Did a Texas retiree who moved to New Mexico owe New Mexico income tax on a lump-sum payment for accrued vacation and sick leave he earned over 20 years in Texas but received after becoming a New Mexico resident?

Plain-English summary

Kevin Pierce owed New Mexico personal income tax on a $24,293.83 lump-sum payment for accrued vacation and sick leave, even though he earned that leave over 20 years working for the El Paso Police Department in Texas before he moved to New Mexico. Because he was a full-year New Mexico resident when he received the check and reported his income on the cash basis, the payment was taxed in the year he received it.

Pierce worked for the El Paso Police Department (EPPD) from 1980 until August 2000. That month he became eligible to retire, left Texas, and became a New Mexico resident after taking a job with San Juan College in Farmington. He used his accrued leave to stay on the EPPD payroll until his official retirement on December 30, 2000. In February 2001, EPPD paid him $24,293.83 for the balance of his accrued leave, and the City of El Paso reported that amount as wages on a 2001 Form W-2.

Pierce reported the payment as income on his 2001 federal and New Mexico returns, then filed a refund claim arguing the money should have been taxed as of when the leave accrued — before he was a New Mexico resident — rather than when he was paid. The Department denied the claim, and the hearing officer agreed.

A full-year resident allocates all compensation to New Mexico

Under NMSA 1978, § 7-2-3, New Mexico taxes the net income of every resident individual, starting from federal adjusted gross income. The accrued-leave payment was "compensation" under both I.R.C. § 61 and NMSA 1978, § 7-2-2(C).

While § 7-2-11 lets a taxpayer allocate some income between New Mexico and other states, subsection A(3) requires a full-year resident's compensation to be allocated 100 percent to New Mexico. Regulation 3.3.11.11 NMAC confirms that all compensation received while a New Mexico resident is allocated to the state "whether or not such compensation is earned from employment in this state." The fact that the work was performed in Texas was irrelevant.

Cash-basis income is taxed when received

Pierce reported his income on the cash basis, which counts income only when it is actually received. NMSA 1978, § 7-2-21.1 requires taxpayers to use the same accounting method for New Mexico as for federal purposes, and I.R.C. § 446 bars changing methods without IRS approval. Because Pierce received — and reported federally — the payment in 2001, it had to be recognized on his 2001 New Mexico return. There was no legal basis to treat it as 2000 income just because EPPD could have cut the check sooner.

A state may tax its residents on out-of-state earnings

The hearing officer noted the long-standing rule that a state may tax its own residents on income earned elsewhere, citing Shaffer v. Carter and Lawrence v. State Tax Commission of Mississippi: "domicile in itself establishes a basis for taxation." Pierce did not dispute New Mexico's tax on his EPPD pension or his San Juan College wages, and because Texas has no income tax, the § 7-2-13 credit for taxes paid to another state did not apply.

Result: protest DENIED. Pierce was not entitled to a refund of the New Mexico income tax he paid on the accrued-leave payment.

What this means for you

People who move to New Mexico and later get paid for past work

A lump sum you receive after becoming a New Mexico resident — a final paycheck, accrued leave, a bonus, or deferred pay — is generally New Mexico income if you receive it while living here and report on the cash basis, even if you earned it in another state.

Cash-basis taxpayers

Income is taxed in the year you actually receive it, not the year you earned the right to it. You cannot move a payment to an earlier year on the theory that it could have been paid sooner.

Full-year New Mexico residents with out-of-state income

Compensation earned by a full-year resident is allocated entirely to New Mexico. Allocation and apportionment between states are available only for certain categories of income, and resident compensation is not one of them.

Anyone relying on a prior Department ruling

Before filing his refund claim, Pierce had already received a written ruling (No. 200-01-3) telling him the payment was taxable. A refund claim that simply disputes a correct ruling will not succeed.

Common questions

Q: What was the payment for?
A: $24,293.83 for the balance of Pierce's accrued vacation and sick leave from 20 years at the El Paso Police Department.

Q: Why did New Mexico get to tax leave earned in Texas?
A: Pierce was a full-year New Mexico resident when he received the payment, and § 7-2-11(A)(3) allocates a resident's compensation entirely to New Mexico regardless of where it was earned.

Q: Could he treat it as 2000 income because the check was late?
A: No. On the cash basis, income is taxed when received. He received and federally reported it in 2001, so it was 2001 New Mexico income.

Q: Did he pay tax twice on the same money?
A: No. Texas has no income tax, so the § 7-2-13 credit for taxes paid to another state did not apply; the income was taxed only by New Mexico.

