A consultant reported business income on his federal Schedule C, then said it was really tax-free expense reimbursements. Could he use the lower figure for New Mexico gross receipts tax?

Subject

Chiles Consulting Company (D&O 00-15)

Plain-English summary

J. Hunter Chiles moved to New Mexico in 1993 to run Southwest Energy Ventures (SEV). When SEV ran out of money in late 1994, he began doing independent consulting work, invoicing under "Chiles Consulting Company." His CPA prepared his 1994 federal return, which reported $14,958 of business income on Schedule C, offset by $21,544 of expenses, for a net business loss of $6,586. That loss wiped out his federal (and New Mexico) income tax for the year. He never registered for or paid gross receipts tax on the Schedule C income.

When the Department later asked why that business income wasn't reported for gross receipts tax, Chiles argued his accountant had mistakenly lumped in employee expense reimbursements from SEV as business income, and that his real independent-contractor receipts were only about $6,846. He offered a spreadsheet from his personal records to prove it. The Department assessed gross receipts tax (a modest $1,208.69 total with penalty and interest), and he protested.

The Hearing Officer denied the protest on two grounds:

• He didn't overcome the presumption of correctness. Under Section 7-1-17(C), an assessment is presumed correct and the taxpayer must prove it wrong. Chiles's hearing spreadsheet could not be reconciled with the numbers on his filed 1994 return, and there was "no basis for determining which figures are accurate" — so he failed to carry his burden.
• Federal-state consistency binds him. New Mexico law requires a taxpayer to treat a transaction uniformly for all tax purposes. Having reported the income (and claimed the loss) on his federal Schedule C, Chiles could not now recharacterize it as nontaxable employee reimbursements just for gross receipts tax. The Hearing Officer relied on the classic consistency line — Co-Con, Stohr, and Sutin, Thayer & Browne — and noted he never amended his return, even though he had until January 1999 (under the three-year federal rule, 26 U.S.C. § 6511) — eighteen months after the Department's July 1997 inquiry. Fixing the Schedule C would also have raised his federal and state income tax, which he had avoided.

What this means for you

• How you report income on your federal return controls its state tax treatment. If you put money on your Schedule C as business income, New Mexico can treat it as taxable gross receipts. You cannot report it one way federally and a different, tax-free way for the gross receipts tax.
• You can't keep the federal benefit and dodge the state tax. Chiles used the Schedule C loss to zero out his income tax. Having taken that benefit, he was locked into treating the same receipts as business income for gross receipts tax. Consistency runs both directions.
• If your return is wrong, amend it — don't just argue at the hearing. The way to fix a misreported Schedule C is to file an amended return, which also adjusts your income tax. Chiles never did, and had plenty of time. An uncorrected return is strong evidence against a later, inconsistent story.
• An assessment is presumed correct; a spreadsheet that doesn't tie out won't rebut it. To beat an assessment you must produce evidence that actually reconciles to the record. Numbers that can't be squared with your own filed return will not carry your burden of proof.

Key questions answered

Why couldn't Chiles use his lower "real" receipts figure?
Because he never proved the filed return was wrong (failing the presumption of correctness) and because he was bound to treat the income consistently with how he reported it on his federal Schedule C.

What is the "consistency" rule?
New Mexico courts require taxpayers to treat a transaction the same way for all tax purposes. You may not report income (with offsetting expenses) on your income tax return and then call it a nontaxable event for gross receipts tax. (Co-Con; Stohr; Sutin, Thayer & Browne.)

Couldn't he say it was too late to amend the return?
No. He claimed the three-year limit had run, but the Hearing Officer noted his 1994 return wasn't filed until January 1996, so the federal three-year window (26 U.S.C. § 6511) ran until January 1999 — well after the Department's 1997 inquiry. He simply never amended.

Why would fixing the return have hurt him anyway?
Because correcting the Schedule C would have turned his $6,586 loss into positive income, raising his federal taxable income from zero to about $9,528 and adding roughly $1,400 of federal tax, plus more New Mexico income tax. He had reaped the benefit of the loss as filed.

Verbatim citations

The consistency rule:

Having accepted the benefit of the business loss reported on his 1994 federal income tax return, the Taxpayer cannot now claim that the figures shown on the return are incorrect and should be ignored for purposes of determining his gross receipts tax liability for the same period. New Mexico law holds that a taxpayer must treat transactions uniformly for all purposes within the tax laws.

From Stohr, the controlling principle:

The controlling factor, however, is that the taxpayer must treat transactions uniformly for all purposes within the tax laws. The taxpayer must not attempt to show one scheme for federal tax purposes and a nontaxable event for purposes of state gross receipts taxes.

