An AgencyEquity Exclusive
Farmers Insurance has recently introduced a program that allows its agents to sell their agencies as they retire or leave the company. Allstate has been allowing its agents to sell for many years now. There are other exclusive carriers that allow this option as well. The agencies can be sold to other exclusive agents or sometimes to other interested parties. In either case the sale must be approved by the carrier.
Most of these exclusive carriers also have another option called termination pay. This is a formula that, in most cases, is based on the annual commission revenues. This is rarely paid as a lump sum, but rather paid over a period of a year or more.
If you are an agent that has these options and want to know your best option, then this article is for you.
Two Possible Ways You Can Be Taxed on These Transactions:
- Capital Gains – This is a 15% or 20% federal tax that is calculated based on the increased value of the agency (sales price less any basis the seller may have). .
- Ordinary Income – This is no different than how you are taxed on your regular income. You will pay regular income taxes, Social Security and Medicare taxes.
In addition to the federal taxes listed above, you may also have to pay state income tax if you are in a state that has income tax. Each state has different tax laws. This is why it is in your best interest to discuss your options with a tax professional who understands the tax laws in your state. Since the readers of this article come from nearly all 50 states, this article will only touch upon the federal tax implications.
Selling the rights of the exclusive agency's income stream to a party approved by the exclusive carrier is generally treated as capital gains. On the other hand, receiving termination pay is generally treated as deferred compensation by the exclusive carrier. This means that it is ordinary income to the buyer. It must be noted, however, that it is not always cut-and-dry, and the tax implications will still depend on the nature of each case.
“Depending on the sales price and the tax rate, capital gain is usually more favorable,” says CPA and insurance industry expert Jon Persky. “Ordinary tax rates range up to 39.6 percent, while the capital gains tax is 15 percent for a married couple filing a joint tax return with adjusted gross income of under $450,000 and 20 percent if it is over $450,000. Capital gain in excess of $250,000 is also subject to a 3.8 percent tax to help pay for Obamacare.”
Sample Scenario Based on a $300,000 sale
Persky further illustrates an example based on a $300,000 sale with a zero basis – resulting in a $300,000 capital gain.
“Assuming a capital gain of $300,000, a married couple filing jointly who receives all the income in one year with no other additional income would have the entire $300,000 taxed at 15 percent, which equals $45,000. There would also be a 3.8% Obamacare tax on $50,000 amounting to $1,900 for a total federal tax liability of $46,900,” Persky explains. “If all $300,000 was ordinary income the federal tax liability could be over $70,000.”
Is there a scenario when one option is better regardless of the tax implications? “It's all about the taxes and the risk of a buyer not paying you,” Persky says. “Be aware of the factors you should consider when selling your agency.”
Factors to Consider When Selling Your Agency:
- Do business only with buyers that are approved by the insurance carrier.
- Remember that the termination pay will transfer to the buyer when you sell the agency to an approved third party. Make sure that you have that termination payment assigned to you as collateral until you are paid in full. You should also get additional collateral from the buyer if the termination pay is inadequate.
- Unless you get 100% cash up front, there is always a risk that a buyer may not pay you. All agreements must be in writing and as detailed as possible.
- Hire an attorney as well as an insurance industry specialist in structuring the transaction and drafting the needed documents.
To learn more about the different scenarios, tax implications and impacts of selling your agency or receiving termination payment, talk to your CPA and discuss your options.
You may also email Jon Persky at email@example.com or contact insurance industry management consulting firm Optimum Performance Solutions (www.optperform.com) for a complete range of services for insurance agency buyers and sellers.