Can a company escape a negligence penalty when its office manager, left in sole control of the books, quietly stopped filing the company's tax returns for years?

Plain-English summary

A company whose office manager quietly stopped filing its tax returns for years still owed the negligence penalty — both because her inaction is charged to the employer and because the company's own officers failed to supervise her. Protest DENIED.

MZA Associates, a federal software contractor, hired an office manager ("Michelle") in 1995 and gave her responsibility for nearly all of the company's finances — reviewing bank statements, balancing accounts, and signing checks and tax returns. Beginning in July 1997, her filing of the company's monthly CRS returns (used to report gross receipts and withholding taxes) became erratic and then stopped. She sometimes prepared returns and wrote checks but never mailed them, and many returns were prepared incorrectly. The company's officers left the finances entirely to her and did not review anything. A burglary in late 1997 damaged the accounting records, and the manager also ran up about $30,000 in unauthorized personal charges and checks to cash — but the decision found no evidence she embezzled the tax money, since the unpaid taxes exceeded $120,000.

A new controller hired in 1999 eventually uncovered the problem. Using the Department's three-month tax amnesty, MZA cleared the 1997 periods with a $65,000 payment and had interest and penalty waived for those months. But the manager withheld records for 1998 and 1999 until she was fired in 2000, and the later returns were found unfiled in her desk with checks that never cleared. The Department assessed the 1998–1999 taxes plus interest and penalty (over $160,000 total). MZA paid and protested only the penalty.

The office manager's failure to file is charged to the employer

Under respondeat superior, an employee's failure to carry out her duties is attributed to the employer. MZA argued that a non-managerial employee's conduct should not be imputed to the corporation — a distinction New Mexico courts draw for punitive damages. But the hearing officer explained that the negligence penalty under Section 7-1-69(A) is not a punitive damage; it applies to unintentional failures, so the punitive-damages limitation does not apply (El Centro Villa). Delegating tax duties to an employee who is negligent does not relieve the employer of the penalty.

The officers were independently negligent

Beyond the manager's inaction, MZA's own officers failed to exercise ordinary business care. They gave one employee complete, unchecked control of the accounting system — picking up mail, sending invoices, writing checks, balancing statements, and filing returns — with no review process, and more than two years passed before obvious errors surfaced. That inattention and lack of internal controls independently supported the penalty. Hiring a controller to clean up the problem was prudent, but it did not excuse the years of negligence that came before.

Result: protest DENIED; the negligence penalty was upheld.

What this means for you

Delegating your taxes to an employee does not shift the blame

If you put an employee in charge of filing and paying your taxes and they fail, the negligence penalty still falls on your business. Because the penalty is not a punishment for intentional wrongdoing, even a lower-level employee's failure is charged to the employer.

Build in checks and balances — one person should not control everything

MZA's officers were found negligent for letting a single employee handle the mail, invoices, checks, reconciliations, and tax returns with no oversight. Separating duties and regularly reviewing filings and bank statements is ordinary business care; going years without looking is negligence.

Reconcile your accounts and confirm returns were actually filed

Several returns here were prepared but never mailed, and checks were written but never cashed. Regular reconciliation would have revealed the uncashed checks and missing filings quickly. Confirm that returns are filed and payments clear, rather than assuming they were handled.

Fixing the problem later helps, but does not erase past negligence

Hiring a professional to uncover and correct the errors was viewed as prudent, and using an amnesty program eliminated interest and penalty for the periods paid during it. But cleaning up afterward did not undo the penalty for the years the company was negligent.

Common questions

Q: The office manager caused this — why is the company penalized?
A: Under respondeat superior, her failure to file is attributed to her employer. The negligence penalty is not a punitive damage, so the rule shielding employers from a non-managerial employee's conduct in punitive-damages cases does not apply here.

Q: Didn't the burglary and the manager's misconduct excuse the company?
A: No. The decision found no evidence the tax money was embezzled (the unauthorized charges were far smaller than the unpaid taxes), and the company's own lack of oversight was an independent basis for the penalty.