He never amended, and had time to:

The Taxpayer failed, however, to take any action to correct the return. ... the Taxpayer's 1994 federal income tax return was not filed until January 1996. This means the three-year statute of limitations set out in 26 U.S.C. § 6511 did not expire until January 1999, eighteen months after the Taxpayer received the Department's inquiry letter in July 1997.

The holding:

Having claimed the benefit of the business income and expenses reported on his 1994 Schedule C, the Taxpayer may not take an inconsistent position concerning that income for purposes of calculating New Mexico gross receipts tax. For the foregoing reasons, the Taxpayer's protest IS DENIED.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Chiles Consulting Company
• Decision PDF: D&O 00-15

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
CHILES CONSULTING COMPANY No. 00-15
ID NO. 02-348340-00 7
ASSESSMENT NO. 2180303

DECISION AND ORDER

A formal hearing on the above-referenced protest was held May 25, 2000, before Margaret

B. Alcock, Hearing Officer. The Taxpayer, J. Hunter Chiles, III, d/b/a Chiles Consulting Company,

represented himself. The Taxation and Revenue Department was represented by Bruce J. Fort, Special

Assistant Attorney General. Based on the evidence and arguments presented, IT IS DECIDED AND

ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer became a resident of New Mexico in July 1993, when he moved to the

state to begin employment as president of Southwest Energy Ventures, Inc. (SEV).

2. SEV, which was owned by the Taxpayer and three other shareholders, was formed to

determine the best location for new power plants in the Southwestern United States.

3. The Taxpayer was paid a salary for his work as an employee of the company and was

also reimbursed for travel and other expenses.

4. In October 1994, SEV ran out of money and stopped paying the Taxpayer.

5. Beginning in October, the Taxpayer contracted to perform services for other

companies as an independent contractor. The Taxpayer was paid an hourly fee, plus expenses.

6. During 1994, the Taxpayer also performed work for a family trust, for which he was

paid an hourly fee, plus expenses.

7. The Taxpayer invoiced his independent contractor fees and expenses under the name

“Chiles Consulting Company.”

8. For tax year 1994, the Taxpayer received a Form W-2 from SEV reflecting wages of

$56,645.55. The W-2 did not include any of the reimbursed expenses paid to the Taxpayer.

9. The Taxpayer’s 1994 federal income tax return, Form 1040, listed wages of $56,646

on Line 7, a business income loss of $6,586 on Line 12, and a $3,000 capital loss on Line 13.

10. The business loss claimed by the Taxpayer was based on Schedule C to the 1994

Form 1040, which reported $14,958 of business income from the Taxpayer’s services as a consultant

and $21,544 of business expenses, for a net loss of $6,586.

11. The Taxpayer never questioned the certified public accountant who prepared the

return concerning the business income and expenses reported on Schedule C.

12. As a result of the business loss claimed on Form 1040, the Taxpayer had no federal

taxable income and no federal income tax liability for 1994. The Taxpayer’s New Mexico income

tax return, which he prepared based on the federal return, also showed a zero tax liability.

13. The Taxpayer did not register with the Department for payment of gross receipts tax

and did not report or pay gross receipts tax on the business income shown on Schedule C to his 1994

federal income tax return.

14. In July 1997, the Department sent the Taxpayer a letter asking him to explain why

the business income reported on his 1994 federal income tax return was not reported to the

Department for gross receipts tax purposes.

15. In September 1997, the Taxpayer responded in writing (Dept. Ex. 4), stating: “I

cannot explain why my accountant showed a figure of $14,958 on the Schedule C, although it is

probably a combination of adding certain expense reimbursements, and balancing them out with the

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actual expenses.” The Taxpayer maintained that his business income for 1994 should have been

$6,680.

16. The Department did not accept the Taxpayer’s explanation. On October 4, 1997,

Assessment No. 2180303 was issued to the Taxpayer in the total amount of $1,208.69, representing

gross receipts tax, interest and penalty for the period January-December 1994.

17. On October 8, 1997, the Taxpayer filed a written protest to the assessment.

18. During the course of the protest, the Taxpayer provided additional information to the

Department’s protest auditor, stating in a June 30, 1998 letter (Dept. Ex. 5): “I think the only way

for you and I to get to the bottom of this is to ignore what was done for Federal tax purposes, and

look only at the invoices for Chiles Consulting, as these constitute the best record of the REAL Gross

Receipts.”

