2.4 Commissions Taxable When Credited

Earned commissions are taxable in the year they are credited to your account and subject to your drawing, whether or not you actually draw them.

Do not report commissions that were earned in 2012 on your 2012 return if they cannot be computed or collected until a later year.

Caution

Earned Commissions Credited to Your Account

You may not postpone tax on earned commissions credited to your account in 2012 by not drawing them until 2013 or a later year. However, where a portion of earned commissions is not withdrawn because your employer is holding it to cover future expenses, you are not taxed on the amount withheld.

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Advances against unearned commissions.

Under standard insurance industry practice, an agent who sells a policy does not earn commissions until premiums are received by the insurance company. However, the company may issue a cash advance on the commissions before the premiums are received. Agents have claimed that they may defer reporting the income until the year the premiums are earned. The IRS, recognizing that in practice companies rarely demand repayment, requires that advances be included in income in the year received if the agent has full control over the advanced funds. A repayment of unearned commissions in a later year (2.8) is deducted on Schedule A.

Salespeople have been taxed on commissions received on property bought for their personal use. In one case, an insurance agent was taxed on commissions paid to him on his purchase of an insurance policy. In another case, a real estate agent was taxed on commissions he received on his purchase of land. A salesman was also taxed for commissions waived on policies he sold to friends, relatives, and employees.

Kickback of commissions.

An insurance agent’s kickback of his or her commission is taxable where agents may not under local law give rebates or kickbacks of premiums to their clients. The commissions are income and may not be offset with a business expense deduction; illegal kickbacks may not be deducted.

However, in one case, a federal appeals court allowed an insurance broker to avoid tax when he did not charge clients the basic first-year commission. The clients paid the broker the net premium (gross premium less the commission), which he remitted to the insurance company. The IRS and Tax Court held that the commissions were taxable despite the broker’s voluntary waiver of his right to them. He could not deduct them because his discount scheme violated state anti-rebate law (Oklahoma). On appeal, the broker won. The Tenth Circuit Court of Appeals held that since the broker never had any right to commissions under the terms of the contracts he structured with his clients, he was not taxed on the commissions. The court cautioned that if the broker had remitted the full premium (including commission) to the insurance company and then reimbursed the client after having received the commission from the company, the commission probably would have been taxable.