827 F.3d 968
11th Cir.2016Background
- Christine Peterson was a Mary Kay National Sales Director (NSD); NSDs are independent contractors who earn commissions from networks they build and train.
- Mary Kay offered two post-retirement programs for NSDs: the Family Security Program (domestic commissions for 15 years) and the Great Futures Program (foreign-network commissions for 12 years); both required retirement/eligibility and contained noncompete clauses and amendment clauses allowing Mary Kay unilateral changes.
- Mary Kay amended both programs in Dec. 2008 to state they were nonqualified deferred compensation plans intended to comply with I.R.C. § 409A; Peterson received program payments after she retired Jan. 1, 2009, and Mary Kay reported them on Form 1099 as nonemployee compensation.
- The IRS challenged the Petersons’ tax reporting; Tax Court held (inter alia) that the 2009 program payments derived from Peterson’s prior Mary Kay business and were subject to self-employment tax under 26 U.S.C. § 1401.
- On appeal the Eleventh Circuit reviewed whether those 2009 distributions were subject to self-employment tax; the court affirmed as to 2009 (and dismissed the separate appeal for 2006–2007 as improperly filed).
Issues
| Issue | Plaintiff's Argument (Peterson) | Defendant's Argument (IRS/Mary Kay) | Held |
|---|---|---|---|
| Are 2009 payments from Mary Kay’s Family and Futures Programs subject to self-employment tax? | Payments are consideration for cessation of business and a noncompete (a sale), not derived from prior self-employment, so not SE tax. | Programs are expressly characterized (by amendment) as deferred compensation tied to prior services; deferred compensation is self-employment income. | Affirmed: payments are deferred compensation derived from prior Mary Kay association and subject to self-employment tax. |
| Does the Danielson rule bind Peterson to Mary Kay’s post‑2008 characterization of the programs as deferred compensation? | Peterson did not personally characterize the payments; Mary Kay unilaterally amended the plan, so Danielson inapplicable. | Peterson consented to amendment power in original agreements; under Danielson taxpayer is bound to the contractual characterization. | Court applies Danielson and holds Peterson is bound by the unambiguous program characterization as deferred compensation. |
| Were NSD Interests partnership receipts properly treated to avoid SE tax? | (Tax reporting strategy) Reported program receipts through entities to avoid SE tax. | IRS: entity arrangements were ineffective; income allocable to Peterson. | Tax Court findings on entity issues not successfully appealed here; appeal focused on 2009 SE tax and was affirmed as to that year. |
| Is Milligan/Gump insurance-agent precedent controlling to exempt payments from SE tax? | Those cases support treating post-termination payments as non‑SE income; Peterson urges similar treatment. | Those precedents are limited to insurance-agent termination payments; Mary Kay programs differ in substance and were expressly deferred compensation. | Court rejects extension of Milligan/Gump; distinguishes insurance cases and declines to expand § 1402(k). |
Key Cases Cited
- Comm’r v. Danielson, 378 F.2d 771 (3d Cir. 1967) (taxpayer bound to contractual characterization absent proof to set it aside)
- Plante v. Comm’r, 168 F.3d 1279 (11th Cir. 1999) (applying Danielson rule; taxpayer bound to agreement form)
- Newberry v. Comm’r, 76 T.C. 441 (Tax Ct. 1981) (nexus test: income must be derived from trade or business carried on)
- Milligan v. Comm’r, 38 F.3d 1094 (9th Cir. 1994) (post‑termination payments to insurance agent not SE income under facts; later codified narrow rule in §1402(k))
- Gump v. United States, 86 F.3d 1126 (Fed. Cir. 1996) (insurance-agent extended earnings not deferred compensation / not SE income on similar facts)
- Schelble v. Comm’r, 130 F.3d 1388 (10th Cir. 1997) (distinguishing Milligan/Gump and holding certain termination payments were SE income)