19. Using his personal computer records, the Taxpayer prepared a reconciliation

spreadsheet showing his wages, fees and reimbursed expenses for 1994 (Dept. Ex. 1). According to

the spreadsheet, the Taxpayer received $56,343.60 in employee wages from SEV; $14,077.01 in

reimbursed expenses incurred as an employee of SEV; $6,620.00 in independent contractor fees; and

$226.26 in reimbursed expenses related to this independent contractor work.

20. The Taxpayer never consulted with an accountant or made any effort to amend his

1994 federal and state income tax returns to correct the amount of business income and expenses

reported on those returns.

DISCUSSION

At issue is whether the Taxpayer is liable for gross receipts tax on the $14,958 of business

receipts reported on Schedule C to his 1994 Form 1040. The Taxpayer maintains his accountant

incorrectly included employee expense reimbursements the Taxpayer received from Southwest

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Energy Ventures, Inc. as business income on Schedule C. Based on his personal computer records,

the Taxpayer asserts that his total receipts from doing business as an independent contractor during

1994 were $6,846.26 and this is the only amount that should be subject to New Mexico gross

receipts tax.

Section 7-1-17(C) NMSA 1978 provides that any assessment of tax by the Department is

presumed to be correct, and it is the taxpayer's burden to overcome this presumption. See also,

Archuleta v. O'Cheskey, 84 N.M. 428, 431, 504 P.2d 638, 641 (Ct. App. 1972). Accordingly, the

Taxpayer has the burden of producing evidence to establish that the Department's assessment of

gross receipts tax, penalty and interest on his 1994 income is incorrect.

At the hearing, the Taxpayer presented information from his personal computer records

indicating that he had $6,846.26 of taxable gross receipts during 1994. Unfortunately, there is no

way to reconcile his current figures with the figures reported on his 1994 federal income tax return.

According to the Taxpayer’s records, he received $56,343.60 in employee wages from SEV;

$14,077.01 in reimbursed expenses incurred as an employee of SEV; $6,620.00 in independent

contractor fees; and $226.26 in reimbursed expenses related to this independent contractor work. If

the Taxpayer’s accountant had simply included all employee reimbursements as business income and

offset those reimbursements with the underlying expenses, the Schedule C would show business

income of $20,923.27 ($14,077.01 of employee reimbursements plus $6,846.26 of independent

contractor fees and expenses) and offsetting business expenses of $14,303.27 ($14,077.01 of employee

expenses plus $226.26 of independent contractor expenses), resulting in net business income of

$6,620.00. Instead, the Schedule C shows $14,958.00 of business income and $21,544.00 of business

expenses, resulting in a net loss of $6,586.00

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The Taxpayer cannot explain how his accountant came up with the figures reported on the

1994 Schedule C.. It must be assumed, however, that the Taxpayer’s certified public accountant did

not simply make up the numbers shown on the return, but relied on information provided to him by

the Taxpayer. There is simply no basis for determining which figures are accurate—those used by

the accountant to prepare the original return or those presented by the Taxpayer at the hearing.

Having accepted the benefit of the business loss reported on his 1994 federal income tax return, the

Taxpayer cannot now claim that the figures shown on the return are incorrect and should be ignored for

purposes of determining his gross receipts tax liability for the same period. New Mexico law holds that

a taxpayer must treat transactions uniformly for all purposes within the tax laws. A taxpayer may not

report business income (with offsetting expenses) on his income tax returns and then recharacterize the

income as nontaxable employee reimbursements for purposes of the gross receipts tax.

The first case to address the requirement of consistency in state tax reporting was Co-Con, Inc.

v. Bureau of Revenue, 87 N.M. 118, 529 P.2d 1239 (Ct App., 1974), cert. denied, 87 N.M. 111, 529

P.2d 1232 (1974). Co-Con, Inc. was a wholly owned subsidiary of Universal Constructors, Inc.

During the audit period, construction equipment was used in common by both companies. Each

corporation attributed a value to the other corporation's use of the equipment and reflected that value

as “gross rentals” for federal income tax purposes. The Department treated the rental income

reported on the federal returns as receipts from leasing property in New Mexico and assessed gross

receipts tax on this amount. The corporations maintained the federal returns were incorrect and tried

to recharacterize the income reported on those returns. The court of appeals upheld the assessments,

finding that the corporations' treatment of the transactions as rentals for federal income tax purposes

was binding for state tax purposes. As the court stated:

Taxpayers must treat transactions uniformly for all purposes within
the tax scheme and not attempt to show, first, a lease for federal

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purposes and second, a non-taxable event for state tax purposes. We
find ample evidence in the record to indicate that taxpayers engaged
in leasing, both by intent and within the scope of the statutory
definition.

