Agency Tax Laws Shareholders Need to Know

I find that most agency owners who call me regarding having their agency valued or developing a producer vesting program have no idea that important specific laws and regulations exist, even though these laws and regulations have been in place for between 15 and 60 years.

I feel bad for these agents because their accountants and professional advisors have completely failed to advise them of these important regulations.

Here are a few of the key rules/laws most important to the people who call me.

IRS Revenue Ruling 59-60 (RR 59-60)

As the “59-60” nomenclature suggests, this rule has been in place since 1959.

Many subsequent rulings and case law have added to the texture of this ruling, but the basic element remains unchanged from the original revenue ruling.

This ruling mandates, MANDATES, that all transactions between family generations be valued on a Fair Market Value basis. Additionally, the valuation must be completed by an independent third party possessing significant credentials (and these credentials are being further refined as I write this).

In other words, you CANNOT transfer ownership or shares or value to your offspring without having this valuation completed. Additionally, the valuation report must meet specific standards. The requirement is not just to calculate the applicable value using correct methods but to calculate it in an accepted report format.

This also means the agency owner cannot ever do the valuation themselves.

How a ruling that is approaching 70 years old, that has been upheld over and over, is frequently overlooked by many CPAs is beyond me. There are no exceptions of which I am aware.

Additionally, when ERISA was passed, this standard was largely accepted as the standard for employees becoming shareholders in many, though not all, transactions. Depending on the nature of the transaction (ESOP vs. an individual employee, for example) the details of the valuation and applicable standard may vary materially. High-quality third-party advisors are required.

50.1% Inside/Outside Rule

This rule has been around since the 1950s, too, though it really did not become important to my clients until the 1990s due to how a case was decided, and the final rules were only issued in April 2024.

This is a complicated rule, but agents’ CPAs should be advising that it exists if they know the agency has producers. An extreme oversimplification of the rule is that if your producers are inside your office (including their home office if working from home) more than 50% of the time, measured in minutes, they must be paid overtime. This is especially applicable to new producers who don’t yet have enough clients to visit and bad producers who sit around too much.

A requirement is tracking the time they are in the office to categorically prove they are out of the office more than 50% of the time. I have had clients who had to literally install time clocks to comply.

The penalties for not being able to prove this usually begin around $50,000, in my experience. If you have producers, I strongly encourage you to talk to your CPA and a high-quality labor attorney because you may need to amend your producer contracts to comply.

409A Rules

These rules are among the most complex in the tax code but are also the newest of these listed. The rules exceed 500 pages, so this is not something most agency owners are going to figure out on their own. Failure to comply with these rules can have significant negative effects on an agency’s value and marketability. The fines are considered some of the most onerous fines in the tax code.

These rules were written in the wake of the Enron fiasco where the key executives in Enron enriched themselves unfairly in the eyes of many.

Unfortunately for agencies, Congress wrote the initial rules to include every employee, not just executives. The greatest effect I have seen is on producer vesting agreements.

409A rules affect executive compensation including the deferral of compensation and producer vesting agreements that are deferred compensation agreements.

For example, if a producer achieves $X of commission in their book, they become eligible for $Y of future compensation.

If these agreements are not written and executed correctly, the producer becomes immediately responsible for paying taxes on $Y, plus penalties, interest, and a special excise tax. Keep in mind, the producer is not going to receive $Y for maybe 10 or 20 years, but they must pay the tax, in cash, immediately. The taxes in total can equal 50% of $Y. And then the employer must pay taxes and penalties, too.

Writing these agreements to comply with this complex set of laws and regulations is a legal specialty within a legal specialty. You need a tax attorney that specializes in this field. No one else is likely competent.

Reasonable Compensation Rule

This rule has been around for a long time, too–almost as long as S corps have been around. Some CPAs and business owners figured out that under an S-corp, they could pay the business owner less to minimize employment taxes. In other cases, overpayment was more advantageous. What the IRS wants to see is business owners be paid reasonable compensation for the job they do as if they were not the owner.

For example, if the producers are paid 35%/35%, then the owner should pay themselves 35%/35% for their sales, too.

This prevents owners from minimizing their company’s profits unfairly and keeps them from moving compensation to distributions that are really compensation.

All agency CPAs should be discussing this with you, and when you inquire, don’t let them brush off your inquiry with a response such as, “You have nothing to worry about.” Ask them, “Why?” Have they done the research into comparable pay?

These are key rules, laws, and regulations most agency owners need to know about. If your advisors are not advising or are not qualified to advise on these points, find better advisors because it is your neck on the line.