Q: MZA hired a controller and fixed everything — why didn't that help?
A: Hiring the controller was prudent and, through the amnesty program, eliminated interest and penalty for the 1997 periods. But it did not excuse the negligence during the earlier 1998–1999 periods still at issue.

Q: Were interest and the tax also disputed?
A: No. MZA paid the tax and protested only the penalty. The sole issue was whether the negligence penalty was proper, and it was upheld.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-1-69(A) — negligence penalty (2% per month, up to 10%) for failing to timely file returns or pay tax
• NMSA 1978, § 7-1-17(C) — a Department assessment, including penalty, is presumed correct
• NMSA 1978, § 7-1-3(X) — "tax" includes related interest and civil penalty
• Regulation 3.1.11.10 NMAC — defines taxpayer negligence

Cases cited:

• El Centro Villa Nursing Center v. Taxation and Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989)
• Albuquerque Concrete Coring Company, Inc. v. Pan Am World Services, Inc., 118 N.M. 140, 879 P.2d 772 (1994)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: MZA Associates Corporation
• Decision PDF: D&O 01-16

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
MZA ASSOCIATES CORPORATION No. 01-16
ID NO. 02-202518-00 9
ASSESSMENT NOS. 2594885 through 2594897

DECISION AND ORDER

A formal hearing on the above-referenced protest was held July 30, 2001, before Margaret B.

Alcock, Hearing Officer. MZA Associates Corporation (“MZA”) was represented by its attorney,

Gary D. Eisenberg, Esq., Betzer, Roybal & Hill, P.C. The Taxation and Revenue Department

("Department") was represented by Donald F. Harris, Special Assistant Attorney General. Based on

the evidence and arguments presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. MZA, which began business in 1991, is a federal contractor involved in developing

software for the government.

2. In 1995, MZA hired a woman named Michelle as its office manager.

3. Michelle’s duties were extensive and included responsibility for MZA’s financial

records and accounting system. She was in charge of reviewing MZA’s monthly bank statements

and balancing its accounts and was also authorized to sign checks and tax returns on behalf MZA.

4. Beginning in July 1997, Michelle’s filing of monthly CRS returns used to report the

corporation’s gross receipts, compensating and withholding taxes to New Mexico, became erratic

and she eventually stopped filing returns altogether.

5. In November 1997, MZA was broken into and all its computers and software,

including its accounting system, were stolen. MZA’s backup accounting system had some problems

and was not completely accurate after the robbery.

6. From July 1997 through September 1999, Michelle continued to be sporadic in filing

MZA’s CRS returns. For several months, she prepared the returns and wrote checks to cover the

taxes due, but never mailed the returns or payments to the Department. Many of the returns she did

file were prepared incorrectly.

7. During this period, Michelle used the corporation’s credit card for personal expenses

and also wrote several checks to “cash” with no accounting entries to show how the money was

spent. The combined value of unauthorized charges and checks was about $30,000.

8. MZA’s corporate officers did not review the corporation’s financial or tax records on

any regular basis, but left MZA’s financial operations completely up to Michelle. For this reason,

they were not aware that Michelle was not filing the corporation’s tax returns.

9. At some point, the corporate officers realized Michelle had not prepared the annual

“incurred cost submissions” MZA was required to submit under the terms of MZA’s government

contracts.

10. In March 1999, MZA hired Edward J. Cunion, III, in the newly created position of

Controller.

11. Mr. Cunion’s primary task was to prepare 1997 and 1998 “incurred cost

submissions” to bring MZA into compliance with its government contracts. Mr. Cunion reviewed all

of the corporation’s invoices and traced each invoice to MZA’s bank statements to insure the

company had actually incurred the costs charged to the government.

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12. In the process of reconciling MZA’s checkbook to its bank statements for the 1997

calendar year, Mr. Cunion noticed that starting in July 1997, there were no checks in payment of

New Mexico CRS taxes or, in some cases, that the checks written to pay taxes had never been

cashed.

13. Mr. Cunion discovered the problem with MZA’s 1997 taxes in November 1999. He

asked Michelle whether there were any other nonfiled tax periods, and she said no, indicating that all

other returns had been filed.

