Could a Public Health Service officer avoid penalty and interest after relying on employer statements and tax software to claim the armed-forces exemption?

Plain-English summary

Tracy Sanchez remained liable for penalty and interest after incorrectly exempting her Public Health Service pay from New Mexico income tax. Reliance on employer earnings statements and tax software made the error understandable but did not fit the decision's recognized grounds for penalty relief.

Sanchez was a commissioned PHS officer during 2010 through 2012. Her earnings statements indicated that her pay was exempt from New Mexico tax, and her software said active military members qualified for an exemption.

She later conceded that PHS income was taxable because her service was not in the “armed forces” covered by Section 7-2-5.11. The protest therefore concerned only penalty and interest.

PHS was outside the cited armed-forces definition

The federal provisions cited in the decision distinguished the armed forces from the broader uniformed services that included the PHS commissioned corps.

The New Mexico residency regulation included only PHS officers properly detailed to the Army or Navy in its armed-forces definition. Sanchez's PHS duties were not detailed to either service, and the regulation addressed residency in any event.

The 2011 and 2012 PIT instructions expressly excluded PHS pay from the exemption. The 2010 instructions defined armed forces but did not contain the same explicit PHS exclusion. Sanchez used software and did not see the paper instructions for any year.

Understandable reliance was still negligence under the rule

The hearing officer found no attempt to defraud or evade tax and described Sanchez's reliance on her software and employer assurances as understandable.

Penalty relief, however, covered specified circumstances such as qualifying reliance on counsel or an accountant. Employer statements and tax software did not fall within those provisions.

The decision also rejected the good-faith mistake-of-law exception. It characterized Sanchez's error as a factual mistake about whether her PHS service was service in the armed forces, not a mistake about the legal effect of known facts.

Interest was mandatory because the personal income tax had not been paid when due.

Result: protest DENIED. The original assessments for 2010 through 2012 included $5,497.00 tax, $1,073.34 penalty, and $303.17 interest, totaling $6,873.51.

What this means for you

Public Health Service officers

Do not assume that every federal uniformed-service benefit uses the same “armed forces” definition. Check the exact state statute and instructions for the tax year involved.

Taxpayers using preparation software

Software output does not necessarily establish reasonable cause for penalty relief. Review the underlying eligibility question and retain documentation supporting any exemption.

Employers preparing earnings statements

An employer's tax characterization did not bind the Department here. Workers remained responsible for determining their state return position.

Common questions

Q: Was Sanchez still contesting the income tax principal?
A: No. She conceded that the PHS pay was taxable and sought only penalty and interest relief.

Q: Did the hearing officer think she acted fraudulently?
A: No. The decision expressly said she did not willfully attempt fraud or tax evasion.

Q: Why didn't the 2010 instructions support relief?
A: Although they lacked the later explicit PHS exclusion, Sanchez did not read them, and her employer/software reliance did not meet a listed nonnegligence ground.

Q: Why was the mistake not a mistake of law?
A: The decision viewed it as a factual error about whether PHS service counted as armed-forces service.

Citations and references

Statutes and regulations:

• NMSA 1978, §§ 7-2-3 and 7-2-5.11 — resident income tax and active-duty armed-forces exemption
• NMSA 1978, §§ 7-1-69 and 7-1-67(A) — civil penalty and mandatory interest
• Regulations 3.1.11.8, 3.1.11.10, and 3.1.11.11 NMAC — penalty presumption, negligence, and relief circumstances
• Regulation 3.3.1.9(D)(5) NMAC — residency definition of armed forces
• 5 U.S.C. §§ 2101 and 8331 and 10 U.S.C. § 101 — armed forces, uniformed services, and military service definitions

Cases cited:

• Tiffany Construction Co. v. Bureau of Revenue, 1976-NMCA-127 — erroneous belief that tax was not due as negligence
• State v. Hubble, 2009-NMSC-014 — definition of mistake of law

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Tracy Sanchez
• Decision PDF: D&O 14-23

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
TRACY SANCHEZ, No. 14-23
TO ASSESSMENTS ISSUED UNDER
ID NOS. L0974228944; L2047970768; and L0101813712

DECISION AND ORDER

A formal hearing on the above-referenced protest was held April 23, 2014, before Dee

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

represented by Ms. Elena Morgan, Staff Attorney. Ms. Milagros Bernardo, Auditor, also appeared

on behalf of the Department. Ms. Tracy Sanchez (Taxpayer) appeared for the hearing and

represented herself. The Hearing Officer took notice of all documents in the administrative file.

The Taxpayer and Ms. Bernardo testified at the hearing. Based on the evidence and arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. On January 16, 2014, the Department assessed the Taxpayer for personal income tax

(PIT), penalty, and interest for the tax period ending on December 31, 2010. The

assessment was for $1,632.00 tax, $326.40 penalty, and $141.11 interest.

