 percent x

$516,397 = $263,156).

     Respondent's notice of deficiency disallowed the reduction

from “contract value” for the payments made by Farmers directly

to Gloria Farnsworth, disallowed the reduction of Mr.

Farnsworth’s claimed recovery of basis in the DMAA, and
                             - 11 -

determined that the “contract value” payments are subject to

self-employment tax under section 1401.

     Respondent’s answer concedes that the $167,126 in “contract

value” paid by Farmers directly to Gloria Farnsworth during 1995

should be taxable to Gloria Farnsworth and not to petitioners.

                             OPINION

Issue 1. Are Petitioners Entitled To Exclude From Income, As a
Recovery of Basis, Any Portion of the DMAA Payments They Received
in 1995?

     Petitioners have the burden of proof to establish the amount

of Mr. Farnsworth’s basis, if any, in the DMAA contract.   See

Rule 142 (burden of proof generally on petitioner); Martin Ice

Cream Co. v. Commissioner, 110 T.C. 189, 220 (1998) (Court

accepted Commissioner’s determination that taxpayer had no basis

in stock where taxpayer failed to introduce evidence to establish

basis in stock); Reinberg v. Commissioner, 90 T.C. 116, 142

(1988) (petitioners not entitled to depreciation deductions

because they failed to meet burden of proof by establishing

basis).

     Petitioners argue that Mr. Farnsworth has basis in the DMAA

contract because he treated the retention amounts as income on

his Federal income tax returns.   Petitioners failed to introduce

any documentary evidence to support their contention.

Petitioners do not have copies of Mr. Farnsworth’s Federal income

tax returns from the relevant years to show that he reported as
                               - 12 -

taxable income any of the “retention amounts” withheld by

Farmers.

     Mr. Farnsworth’s testimony regarding the retention amounts

was vague and inconsistent with the provisions of the DMAA and

the addenda.   Mr. Farnsworth claims to have a basis in the DMAA

of $86,000.    He testified that Farmers withheld retention amounts

for 6 years.   Yet the documentary evidence shows originally

required retentions of $935, which were thereafter reduced to

$605 per month.   Retentions of $935 per month for 6 years would

total only $67,320, substantially less than the $86,000 basis

petitioners claimed.   The reduced retention of $605 per month

beginning in March 1968 for the remainder of the 6-year period

would have resulted in total retentions of only $49,170.4   Mr.

Farnsworth was unable to explain the discrepancies between his

recollection of the facts, the basis he claimed, and the terms of

the addenda.   Mr. Farnsworth admitted that he had no

documentation to show the amount that Farmers actually retained.

The only evidence offered to support Mr. Farnsworth’s claim that

he has basis in the DMAA was his self-serving testimony,

testimony that was based on his recollection of events 25 to 30

years before the trial.




     4
      Payments of $935 per month for 17 months from November 1966
to March 1968, plus the remaining 55 months of payments at $605
per month, for a total of 72 months of payments (6 years).
                               - 13 -

     Mr. Farnsworth also claimed that the retention amounts

included interest (at a rate he does not recall), which he

deducted.   Presumably, Mr. Farnsworth’s basis would be less than

the $67,320 or $49,170 if some portion of the monthly retention

amounts included interest that he deducted.    Mr. Farnsworth’s

testimony showed that he did not clearly recollect the facts, and

that the amount claimed as “basis” was, at best, a very rough

estimate.

     Petitioners offered no reliable evidence upon which the

Court could determine the actual retention amounts withheld by

Farmers.    Mr. Farnsworth has asserted that the terms of the

addenda were not followed, but he has failed to provide any

credible evidence of the amounts actually retained by Farmers.

Petitioners have thus failed to meet their burden of establishing

the retention amounts with credible evidence.

     While we should not disallow entirely all amounts because

only some amounts have been proven, see Cohan v. Commissioner, 39

F.2d 540, 543 (2d Cir. 1930), “the basic requirement is that

there be sufficient evidence to satisfy the trier that at least

the amount allowed in the estimate was in fact spent or incurred

for the stated purpose.    Until the trier has that assurance from

the record, relief to the taxpayer would be unguided largesse.”

See Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).
                              - 14 -

     In the case at hand, petitioners have failed to convince us

of a specific amount that was withheld as retentions.   We know

that the contractual terms were not followed, that no reliable

documentary evidence is available to establish the true retention

amounts, and that Mr. Farnsworth’s testimony concerning the

retention amounts satisfies neither the rules of arithmetic nor

the laws of probability.

     More importantly, even if petitioners had established the

retention amounts, petitioners have failed to establish by a

preponderance of the evidence that the retention amounts were

included in Mr. Farnsworth’s taxable income.   In order for the

retention amounts to give Mr. Farnsworth a basis in the DMAA,

petitioners would have to establish that Mr. Farnsworth reported

the retention amounts as income for the years in which they were

withheld; otherwise the retention amounts would not constitute a

cost of his interest in the DMAA that would be taken into account

for income tax purposes.   See sec. 1012 (basis of property is

cost); Gertz v. Commissioner, 64 T.C. 598 (1975) (disallowing bad

debt deduction for unpaid wages that were never included in

income).

     Petitioners offered no evidence, other than Mr. Farnsworth’s

self-serving testimony, to show that Mr. Farnsworth previously

included the retention amounts in income.
                              - 15 -

     Respondent called Carl Earl Diltz, Jr., to explain Farmers’s

policy regarding the tax treatment of retention amounts.    Mr.

Diltz was employed by Farmers in its accounting department for 36

years and is now retired.   Mr. Diltz began his career at Farmers

as an accounting clerk in 1959 and ended his career in 1995 as

director of accounting for the entire company.   Mr. Diltz was

thoroughly familiar with Farmers’s DMAA contracts, including the

terms, dates that the terms were changed, and the reasons why the

terms were changed.   Mr. Diltz’s testimony was highly credible.

     Mr. Diltz testified that Farmers always reduced the amount

of income to the district managers reported on the Forms 1099 by

the retention amounts, and that Farmers did not treat the

retention amounts as taxable income to the managers under the

DMAAs:

     Q.   [D]uring your tenure from * * * 1959 to 1995 when
     you retired, was it ever Farmers procedure to report
     those retention amounts as income to district managers?

     A.   No.

Mr. Diltz also testified that Farmers’s procedures were

consistently followed on a nationwide basis, and that it was his

“primary responsibility as a director to develop those procedures

and to see that all 16 offices were doing exactly the same

thing”.   We therefore have found that Farmers did not report the

retention amounts as income to Mr. Farnsworth.
                              - 16 -

     We sustain respondent’s determination denying petitioners

any reduction in income attributable to Mr. Farnsworth’s claimed

basis in the DMAA.   Petitioners have established neither the

amount of the retentions nor that any such retentions would

bestow on Mr. Farnsworth a basis in the DMAA.

Issue 2.   Are the DMAA Payments Subject to Self-Employment Tax?

     The self-employment tax was enacted in 1950 to finance the

extension of Social Security benefits to self-employed

individuals.   Social Security Act Amendments of 1950, ch. 809, 64

Stat. 477; S. Rept. 1669, 81st Cong., 2d Sess. (1950), 1950-2

C.B. 302, 307-308, 352-353.

     Section 1402(a) defines self-employment earnings as “gross

income derived by an individual from any trade or business

carried on by such individual”.

     The seminal case considering the meaning of the “carried on”

requirement is Newberry v. Commissioner, 76 T.C. 441 (1981), in

which this Court held that business interruption insurance

proceeds paid to the owner of a grocery store destroyed by fire

were not subject to self-employment tax.   The Commissioner argued

in Newberry that business interruption insurance proceeds were a

substitute for the business income that would have been earned

but for the fire that destroyed the grocery store.   The income

that would have been earned but for the fire would have been
                               - 17 -

subject to self-employment tax.    Therefore, the Commissioner

argued, so should the insurance proceeds.

       This Court rejected the Commissioner’s argument, holding

“that there must be a nexus between the income received and a

trade or business that is, or was, actually carried on”.      Id. at

444.    Since the insurance proceeds were received not from the

operation of the business, but rather because of the nonoperation

of the business, we held that the proceeds were not subject to

self-employment tax.

