Lewis N. COTLOW, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent

United States Court of Appeals for the Second Circuit1955-12-12No. No. 6, Docket 23399

228 F.2d 186

Summary · law.co

Holding. The Tax Court's determination that approximately $22,694 in renewal commissions received in excess of acquisition costs constitutes taxable ordinary income to Cotlow for 1948 is affirmed. Cotlow is not entitled to capital gains treatment for commission receipts, nor may he deduct against current-year income the cost of acquiring renewal commission assignments that will produce income in future years.

Cotlow, a life insurance agent, purchased renewal commission rights from other agents and received substantial payments from those assignments in 1948. He reported no income that year despite receiving over $45,000 in commissions, arguing these payments were not taxable. The Tax Court determined that the amount received in excess of his original acquisition costs—approximately $22,694—constituted taxable ordinary income. Cotlow appealed on three grounds: that he realized no taxable income, that any income qualified as long-term capital gain, and that he could deduct the cost of new commission assignments purchased that year against current profits.

The court rejected all three arguments. It characterized Cotlow's business as a brokerage and discounting service involving real economic risk, with income arising from the performance of services rather than from a mere assignment of pre-existing income rights. The court distinguished cases involving gratuitous family assignments, finding instead that Cotlow's arm's length purchases of income rights for valuable consideration made him taxable on amounts received in excess of what he paid. The court further held that commission receipts do not qualify for capital gains treatment because they do not result from a sale or exchange of capital assets as required by tax law. Finally, the cost of acquiring future commission rights constitutes a capital expenditure to be recovered against future income, not a deductible business expense in the year of purchase.

Summary generated by law.co from the public-domain opinion. The opinion text itself is public domain.

Key issues

Whether excess renewal commission receipts over original acquisition costs constitute taxable income
Whether such income qualifies for long-term capital gains treatment
Whether costs of acquiring future commission assignments are deductible in the year of purchase

Procedural posture

Cotlow appealed a Tax Court decision that determined he owed tax on approximately $22,694 in net renewal commission income for 1948.

Authorities cited

No cited authorities resolved to law.co cases yet.

Opinion · public domain

majority opinion

WATERMAN, Circuit Judge.

Petitioner is a life insurance agent who has been engaged since 1927 in purchasing from other insurance agents their rights to renewal commissions on life insurance policies. In 1948 he filed his individual return on the cash receipts and disbursements basis. He reported no income on account of assigned renewal commissions that year although he received during the year the total sum of $45,500.70 from assigned commissions on 1,648 policies. Of this amount $23,-563.33 represented receipts over and above the aggregate original cost of the assignments to the petitioner, which cost had been recovered by him in the form of prior receipts. The Tax Court held, 22 T.C. 1019, that $22,694.50 (being the $23,563.33 less $868.83 representing un-recovered costs of policies lapsed during 1948) was taxable to the petitioner as ordinary income for 1948. Petitioner now seeks to upset this determination on this appeal. He raises three questions: (1) whether he realized any taxable income on the receipt by him of commissions on assigned renewals; (2) if so, whether the income received is taxable as ordinary income or long-term capital gain; and (3) whether he may deduct from such income the total cost of all assignments of renewal commissions purchased in 1948.

Petitioner performs a form of brokerage service for life insurance agents when he converts their rights to future income into immediate hard cash. He not only performs a discounting function, but, in addition, he undertakes the risk that by lapse or termination of a policy renewal commissions will cease. We find it difficult, under these circumstances, to view the petitioner’s earnings or profits arising from the performance of these services as other than taxable income. And petitioner relies on cases which have no application to this case. Lucas v. Earl, 1930, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731; Helvering v. Horst, 1940, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75; and Helvering v. Eubank, 1940, 311 U.S. 122, 61 S.Ct. 149, 85 L.Ed. 81. The principle of those cases is that a taxpayer, despite an intra-family gratuitous assignment of income, rights, remains taxable on the income which he earns by his personal services or which is derived from property which he owns. The rationale of the Horst case was that the receipt of income by the donee is an economic benefit or satisfaction to the donor, and therefore a realization of income by him. Where there is an arm’s length assignment .of income rights for a valuable consideration, it is clear that the assignor realizes only the amount of the consideration received, Rhodes v. Commissioner, 1941, 43 B.T.A. 780, affirmed 6 Cir., 1942, 131 F.2d 50, and the assignee is taxable for receipts in excess of this amount. See Blair v. Commissioner, 1937, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465; G.C.M. 24849, 1946-1 Cum.Bull. 66, 67-68.

The petitioner further contends that even if the receipts of assigned renewal commissions in excess of their original cost do in fact constitute taxable income, such taxable income should be treated as a long-term capital gain. He cites no authority for this contention. 26 U.S.C.A. (I.R.C.1939) § 117 requires thatthere be a “sale or exchange” of certain defined capital assets in order that income may receive capital gain treatment. The receipt of commissions is not a “sale or exchange”. And petitioner has never sold any of the renewal commissions purchased by him. See Fairbanks v. United States, 1939, 306 U.S. 436, 59 S.Ct. 607, 83 L.Ed., 855; Commissioner v. Starr Bros., 2 Cir., 1953, 204 F.2d 673; General Artists Corp. v. Commissioner, 2 Cir., 1953, 205 F.2d 360, certiorari denied, 1953, 346 U.S. 866, 74 S,Ct. 105, 98 L.Ed. 376; Guthrie v. Commissioner, 1940, 42 B.T.A. 696.

III

The taxpayer also contends that he should be allowed to deduct, against the profits realized in the current year, the cost of acquiring additional assignments of renewal commissions, which will start to yield payménts only in future years. The cost of acquiring additional assignments of renewal commissions is a capital expenditure to be recovered by allocation against the income derived from the asset acquired; it is not, in its entirety, an “ordinary and necessary” business expense of the year of purchase. 26 U.S.C.A. (I.R.C.1939) §§ 23(a) (1), 23(i), 43; Treasury Regulations 111, § 29.41-3(2).

The decision of the Tax Court is affirmed.