Q: What was the outcome?
A: The protest was DENIED; no refund.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-2-3 — income tax on the net income of every resident individual
• NMSA 1978, § 7-2-2(C) — definition of "compensation"
• NMSA 1978, § 7-2-11(A)(3) — full-year resident's compensation allocated 100% to New Mexico
• NMSA 1978, § 7-2-21.1 — New Mexico accounting method must match the federal method
• NMSA 1978, § 7-2-13 — credit for income tax paid to another state (inapplicable; Texas has no income tax)
• Regulation 3.3.11.11 NMAC — compensation received while a New Mexico resident is allocated to the state
• I.R.C. §§ 61, 62, 446 — gross income, adjusted gross income, and accounting methods
• 4 U.S.C. § 114 — only the state of residence may tax an individual's retirement income

Cases cited:

• Shaffer v. Carter, 252 U.S. 37 (1919)
• Lawrence v. State Tax Commission of Mississippi, 286 U.S. 276 (1932)
• Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034, 59 P.3d 491

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Kevin Pierce
• Decision PDF: D&O 03-01

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
KEVIN PIERCE No. 03-01
DENIAL OF CLAIM FOR REFUND
OF 2001 PERSONAL INCOME TAX

DECISION AND ORDER

A formal hearing on the above-referenced protest was held January 6, 2003, before Margaret

B. Alcock, Hearing Officer. Kevin Pierce (“Taxpayer”) represented himself. The Taxation and

Revenue Department ("Department") was represented by Bridget Jacober, Special Assistant Attorney

General. Based on the evidence and arguments presented, IT IS DECIDED AND ORDERED AS

FOLLOWS:

FINDINGS OF FACT

1. From 1980 until August 2000, the Taxpayer was a resident of Texas and worked for

the El Paso Police Department (“EPPD”).

2. In August 2000, the Taxpayer became eligible to retire from EPPD.

3. In August 2000, the Taxpayer left Texas and became a resident of New Mexico after

accepting a job with San Juan College in Farmington, New Mexico.

4. The Taxpayer had a substantial amount of accrued vacation and sick leave from his

employment with EPPD and used this leave to remain on the EPPD payroll between August 2000

and December 30, 2000, his official retirement date.

5. In February 2001, EPPD sent the Taxpayer a check for $24,293.83, representing

payment for the balance of the Taxpayer’s accrued leave as of the date of his retirement.

6. For tax year 2001, the City of El Paso sent the Taxpayer a “Form W-2 Wage and Tax

Statement” reporting the $24,293.83 payment as “wages, tips, other compensation.”

7. After receiving payment for his accrued leave from EPPD in February 2001, the

Taxpayer asked the Department for a written ruling as to whether this payment was subject to New

Mexico income tax.

8. On September 21, 2001, the Department issued Ruling No. 200-01-3, advising the

Taxpayer that all compensation the Taxpayer received while he was a full-year resident of New

Mexico, including the compensation he received from EPPD for accrued leave, was subject to New

Mexico income tax.

9. The Taxpayer reported the payment from EPPD as income on his 2001 federal and

New Mexico income tax returns.

10. The Taxpayer reported his 2001 income using the cash basis method of accounting.

11. On March 27, 2002, the Taxpayer filed a claim for refund with the Department,

stating that he believed the Department’s ruling concerning his liability for tax on the $24,293.83

payment he received from EPPD in 2001 was in error and asking that the tax he had paid on this

amount be refunded.

12. The Taxpayer did not request a refund or dispute his liability for New Mexico

income tax on the pension payments he received from his EPPD retirement plan during 2001 or on

the income he received from his employment with San Juan College in Farmington, New Mexico.

13. On May 18, 2002 the Department denied the Taxpayer’s claim for refund.

14. On May 30, 2002, the Department’s protest office received the Taxpayer’s written

protest to the denial of his claim for refund.

DISCUSSION

The issue presented is whether New Mexico has the right to impose personal income tax on

the $24,293.83 cash payment the Taxpayer received in February 2001 as compensation for vacation

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and sick leave the Taxpayer accrued during the 20 years he worked for EPPD. The Taxpayer argues

that the taxability of this payment should be determined as of the date the benefit or right to payment

accrued, rather than the date the payment was received. It is the Department’s position that cash

basis taxpayers are liable for tax on income actually received during the taxable year, and that New

Mexico has the right to tax all compensation received by full-year residents, regardless of the source

of that payment or the date that the right to payment accrued.

New Mexico imposes income tax on the “net income of every resident individual...." NMSA

1978, § 7-2-3. New Mexico is among the majority of states that use the federal income tax system as

the basis for calculating state income tax. See, NMSA 1978, § 7-2-2(A), (B) and (N). See also, Holt v.

New Mexico Department of Taxation and Revenue, 2002-NMSC-034 ¶¶ 8, 9, 59 P.3d 491. The starting

point for calculating New Mexico income tax is a taxpayer’s federal adjusted gross income, which is

defined in Section 62 of the Internal Revenue Code (“I.R.C.”) as gross income minus certain specified

deductions. I.R.C. § 61(a) defines gross income to include “all income from whatever source derived,

including (but not limited to)...[c]ompensation for services, including fees, commissions, fringe

benefits, and similar items....” The term "compensation" is defined in New Mexico’s Income Tax Act

as "wages, salaries, commissions and any other form of remuneration paid to employees for personal

services." NMSA 1978, § 7-2-2(C).