       The comparable statutory terms--carrying on a trade or
       business and rendering services--suggests to us that
       any income must arise from some actual (whether
       present, past or future) income-producing activity of
       the taxpayer before such income becomes subject to
       either FUTA, FICA, or self-employment taxes, as the
       case may be. * * * [Id. at 446.]

       From this small seed has grown a great tree of self-

employment tax jurisprudence, a tree with many branches.      One

large branch of the tree is made up of cases concerning insurance

company agent and manager termination payments.

       One of the principal cases addressing whether insurance

company agent termination payments are subject to self-employment

tax is Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994),

revg. T.C. Memo. 1992-655, in which the Court of Appeals for the

Ninth Circuit, to which the case at hand would be appealable,

reversed a decision of this Court.      The taxpayer in Milligan, a

former State Farm insurance agent, received termination payments
                              - 18 -

upon retirement.   Under the State Farm agreement, the taxpayer

was entitled to 5 years of termination payments based on a fixed

percentage of his final year’s commissions.   The taxpayer was

eligible for termination payments only if the termination

occurred more than 2 years after the contract was entered into.

     The termination payments were also subject to reduction for

refundable commissions that had already been earned by the

taxpayer on policies that were canceled during the year following

termination.   The reductions were called “chargebacks”.

     This Court held, in a Memorandum Opinion, that the

termination payments were subject to self-employment tax because

the payments were “derived”, in the dictionary meaning of the

word, from petitioner’s prior employment.   The termination

payments were found to be analogous to the payment of future

commissions on policies written during the term of the contract,

which had been held subject to self-employment tax in Becker v.

Tomlinson, 9 AFTR 2d 1408, 62-1 USTC par. 9446 (S.D. Fla. 1962):

          We find that Termination Payments are the
     equivalent of the deferred compensation which a State
     Farm agent, active or retired, would receive from
     policies sold in prior years. On this basis, we hold
     that Termination Payments are derived from self-
     employment, even though they are received in years
     subsequent to the activity which generated them.
     [Milligan v. Commissioner, T.C. Memo. 1992-655.]

     In reversing the Tax Court’s decision in Milligan, the Court

of Appeals for the Ninth Circuit held that “to be taxable as

self-employment income, earnings must be tied to the quantity or
                               - 19 -

quality of the taxpayer’s prior labor, rather than the mere fact

that the taxpayer worked or works for the payor.”    Milligan v.

Commissioner, 38 F.3d at 1098.

     The Court of Appeals found that the taxpayer’s earnings were

not tied to the quantity of his prior labor.    The Court of

Appeals ruled that the 2-year qualification requirement related

only to the taxpayer’s eligibility for termination payments; the

payment amounts did not depend on the taxpayer’s length of

service beyond the period of eligibility.    The Court of Appeals

pointed out that it did not matter whether the taxpayer had

worked for State Farm for 2 years or 20--the payments would in

either case be the same.    Because the payment amounts did not

depend on the length of service or overall earnings, the payments

were not tied to the quantity of the taxpayer’s services.

     In the same vein, the Court of Appeals held that the

termination payments did not depend on the quality of the

taxpayer’s prior service.    The Court of Appeals recognized that

the payments were based on the taxpayer’s final year’s

commissions.   According to the Court of Appeals, “At most, the

amount of the Termination Payments, not the payments themselves,

actually arose from Milligan’s business activity.”    Id. at 1099.

The Court of Appeals went on to note that even the amount was not

entirely related to Milligan’s prior earnings, because of the

potential for chargebacks based on future policy cancellations
                              - 20 -

over which Milligan had no control.    Because these chargebacks

were entirely unrelated to Milligan’s business activity, the

Court of Appeals held that the payments were not tied to the

quality of the taxpayer’s prior services.    The Court of Appeals

in Milligan therefore concluded that the termination payments did

not derive from the “carrying on” of the taxpayer’s trade or

business and so were not subject to self-employment tax.