Id., 87 N.M. at 121-122.

In Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d 420(Ct. App. 1976), cert.

denied, 90 N.M. 254, 561 P.2d 1347 (1977), the court of appeals upheld an assessment of gross

receipts tax against Mr. Stohr's compensation from performing carpentry work for various

individuals. Mr. Stohr argued that these amounts were wages exempt from gross receipts tax. In

responding to these arguments, the court noted that during the audit period Mr. Stohr filed self-

employment tax returns for social security purposes and filed federal Schedule C's reporting his

compensation as business income. In determining Mr. Stohr liable for gross receipts tax, the court

first examined the indicia of employment found in the Department’s regulations, and then stated:

The controlling factor, however, is that the taxpayer must treat
transactions uniformly for all purposes within the tax laws. The
taxpayer must not attempt to show one scheme for federal tax
purposes and a nontaxable event for purposes of state gross receipts
taxes. (citations omitted, emphasis added).

Thus, the court found that the manner in which Mr. Stohr reported his compensation for federal

purposes controlled the determination of whether that compensation could be considered wages

exempt from gross receipts taxes.

The most recent case to address the need for consistency in filing state and federal returns is

Sutin, Thayer & Browne v. Revenue Division of the Taxation and Revenue Department, 104 N.M.

633, 725 P.2d 833 (Ct. App. 1985), cert. denied, 102 N.M. 293, 694 P.2d 1358 (1986). The issue in

that case was whether the Sutin firm could claim a wage deduction on its state corporate income tax

return that exceeded the wage deduction claimed on its federal return. Under the Tax Reduction and

Simplification Act of 1977, a corporation could either claim a federal tax deduction or elect a jobs

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credit for wages paid to certain new employees. The Sutin firm elected to claim the jobs credit on its

federal return. Because New Mexico did not have a similar jobs credit, the Sutin firm deducted all

of the wages paid to new employees on its New Mexico return. The Department disallowed the

deduction, arguing that a taxpayer cannot claim the jobs credit on its federal return and then add

back the wage deduction it forfeited on its federal return when calculating state taxable income. The

court upheld the Department's position, noting that “a taxpayer who makes an election for federal

purposes is bound by that election in calculating the amount of its state taxes.” Id., 104 N.M. at 636.

The foregoing cases establish that a taxpayer may not treat a taxable transaction one way for

federal tax purposes and a different way for state tax purposes. In this case, the Taxpayer asserts that

his 1994 federal income tax return is incorrect and does not accurately reflect his business income

and expenses for that year. The Taxpayer failed, however, to take any action to correct the return.

At the hearing, the Taxpayer maintained he was unable to amend his return because the three-year

statute of limitations had expired by the time he discovered the error. The Internal Revenue Code

requires taxpayers to file claims for refund of overpaid tax within three years from the date the return

is filed. 26 U.S.C. § 6511. The Taxpayer has not provided any authority to show that a taxpayer

who has underreported tax has only three years to file an amended return to correct the error. Even

if such a provision existed, the Taxpayer had ample time after discovering the error in his 1994

return to file an amended return. Based on the documents submitted at the May 25, 2000 hearing,

the Taxpayer’s 1994 federal income tax return was not filed until January 1996. This means the

three-year statute of limitations set out in 26 U.S.C. § 6511 did not expire until January 1999,

eighteen months after the Taxpayer received the Department’s inquiry letter in July 1997.

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Had the Taxpayer amended his 1994 Schedule C to match the figures shown on his

spreadsheet, the business loss of $6,586 reported on Line 12 of his federal Form 1040 would have

changed to positive income of $6,620. This, in turn, would have increased his federal taxable

income from zero to $9,528 and his federal tax liability from zero to approximately $1,400 (using a

15% tax rate). The Taxpayer’s income tax liability to New Mexico would have increased as well.

Having reaped the benefit of the business loss shown on his original returns, the Taxpayer may not

now recharacterize his business income to avoid payment of gross receipts tax.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to Assessment No. 2180303, and

jurisdiction lies over the parties and the subject matter of this protest.

2. The Taxpayer failed to meet his burden of proving that the business income reported on

his 1994 Schedule C was incorrect.

3. Having claimed the benefit of the business income and expenses reported on his 1994

Schedule C, the Taxpayer may not take an inconsistent position concerning that income for purposes

of calculating New Mexico gross receipts tax.

For the foregoing reasons, the Taxpayer's protest IS DENIED.

DATED June 6, 2000.

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