Was retirement income taxable on a New Mexico return when the pension payor withheld no state tax and the taxpayer believed tax was withheld elsewhere?

Plain-English summary

Sarah Hunter owed $1,126 of additional New Mexico personal income tax on retirement income omitted from her 2004 state return, plus penalty and interest. The absence of state withholding did not make the pension income nontaxable.

Hunter's federal return reported $41,748.21 as adjusted gross income, but her New Mexico return reported only $12,180. The missing amount included retirement pension income received through her ex-husband.

New Mexico used federal adjusted gross income

The state return instructed Hunter to enter the federal adjusted gross income from line 37 of Form 1040. Her federal return showed $41,748.21, but she entered $12,180 on the state return.

The decision held that retirement income was taxable in New Mexico and that the explicit return instructions put her on notice to include the full federal amount.

No withholding did not mean no tax was due

Hunter believed that state tax was not owed if it was not withheld. She also thought the tax might have been withheld from her ex-husband's part of the retirement payments.

The decision explained that a pension or annuity payor was not an “employer” for this purpose and was required to withhold only if the recipient requested it in writing. There was no evidence of such a request, and Hunter's Form 1099-R showed no state withholding.

She also supplied no evidence that someone else had paid her tax through withholding on her ex-husband's share.

Unproved advice did not estop the Department

Hunter said the Department had advised her in writing about her 2003 return that no tax was due if none was withheld. She could not produce the documents, which she said were lost or stolen during home break-ins.

The hearing officer found the claimed advice unproved and unlikely in light of the state return's plain directions. Any document concerning 2003 also would not establish the treatment of the 2004 return.

Estoppel against the state required exceptional circumstances, and the facts did not meet that standard.

Penalty and interest followed

Hunter's belief that unwithheld income was not taxable was an erroneous belief within the regulatory definition of negligence. Interest was mandatory because New Mexico lost the use of the $1,126 between the April 2005 due date and payment in 2007.

Result: protest DENIED. The tax, penalty, and interest stood.

Source-chronology note

The findings say the Department assessed Hunter on April 27, 2007, but also say she paid principal on April 13 and filed her protest on April 23. This summary does not attempt to reconcile those dates.

What this means for you

Pension and annuity recipients

Tax liability and withholding are separate. If no New Mexico tax is withheld, the income may still need to be reported and paid through the return or estimated payments.

Taxpayers preparing a New Mexico return

Reconcile the federal adjusted gross income carried to the state return. A mismatch can omit taxable income even when the underlying Form 1099 is otherwise reported federally.

Taxpayers relying on agency advice

Keep the written guidance and verify the tax year and facts it covers. An unsupported recollection about a prior year's advice did not establish estoppel here.

Common questions

Q: Why was the pension income taxable?
A: New Mexico taxed retirement income and used federal adjusted gross income as the starting point for the state return.

Q: Was the pension payor required to withhold New Mexico tax automatically?
A: No. The decision says withholding was required only after a written request from the recipient.

Q: Did the Form 1099-R show state withholding?
A: No.

Q: Could the Department be barred from collecting because of alleged prior advice?
A: No. Hunter did not produce the advice, and any inquiry concerned 2003 rather than the 2004 return at issue.

Q: Why did the penalty apply?
A: Her mistaken belief that tax was not owed without withholding met the regulation's definition of negligence.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-1-17 — presumption that an assessment is correct
• NMSA 1978, § 7-1-3 — tax includes related interest and civil penalty
• NMSA 1978, § 7-1-13 — self-reporting responsibility
• NMSA 1978, § 7-2-3 and Regulation 3.3.11.13 NMAC — retirement income taxation
• NMSA 1978, § 7-2-2(A) — federal adjusted gross income starting point
• NMSA 1978, §§ 7-3-2 and 7-3-3 — pension payor withholding
• NMSA 1978, § 7-1-69 and Regulation 3.1.11.10 NMAC — negligence penalty
• NMSA 1978, § 7-1-67 — mandatory interest

Cases cited:

• Wisznia v. State of New Mexico, Human Services Department, 1998-NMSC-011, 125 N.M. 140, 958 P.2d 98
• Gonzales v. Public Employees Retirement Board, 114 N.M. 420, 839 P.2d 630 (Ct. App. 1992)
• C & D Trailer Sales v. Taxation and Revenue Department, 93 N.M. 697, 604 P.2d 835 (Ct. App. 1979)
• El Centro Villa Nursing Center v. Taxation & Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Sarah Hunter
• Decision PDF: D&O 08-03

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
SARAH HUNTER TO ASSESSMENT OF No. 08-03
PENALTY AND INTEREST ISSUED UNDER
LETTER ID NO. L1473775232

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on September 22, 2008, before

Dee Dee Hoxie, Hearing Officer. The Taxation and Revenue Department (“Department”) was

represented by Mr. Peter A. Breen, Attorney in the Legal Services Bureau. Ms. Andrea Umpleby,

Protest Auditor, also appeared for the Department. Ms. Sarah Hunter (“Taxpayer”) represented

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

FOLLOWS:

FINDINGS OF FACT

1. In 2005, the Taxpayer filed a timely New Mexico personal income tax return for the

2004 tax year, reporting her federal adjusted gross income to be $12,180.00.