     In Gump v. United States, 86 F.3d 1126 (Fed. Cir. 1996), the

Court of Appeals for the Federal Circuit followed Milligan in a

virtually identical factual situation involving the “extended

earnings” of a Nationwide Insurance Co. agent.    As in Milligan,

the taxpayer in Gump was entitled to receive upon termination of

his agency contract a percentage of his final year’s earnings if

he had performed services under the contract for more than 5

years.   The earnings were subject to reduction for policy

cancellations occurring in the 2 years after termination.

Following Milligan, the Court of Appeals for the Federal Circuit

held that the payments were not based on the “quantity or

quality” of the taxpayer’s prior services and therefore were not

subject to self-employment tax.   The Court of Appeals for the

Federal Circuit explained in Gump the reason for the rule as

follows:

          Thus, the extended earnings are not unpaid renewal
     commissions, they are computed by reference to renewal
     commissions--a reasonable indicator of the value of
     Gump’s insurance business at the time he relinquished
                              - 21 -

     control of it. The amount is unaffected by his income
     during any prior period, by the total number of
     policies written over his career, by the total time
     period he served as an agent, or even by the length of
     his service to Nationwide. In other words, the amount
     is not “tied to the quantity or quality” of his labor
     in any meaningful way. [Id. at 1130.]

     An offshoot of the tree sprouted in Schelble v.

Commissioner, 130 F.3d 1388 (10th Cir. 1997), affg. T.C. Memo.

1996-269.   There, the “extended earnings” of an American Family

Life Insurance Co. independent agent were held to be subject to

self-employment tax.   Both the Tax Court and the Court of Appeals

for the Tenth Circuit distinguished Milligan on its facts, on the

ground that the payments to the taxpayer in Schelble depended on

the quantity and quality of his prior self-employment services.

     In general, the extended earnings payments were
     calculated based on a percentage of the renewal service
     fees paid to the agent during the six- or twelve-month
     period preceding the month the Agreement terminated.
     The percentage was based upon the agent’s length of
     consecutive service for the Companies immediately
     preceding termination of the Agreement. * * * [Id. at
     1390.]

Unlike Milligan, the amount of termination payments to be

received by the taxpayer in Schelble depended on the length of

his service to the insurance company and were tied entirely to

his earnings during the 12-month period prior to termination

without being subject to any posttermination adjustments for

events outside of his control (such as, in Milligan, chargebacks

for policy cancellations after termination of the agreement).

The Court of Appeals in Schelble distinguished Milligan and held
                                - 22 -

that “Mr. Schelble’s payments are tied to the quantity and

quality of his prior services performed for the Companies.”     Id.

at 1393.

     The Court of Appeals in Schelble also distinguished Gump v.

Commissioner, supra.   Id.    The “extended earnings” payments in

Gump were calculated in the same way as the termination payments

in Milligan and differently from the “extended earnings” in

Schelble.   The Court of Appeals for the Tenth Circuit rejected

the taxpayer’s suggestion that the label attached to the payments

has any tax significance.

     However, the payment scheme in Gump is nearly identical
     to that in Milligan and distinguishable from Mr.
     Schelble’s payment scheme. For the same reasons we
     reject Milligan, we also find Gump does not apply [to]
     Mr. Schelble’s case. [Schelble v. Commissioner, supra
     at 1393-1394.]

     In Jackson v. Commissioner, 108 T.C. 130 (1997), the Tax

Court, in a reviewed opinion, followed Milligan in a case that

would not have been appealable to the Court of Appeals for the

Ninth Circuit.   Like Milligan, Jackson involved termination

payments to a State Farm agent under a contract providing for a

2-year qualification period, payments based on a fixed percentage

of the final-year’s compensation without regard to the length of

service, and a reduction for commission chargebacks on policies

canceled after termination.    Following Milligan, this Court held

that the termination payments were not subject to self-employment
                               - 23 -

tax because the payments were not tied to the “quantity or

quality” of the employee’s services.

       This Court in Jackson also recognized the factual

distinction identified in Schelble: where the termination

payments are tied to the quantity or quality of the taxpayer’s

prior services, the payments will be subject to self-employment

tax.    Jackson v. Commissioner, supra at 136.