14. Mr. Cunion notified MZA’s corporate officers of the problem and began work on

preparing MZA’s CRS returns for the period July through December 1997.

15. November 1999 was the last month of the Department’s three-month “Amnesty

Program”, under which the state waived the imposition of interest and penalty on payments of

outstanding tax liabilities made during the amnesty period.

16. Mr. Cunion was able to file MZA’s delinquent 1997 CRS returns, together with a

payment of $65,000 in tax principal, before the end of the amnesty period. As a result, interest and

penalty were waived for these months.

17. Mr. Cunion continued his investigation into the 1998 and 1999 calendar years. He

realized there were additional problems with MZA’s tax accounts, but his work was hampered by the

fact that Michelle refused to give him access to certain bank statements and other financial records.

18. Mr. Cunion discussed the situation with MZA’s president. The president spoke to

Michelle, but she continued to delay the production of documents.

19. In September 2000, Michelle was fired and Mr. Cunion took over her duties.

20. Shortly after Michelle left the company, Mr. Cunion discovered CRS returns for July

1998 and October 1998 through September 1999 in her desk. It did not appear the returns had been

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filed. When Mr. Cunion reviewed MZA’s bank statements, he found that checks had been written to

cover the tax liabilities but had never cleared the bank.

21. In October 2000, Mr. Cunion filed MZA’s delinquent CRS returns without payment.

22. On November 8, 2000, the Department issued Assessment Nos. 2594885 through

2594897 to MZA, assessing $84,341.52 gross receipts tax, $36,474.99 withholding tax, $27,880.70

interest, and $12,081.67 penalty for tax periods July 1998 and October 1998 through September 1999.

23. On December 6, 2000, MZA filed a written protest to the penalty portion of the

assessments.

24. In January 2001, MZA made a $21,000 payment toward its outstanding tax liability

and has continued to make regular monthly payments to the Department.

DISCUSSION

The sole issue to be determined is whether penalty was properly assessed against MZA for

tax periods July 1998 and October 1998 through September 1999. Section 7-1-17(C) NMSA 1978

provides that any assessment of taxes made by the Department is presumed to be correct. Section 7-

1-3(X) NMSA 1978 defines tax to include not only the amount of tax principal imposed but also,

unless the context otherwise requires, “the amount of any interest or civil penalty relating thereto."

Accordingly, the presumption of correctness of an assessment of taxes applies to the assessment of

penalty. See also, El Centro Villa Nursing Center v. Taxation and Revenue Department, 108 N.M.

795, 779 P.2d 982 (Ct. App. 1989).

Section 7-1-69 NMSA 1978 governs the imposition of penalty. Subsection A imposes a

penalty of two percent per month, up to a maximum of ten percent when a taxpayer fails “due to

negligence or disregard of rules and regulations” to pay taxes or file required tax reports in a timely

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manner.1 Taxpayer negligence for purposes of assessing penalty is defined in Regulation 3.1.11.10

NMAC as:

A. failure to exercise that degree of ordinary business care and
prudence which reasonable taxpayers would exercise under
like circumstances;

B. inaction by taxpayers where action is required;

C. inadvertence, indifference, thoughtlessness, carelessness,
erroneous belief or inattention.

In this case, MZA’s failure to timely file its monthly gross receipts tax reports was attributable to two

factors: (1) the inaction of MZA’s office manager and (2) the lack of attention paid to the financial

and tax aspects of the business by MZA’s corporate officers. Both of these factors support

imposition of the negligence penalty.

Inaction of the Office Manager. In 1995, MZA hired a woman named Michelle as its office

manager. Michelle was given responsibility for almost every aspect of the routine management of

the business, including filing and payment of the company’s taxes. Beginning in July 1997,

Michelle’s filing of New Mexico gross receipts tax returns became erratic, and she eventually

stopped filing returns altogether. MZA did not introduce any evidence to explain Michelle’s actions

or suggest a motive for her failure to file returns. There is nothing to indicate she was ill or had

suffered an emotional breakdown, nor is there any evidence she was embezzling the tax funds.