2. In completing her 2004 federal income tax return, which is used as the basis for

calculating tax due to New Mexico, the Taxpayer reported her gross income to be $41,748.21.

3. The tape match system revealed the discrepancy between the federal and state

returns. The discrepancy occurred because the Taxpayer did not include income she received from

her ex-husband’s retirement pension on her New Mexico return.

4. As a result of the error on her New Mexico return, the Taxpayer had underreported

her 2004 New Mexico income tax by $1,126.00.

5. The Taxpayer contacted the Department regarding her retirement income for the tax

year 2003 in March 2004.

6. The Taxpayer erroneously believed that if state taxes were not withheld then they

were not owed. The Taxpayer also believed that her taxes might have been withheld from her ex-

husband’s portion of the retirement income.

7. On April 4, 2007, the Department notified the Taxpayer of the commencement of a

Limited Scope Audit on her 2004 New Mexico income tax return. On April 27, 2007, the

Department assessed the Taxpayer for the additional $1,126.00 of tax due for 2004, plus penalty and

interest on that amount.

8. On April 13, 2007, the Taxpayer paid the principal tax amount to stop the accrual of

interest. The Taxpayer also made a subsequent payment of $77.00, leaving an outstanding balance

of $371.23 as of the date of the hearing.

9. On April 23, 2007, the Taxpayer filed a written protest to the Department’s

assessment, as she feels that she did not owe the tax, and therefore did not owe penalty and interest.

If it is found that the tax was owed, the Taxpayer does not dispute the amount of tax principal or the

computation of penalty and interest.

DISCUSSION

The issue to be decided is whether the Taxpayer is liable for the Department’s assessment of

tax, penalty, and interest on her underpayment of 2004 New Mexico income tax. At the

administrative hearing, the Taxpayer did not protest the amount of tax, penalty, and interest. The

Taxpayer is protesting that the tax was owed and whether penalty and interest are appropriate.

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Burden of Proof. Assessments by the Department are presumed to be correct. See NMSA

1978, § 7-1-17. Tax includes, by definition, the amount of tax principal imposed and, unless the

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

1978, § 7-1-3. See also, El Centro Villa Nursing Center v. Taxation and Revenue Department, 108

N.M. 795, 779 P.2d 982 (Ct. App. 1989). Therefore, the assessment issued to the Taxpayer is

presumed to be correct, and it is the Taxpayer’s burden to present evidence and legal argument to

show that she is not liable for the tax and is entitled to an abatement of penalty and interest.

Estoppel. The Taxpayer maintains that she should not be required to pay the tax, penalty,

and interest. Taxpayer claims that she contacted the Department in regards to her 2003 return on the

issue of her retirement income, and that the Department advised in writing that if the tax was not

withheld then it was not owed. Taxpayer relied on this information for her 2004 return. Taxpayer

admits that she later learned this was incorrect, or had changed, and has filed recent returns correctly.

The Taxpayer is essentially raising an estoppel issue, arguing that the Department should be

estopped from enforcing the collection of tax, penalty, and interest that would otherwise be due.

Estoppel is rarely applied against the state, and then only in exceptional circumstances where

there is “a shocking degree of aggravated and overreaching conduct or where right and justice

demand it.” Wisznia v. State of New Mexico, Human Services Department, 1998-NMSC-11, ¶17, 125

N.M. 140, 958 P.2d 98. In determining whether estoppel is appropriate, the conduct of both parties

must be considered. Gonzales v. Public Employees Retirement Board, 114 N.M. 420, 427, 839 P.2d

630, 637 (Ct. App.), cert. denied, 114 N.M. 227, 836 P.2d 1248 (1992).

New Mexico has a self-reporting tax system, and it is up to taxpayers to determine their tax

liabilities and accurately report those liabilities to the state. NMSA 1978, § 7-1-13. Income, including

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retirement income, is taxable in New Mexico. NMSA 1978, § 7-2-3 and 3.3.11.13 NMAC. New

Mexico bases its definition of adjusted gross income on the federal definition. NMSA 1978, § 7-2-2A.

The Taxpayer claims that she did not include the retirement income based on written

documents from the Department that said if the tax was not withheld it was not owed. The Taxpayer

did not produce any such documents. The Taxpayer explained that she was unable to produce the

documents because they had been lost or stolen during numerous break-ins at her home. Despite her

misfortune, the burden is still on the Taxpayer to prove that these documents exist. The Taxpayer’s

testimony on these documents is dubious, especially in light of the plain directions on the face of her

2004 New Mexico personal income tax return. Line 5 requires the amount of her federal adjusted gross

income and notes that it is from line 37 of federal form 1040. Line 37 from her 2004 federal tax return,

form 1040, has been filled in with $41,748.21. Line 5 of her 2004 New Mexico return has been filled

in with $12,180.00. It is highly unlikely that the Department advised the Taxpayer in writing to ignore

the plain instructions on the return. Furthermore, any documents from the Department would only be

in reference to inquiries the Taxpayer made on her 2003 tax liability, and would not apply to her 2004

taxes.