       In Lencke v. Commissioner, T.C. Memo. 1997-284, after

distinguishing the facts from those in Milligan and Jackson, this

Court held that payments in lieu of renewal commissions to which

an insurance agent would otherwise be contractually entitled are

subject to self-employment tax because the payments retain the

character of the renewal commissions they replaced.

       Congress, in section 1402(k), codified the standard

established in Milligan with respect to termination payments made

after December 31, 1997, to an “insurance salesman”.     Taxpayer

Relief Act of 1997, Pub. L. 105-34, sec. 922(a), 111 Stat. 879-

880.    Section 1402(k) exempts insurance salesman termination

payments from self-employment tax if, among other things, the

amount of the payments “does not depend to any extent on length

of service or overall earnings from services performed for such

company (without regard to whether eligibility for payment

depends on length of service).”    Sec. 1402(k)(4)(B).   The parties

agree that section 1402(k) does not apply to the case at hand,
                              - 24 -

because Mr. Farnsworth was not an “insurance salesman”, and

because the payments were made in 1995, before the effective date

of the statute.   However, the legislative history of section

1402(k) makes it clear that the provision was intended to codify

existing law.5

     Factually, the case at hand is like Schelble, and unlike

Jackson, Gump, and Milligan, because the amount of Mr.

Farnsworth’s termination payments depended on the length of his

relationship with Farmers.   Mr. Farnsworth’s “contract value”

referred to in the DMAA was based upon a schedule that took into

account the number of years of service completed by the district

manager.   This was more than a one-step eligibility requirement.

The longer the taxpayer’s tenure as district manager, the higher

the percentage of the taxpayer’s final 6 months’ earnings that

was used to compute “contract value”.   The amount varied between

three times the last 6 months’ service commission overwrite for a

district manager with 5 years of service to seven times the last

6 months’ service commission overwrite for a manager who had, as



     5
      After citing Jackson v. Commissioner, 108 T.C. 130 (1997),
Gump v. United States, 86 F.3d 1126 (Fed. Cir. 1996), and
Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994), revg.
T.C. Memo. 1992-655, the Conference Committee report states:
“The House bill codifies case law by providing that net earnings
from self-employment do not include any amount received during
the taxable year from an insurance company on account of services
performed by such individual as an insurance salesman for such
company”. H. Conf. Rept. 105-220 at 458 (1997), 1997-4 C.B.
(Vol. 2) 1457, 1927-1929.
                               - 25 -

Mr. Farnsworth did, 20 or more years of service as a district

manager.

     Moreover, unlike the taxpayers in Jackson, Gump, and

Milligan, the payments to which Mr. Farnsworth was entitled were

not subject to reduction for events unrelated to his services and

occurring after termination.

     There is also evidence in the record to suggest a

significant relationship between Mr. Farnsworth’s rights under

the DMAA to recover “contract value” at termination and his

agreement at inception of the DMAA to have the retention amounts

withheld.   Mr. Diltz testified that the retention amounts were

imposed in order to enable Farmers to recover from a successor

manager the cost of paying “contract value” to the retiring

manager replaced by the successor.      Prior to the requirement for

the successor manager to have retention amounts withheld, there

was no provision for the payment of contract value upon

termination.   While there is no relationship between the new

manager’s retention amount and the “contract value” amount

(because the retention amount is based on the former manager’s

contract value), the successor manager’s right to contract value

upon his retirement was conditioned upon his agreement to have

the retention amounts withheld.   There was thus a causal

relationship between the right to contract value and the

retention requirement.   The causal relationship between Mr.
                              - 26 -

Farnsworth’s agreement to allow his overwrite commissions to be

reduced by retentions and his right to recover “contract value”

upon termination creates an additional nexus between the

termination payments and his prior employment.