Although Mr. Cunion discovered some unauthorized credit card charges and unexplained checks

made out to cash, these amounts did not correspond to the delinquent tax liabilities: the total of the

credit card charges and checks was about $30,000; MZA’s unpaid tax liability exceeded $120,000.

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Based on a notation on the Department’s assessment, MZA contends it was assessed only for late filing, and the
issue of late payment is not relevant to this protest. The Department disagrees, arguing that the penalty was assessed
for both late payment and late filing. Because there is sufficient evidence to support imposition of penalty based
solely on MZA’s late filing of its gross receipts tax reports, there is no need to address this issue.

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The reason for Michelle’s behavior remains a mystery. There is no dispute, however, that

she failed to carry out her responsibility to file MZA’s gross receipts tax returns in a timely manner.

Under the doctrine of respondeat superior, her inaction is attributable to her employer and justifies

imposition of the penalty against MZA. Although not raised at the formal hearing, MZA’s original

protest argued that the actions of non-managerial employees should not be imputed to their corporate

employer. This argument is based on the distinction New Mexico courts have drawn with respect to

liability for punitive damages. See, e.g., Albuquerque Concrete Coring Company, Inc. v. Pan Am

World Services, Inc., 118 N.M. 140, 879 P.2d 772 (1994). The Court of Appeals has held, however,

that this distinction does not apply to the imposition of the negligence penalty under Section 7-1-

69(A) NMSA 1978 because that penalty “bears no resemblance to punitive or exemplary damages,

which are limited to punishment of conduct that is intentional.” El Centro Villa Nursing Center v.

Taxation and Revenue Department, 108 N.M. 795, 798, 779 P.2d 982, 985 (Ct. App. 1989). As case

law confirms, delegating tax responsibilities to an employee or other agent will not relieve the

employer of its liability for penalty when the employee is negligent in performing his or her duties.

Inattention of MZA’s Corporate Officers. The most direct cause of MZA’s failure to file tax

returns was the inaction of its office manager, but the failure was also attributable to the inattention of

MZA’s president and vice president. The evidence establishes that the corporate officers delegated

their entire responsibility for many key aspects of the business to Michelle, including the authority to

sign checks and file tax returns. There is nothing in the record to justify their apparent confidence in

her honesty and abilities. The only witness to testify on behalf of MZA was Mr. Cunion, who had no

knowledge of Michelle’s education or qualifications. Mr. Cunion did note, however, that several tax

returns Michelle prepared were incorrect. After reviewing these returns, Mr. Cunion concluded that

she did not even understand the reporting period to which monthly CRS returns applied. Until Mr.

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Cunion took over Michelle’s duties, there was no system of checks and balances and no procedure

for corporate officers to review the corporation’s outgoing payments, invoices, tax returns or

statements of account. Mr. Cunion gave his opinion that it is prudent for corporate officers to review

such documents on a regular basis, and he has now instituted such a system within the corporation.

MZA points to the work of Mr. Cunion, both in uncovering MZA’s tax problems and in

taking prompt steps to correct them, as evidence that the corporation exercised ordinary care and

prudence in the conduct of its business. MZA was indeed prudent in hiring Mr. Cunion to audit its

books and correct the errors in its accounting system. This does not excuse the years of negligence that

preceded this decision. Prior to the time Mr. Cunion became MZA’s Controller in March of 1999, the

corporation allowed a single employee to have complete control over the company’s accounting

system. This employee was responsible for, among other things, picking up the mail, sending out

invoices, writing checks, balancing the bank statements and filing tax returns. There was no

mechanism in place for anyone to review her activities, and more than two years passed before obvious

errors and omissions were discovered in MZA’s financial records. Based on the corporate officers’

inattention, inaction, and apparent indifference to their corporate responsibilities, imposition of the

negligence penalty was justified.

CONCLUSIONS OF LAW

1. MZA filed a timely, written protest to Assessment Nos. 2594885 through 2594897, and

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

2. MZA was negligent in failing to file its monthly CRS returns in a timely manner and

penalty was properly imposed pursuant to Section 7-1-69(A) NMSA 1978.

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

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DATED August 1, 2001.

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