The facts presented in this case do not support a finding of estoppel. The Taxpayer was on

notice that she was required to report her federal adjusted gross income on her New Mexico tax return.

The Taxpayer ignored the explicit instructions on her 2004 New Mexico tax return when she filled in

Line 5.

Withholding. The Taxpayer asserts that it was responsibility of the entity that paid the

retirement benefits to withhold the tax. Employers are required to withhold state income tax in most

cases. NMSA 1978, § 7-3-3. However, a person paying a pension or annuity to someone who lives in

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New Mexico is defined to be a “payor” and not an “employer”. NMSA 1978, § 7-3-2. Payors are only

required to withhold when the person receiving the pension benefit requests in writing that they do so.

NMSA 1978, § 7-3-3. There is no evidence that the payor in this case was obligated to withhold.

Furthermore, the payor supplied the Taxpayer with Form 1099-R for 2004 showing that no state tax

was withheld. Therefore, the Taxpayer was on notice that no state taxes had been withheld on the

retirement benefits she received.

Tax owed. The Taxpayer asserts that the tax owed on her retirement benefits was withheld

from her ex-husband’s portion of the retirement income. The Taxpayer claims that the proof is held by

the payor and/or by the Department, where she did not have access to it. Again, the burden is on the

Taxpayer to prove that the assessment is not correct. The Taxpayer’s testimony on this subject is

highly speculative and involves an assumption that her tax must have been withheld from her ex-

husband’s payments. The Taxpayer has not provided any actual proof that the taxes she owed had

already been paid by another party.

Assessment of Penalty. When a taxpayer fails to pay taxes owed to the state as a result

of negligence or disregard of rules and regulations, a penalty “shall be added” to the amount of

the underpayment. NMSA 1978, § 7-1-69. Negligence, by definition, includes both

“inadvertence” and “erroneous belief or inattention.” 3.1.11.10 NMAC. In this case, the Taxpayer

erroneously believed that she was not liable for tax on her retirement income if it was not withheld.

This error meets the definition of negligence set out in Department regulations and in New Mexico

case law. See C & D Trailer Sales v. Taxation and Revenue Dept., 93 N.M. 697, 699, 604 P.2d

835, 837 (Ct. App. 1979) (a taxpayer's mere belief that he is not liable to pay taxes is tantamount

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to negligence within the meaning of the statute); El Centro Villa Nursing Center v. Taxation &

Revenue Department, 108 N.M. 795, 797, 779 P.2d 982, 984 (Ct. App. 1989) (§ 7-1-69 is

designed specifically to penalize unintentional failure to pay tax.).

Assessment of Interest. NMSA 1978, § 7-1-67 governs the imposition of interest on late

payments of tax and provides, in pertinent part:

A. If a tax imposed is not paid on or before the day on which it becomes due,
interest shall be paid to the state on that amount from the first day following
the day on which the tax becomes due, without regard to any extension of
time or installment agreement, until it is paid... (emphasis added).

The word “shall” indicates that the assessment of interest is mandatory, not discretionary. State v.

Lujan, 90 N.M. 103, 105, 560 P.2d 167, 169 (1977). The assessment of interest is not designed to

punish taxpayers, but to compensate the state for the time value of unpaid revenues. In this case, the

Taxpayer made a mistake on her 2004 tax return based on a misunderstanding. Nevertheless, the

State of New Mexico would have received an additional $1,126 payment if the Taxpayer had

completed her return correctly. As a result of the Taxpayer’s mistake, the state was deprived of the

use of this money for the period between the original due date in April 2005 and the date the final tax

payment was made in 2007. For this reason, interest was properly assessed.

CONCLUSIONS OF LAW

A. The Taxpayer filed a timely, written protest to the assessment of tax, penalty, and

interest issued under Letter ID No. L1473775232, and jurisdiction lies over the parties and the subject

matter of this protest.

B. Pursuant to NMSA 1978, § 7-2-3 and 3.3.11.13 NMAC, the Taxpayer is liable for the

tax owed on the retirement income she received in 2004.

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C. Pursuant to NMSA 1978, § 7-1-69, the Taxpayer is liable for the penalty that accrued.

D. Pursuant to NMSA 1978, § 7-1-67, the Taxpayer is liable for the interest that accrued

between the due date of her 2004 personal income taxes in April 2005 and the date the principal tax

was paid in 2007.

E. The Department is not estopped from collecting the tax, penalty, and interest.

F. The Taxpayer failed to prove that the payor was required to withhold the tax.

G. The Taxpayer failed to prove that the tax had already been paid by another party.

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

DATED: October 8, 2008.

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