     Because, as in Schelble v. Commissioner, 130 F.3d 1388 (10th

Cir. 1997), the contract value payments to Mr. Farnsworth were

based on the quantity (length of service) and quality (final 6

months’ earnings without reduction for post termination events)

of the services rendered by Mr. Farnsworth, and because of the

causal relationship between retentions and the right to “contract

value” payments at termination, Farmers’s contract value payments

to Mr. Farnsworth are subject to self-employment tax.

     Petitioners attempt to distinguish Schelble on three

grounds.   First, petitioners argue, without citation of

authority, that the holding of Schelble should not apply to the

case at hand because the taxpayer was an insurance agent, while

Mr. Farnsworth was a district manager.   Petitioners fail to

explain how a difference in Mr. Farnsworth’s title or duties

would make any difference in the result.   The fact remains that

there is a sufficient nexus between the payments and Mr.

Farnsworth’s self-employment services to cause the payments to be

subject to the self-employment tax.

     Second, petitioners argue that the payments in Schelble were

“based on the future commissions the Agent would have earned if
                                - 27 -

the Agent had stayed with the insurance company”.    The

termination payments in Schelble were based on a percentage of

the renewal commissions paid during the final months of the

contract.    One of Schelble’s companies paid between 50 percent

and 150 percent of the commissions for the final 12 months of

service, while the other company paid between 50 percent and 100

percent of the commissions for the final 6 months of service.      In

both cases, the percentage depended on the length of the agent’s

term of service.    Petitioners argue that the holding in Schelble

should not apply to the case at hand, where the termination

payments are based on prior earnings rather than future

commissions.    Again, we reject petitioners’ argument.    In

Newberry v. Commissioner, 76 T.C. 441, 444 (1981), we held that

it does not matter whether the income arises from a “past,

present, or future income-producing activity”.    See also

Schumaker v. Commissioner, 648 F.2d 1198, 1200 (9th Cir. 1981)

(self-employment income determined from source of income, not

taxpayer’s status when income realized); sec. 1.1402(a)-1(c),

Income Tax Regs. (self-employment income may include payments

received from services provided in a prior taxable year).

     Finally, petitioners argue that the termination payments

should be treated as gain or loss from the sale of property under

section 1402(a)(3)(C), rather than as ordinary self-employment

income.     Following a long line of authority, we held in Clark v.
                             - 28 -

Commissioner, T.C. Memo. 1994-278 and Lowers v. Commissioner,

T.C. Memo. 1991-75, that the “contract value” payments upon

termination of a Farmers DMAA constitute ordinary income and not

capital gains from the sale of property.   In Clark we stated:

     Under the 1967 Agreement, all * * * rights or
     privileges for the continuing effectiveness of policies
     produced on behalf of any of the Companies, including
     all records pertaining thereto, were and should at all
     times remain the property of Farmers. The short answer
     is that petitioner transferred nothing to Farmers. The
     contract with Farmers was not sold or exchanged, but
     was terminated. On December 31, 1986, petitioner’s
     services as a Farmers district manager came to an end.
     The local agents that petitioner had obtained for
     Farmers remained, as before, local agents of Farmers.
     * * *

See also Deal v. Commissioner, T.C. Memo. 1973-49 (ordinary

income treatment for termination payment by Farmers under earlier

form of Farmers DMAA).

     Like the taxpayers in Clark, Lowers, and Deal, Mr.

Farnsworth did not sell any property to Farmers.    Farmers owned

all the business property used by Mr. Farnsworth.   The DMAA

between Mr. Farnsworth and Farmers provides:

     The District Manager understands and agrees that all
     lists and records of any kind pertaining to
     policyholders or expirations, and also the information
     contained therein, are the secret and confidential
     property of the Companies and shall never be used or
     divulged, except as specifically authorized by, and for
     the benefit of, the Companies.

The payments Mr. Farnsworth received were expressly in

consideration for the termination of the DMAA contract; the

payments were not made in return for the transfer of specific
                              - 29 -

property owned by him.   Neither in form nor substance was the

transaction at issue a sale of property by Mr. Farnsworth.

     The “contract value” termination payments to Mr. Farnsworth

under the DMAA are subject to self-employment tax.

     To reflect concessions of the parties,



                                         Decision will be entered

                                    under Rule 155.