In this case, the $24,293.83 payment the Taxpayer received in February 2001 represented the

cash value of leave the Taxpayer accrued during his 20 years of employment with EPPD. This

payment comes within the definition of “compensation” in the I.R.C. and the New Mexico Income

Tax Act and is subject to New Mexico personal income tax. The fact that the payment was

attributable to work performed outside New Mexico is irrelevant. When a taxpayer has income that is

taxable both within and without New Mexico, NMSA 1978, § 7-2-11 allows the taxpayer to allocate

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and apportion certain categories of income between New Mexico and non-New Mexico sources.

There are some categories of income, however, that must be allocated 100 percent to New Mexico,

regardless of the source of the income. Subsection A(3) of § 7-2-11 specifically requires

compensation of full-year residents to be allocated to New Mexico. Regulation 3.3.11.11 NMAC

states that “all compensation received while a resident of New Mexico shall be allocated to this state

whether or not such compensation is earned from employment in this state.”1

The right of a state to impose tax on all income received by its residents, including income

attributable to activities in other states, is one of long-standing. More than 70 years ago, the United

States Supreme Court recognized the rights of the several states “to exercise the widest liberty with

respect to the imposition of internal taxes” noting that “states have full power to tax their own

people....” Shaffer v. Carter, 252 U.S. 37, 51 (1919). In Lawrence v. State Tax Commission of

Mississippi, 286 U.S. 276 (1932), the Court confirmed that this power includes the right to tax

residents on income earned outside the state, holding that Mississippi had the right to tax a

Mississippi resident on income earned from services performed on a construction project in the state

of Tennessee. As stated by the Court:

The obligation of one domiciled within a state to pay taxes there, arises from
the unilateral action of the state government in the exercise of the most
plenary of sovereign powers, that to raise revenue to defray the expenses of
government and to distribute its burdens equably among those who enjoy its
benefits. Hence, domicile in itself establishes a basis for taxation.

286 U.S. at 279. See also, 4 U.S.C. § 114 (an individual’s state of residence is the only state allowed

to tax that individual’s retirement income, even when the income is attributable to work performed

in another state); Department Regulation 3.3.11.13(B) NMAC (New Mexico residents are required

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It should be noted that NMSA 1978, § 7-2-13 provides a tax credit to New Mexico residents required to pay
tax to both New Mexico and another state on the same income. Because Texas does not impose a state income
tax, this provision is not applicable in this case.

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to allocate all retirement income to New Mexico, “regardless of the source of the retirement income,

where it is paid from or whether the resident was a resident of New Mexico at the time of the

employment which gave rise to the income....”).

The Taxpayer does not dispute New Mexico’s right to tax his retirement income from EPPD,

but maintains that the payment he received for his vacation and sick leave should not be subject to

tax because his right to payment accrued before he became a full-year resident of New Mexico. The

Taxpayer argues that because EPPD could have processed his leave check more promptly, in which

case he would have received the check during the 2000 tax year instead of the 2001 tax year, he is

entitled to treat that payment as having been received in 2000. The Taxpayer acknowledges,

however, that he did not report his accrued leave as income on his federal income tax return until the

2001 tax year, the year he received payment from EPPD. The Taxpayer reported his income using

the cash basis method of accounting, which is defined as:

That system of accounting which treats as income only that which is actually
received and as expense only that which is actually paid out, in contrast to
accrual basis which records income when due though not received and
expense when incurred though not yet paid.

Black's Law Dictionary 196 (5th ed. 1979). Once a taxpayer has chosen an accounting method,

I.R.C. § 446 requires the taxpayer to obtain IRS approval before changing to another accounting

method. NMSA 1978, § 7-2-21.1 requires taxpayers to “use the same accounting methods for

reporting income for New Mexico income tax purposes as are used in reporting income for federal

income tax purposes.” Accordingly, the $24,293.83 payment the Taxpayer received from EPPD in

February 2001 had to be recognized and reported as income on the Taxpayer’s 2001 New Mexico

income tax return, and there is no legal basis for refunding the tax paid on that income.

CONCLUSIONS OF LAW

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1. The Taxpayer filed a timely, written protest to the Department’s denial of his claim for

refund of 2001 personal income tax, and jurisdiction lies over the parties and the subject matter of this

protest.

2. As a full-year New Mexico resident, the Taxpayer was required to allocate all of his

compensation to New Mexico when calculating his New Mexico personal income tax.

3. Because the Taxpayer filed his federal taxes on the cash basis, and included the

payment he received from EPPD as income on his 2001 federal income tax return, the Taxpayer was

required to include that payment as income on his 2001 New Mexico income tax return.

For the foregoing reasons, the Taxpayer’s protest is DENIED.

DATED January 13, 2003.

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