Why independent insurance agents may want to revisit how they treat insurance commissions for tax purposes.
In the recent case of Fleischer v. Commissioner, Ryan Fleischer, a Series-licensed independent broker with LPL and also an insurance agent with MassMutual for fixed insurance contracts was an independent agent and was structured as an independent contractor. Fleischer also had an S corporation, called Fleischer Wealth Plan (FWP), for which Fleischer was the sole shareholder and officer, and with which he had an “employment agreement” to perform duties as a financial advisor.
In 2009, Fleischer received a total of $147,617 of commissions from LPL and MassMutual, which he reported as income for his S corporation. The business netted $46,775 after expenses that year, of which Fleischer then paid himself $34,851 as salary, and distributed $11,924 as a dividend not subject to self-employment tax. None of his $147,617 of income was reported on his personal Schedule C.
In 2010, Fleischer received $284,963 of insurance and brokerage commissions. He claimed all $284,963 as an “expense” on his Schedule C – netting out to zero – and in spite of the fact they had originally been paid to him, the commissions were all income of FWP, his S corporation. That year, FWP generated $289,201 of total revenue, the business netted $182,498 after expenses, and Fleischer then paid himself another $34,856 as salary, taking the remaining $147,642 as a non-employment-taxed dividend.
In 2011, the same strategy was used, Fleischer received another $266,292 of combined LPL and MassMutual commissions, and again claimed a matching $266,292 of “expenses” for a net profit of $0 on his Schedule C. The commissions ($266,292) were again reported as gross revenue to the S corporation, which then paid Fleischer $34,996 of salary, and $115,327 of employment-tax-free pass-through dividends, after deducting his (valid) business expenses.
Across all three years, Fleischer showed a net Schedule C income of $0, while the S corporation’s net profits (after Fleischer’s salary) were reported on a Form K-1 as pass-through income and claimed on Schedule E of Fleischer’s personal tax return instead. All together, Fleischer took $104,703 of salary (subject to payroll taxes), and $274,893 of pass-through dividends not subject to employment taxes.
Upon audit, the IRS contended that since all the commissions were paid to Fleischer directly (and not the S corporation) that the income should have all be reported directly by Fleischer on his Schedule C and not via the S corporation and its pass-through to Schedule E.
Why this is important: if the income had been (properly) reported on Schedule C, all the income would have been subject to self-employment taxes. By comparison, with the S corp, there was $274,893 of (pass-through dividend) income never subject to payroll/self-employment taxes. Therefore, the IRS issued a deficiency notice that Fleischer owed $41,563 of self-employment taxes across all three years. (see TC 2016-238)
Using an S -Corp to reduce self-employment taxes by distributing S-Corp dividends after reasonable compensation is a common strategy for many businesses but… Fleischer v. Commissioner is a shot across the bow of independent insurance agents assigning commission income to their S-Corp in lieu of claiming it as personal income on their Schedule C.
The “Fleischer Strategy,” is common with independent insurance agents. If you are an agent receiving a 1099-MISC from your S-Corp for broker/agent commissions paid to you may be out of compliance with 26 CFR 31.3121(d)-1(c)(2) because it is you, not your S-Corp, which is licensed to do the work as a registered representative or insurance agent. If this is the case, schedule a consultation with us to consider what action may need to be taken to bring your situation into compliance and avoid any IRS problems.