2. On January 16, 2014, the Department assessed the Taxpayer for PIT, penalty, and interest

for the tax period ending on December 31, 2011. The assessment was for $2,562.00 tax,

$512.40 penalty, and $133.14 interest.

3. On January 16, 2014, the Department assessed the Taxpayer for PIT, penalty, and interest

for the tax period ending on December 31, 2012. The assessment was for $1,303.00 tax,

$234.54 penalty, and $28.92 interest.

4. On February 12, 2014, Taxpayer filed a formal protest letter.

5. On March 25, 2014, the Department filed a Request for Hearing asking that the

Taxpayer’s protest be scheduled for a formal administrative hearing.

6. The Taxpayer was working as a commissioned officer with the United States Public

Health Service (PHS).

7. The PHS is a branch of the United States military.

8. The PHS is an unarmed branch.

9. The Taxpayer believed that her income from PHS as an active duty military officer was

exempt from New Mexico tax.

10. The Taxpayer’s belief was based on her earnings statements from PHS, which all

indicated that her earnings were exempt from New Mexico tax. The Taxpayer also relied

upon a software tax program that indicated that active military members were exempt

from New Mexico tax.

11. The PIT return instructions for the 2010 tax year included a definition of “armed forces”.

The PIT return instructions for the 2011 and 2012 tax years also included a definition of

“armed forces”. However, the 2011 and 2012 PIT instructions also specified that PHS is

excluded from the exemption.

12. The Taxpayer now realizes that her earnings are taxable in New Mexico as PHS is not an

armed branch of the military, but requests that penalty and interest be abated.

DISCUSSION

The issue to be decided is whether the Taxpayer is liable for penalty and interest for the

2010, 2011, and 2012 tax years.

Burden of Proof.

Tracy Sanchez
Letter ID Nos. L0974228944; L2047970768; L0101813712
page 2 of 6
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 Ctr. v. Taxation and Revenue Department, 1989-NMCA-

070, 108 N.M. 795. 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

entitled to an abatement of penalty and interest.

Armed forces exemption.

A tax is levied on the personal income of every resident. See NMSA 1978, § 7-2-3

(1981). Salary paid by the United States “for active duty service in the armed forces of the

United States is exempt from state income taxation.” NMSA 1978, § 7-2-5.11 (2007). The

Taxpayer concedes that she is not a member of the armed forces and that she is subject to PIT.

However, the Taxpayer argues that she was relying on the software tax program as well as her

employer when she claimed the exemption. The Taxpayer argues that the penalty and interest

should be abated.

Assessment of Penalty.

Assessment of penalty is also presumed to be correct. See 3.1.11.8 NMAC (2001).

Failing to pay a tax when it was due because of negligence or disregard for department rules and

regulations is subject to penalty. See NMSA 1978, § 7-1-69 (A) (2007). A taxpayer’s lack of

knowledge or erroneous belief that the taxpayer did not owe tax is considered to be negligence

for purposes of assessment of penalty. See Tiffany Const. Co., Inc. v. Bureau of Revenue, 90

N.M. 16, 558 P.2d 1155 (Ct. App. 1976). See also 3.1.11.10 NMAC (2001).

Tracy Sanchez
Letter ID Nos. L0974228944; L2047970768; L0101813712
page 3 of 6
The Taxpayer mistakenly believed that she was entitled to an exemption from PIT based

upon her service in the PHS. See NMSA 1978, § 7-2-5.11 (2007) (providing an exemption for

members of the armed forces). “Armed forces” is not defined by the statute. See id. See also

NMSA 1978, § 7-1-3 (2013) and § 7-2-2 (2010). However, a definition for “armed forces”

occurs in a regulation under the Income Tax Act. See 3.3.1.9 NMAC (2010). The definition

relates to residency and includes all members of the army, navy, marines, air force, coast guard,

“and all officers of the public health service detailed by proper authority for duty either with the

army or the navy”. 3.3.1.9 (D) (5) NMAC (2010) (emphasis added). As the regulation

specifically addresses residency, it is not clear that the regulation would apply. Moreover, the

Taxpayer’s services with PHS were not detailed for duty with the army or the navy. Federal law

also defines “armed forces” as “the Army, Navy, Air Force, Marine Corps, and Coast Guard”

and defines “uniformed services” as “the armed forces, [and] the commissioned corps of public

health service”. 5 U.S.C. § 2101 (1979). See also 10 U.S.C. § 101 (2013).

The Department argues that the statute is clear that only members of the “armed forces”

may claim the exemption. The Department also argues that the Taxpayer was not relying on the

advice of counsel or an accountant. The Department also argues that the instructions that were

included with the PIT return forms for 2010, 2011, and 2012 tax years made it perfectly clear

that a member of the PHS was not able to claim the exemption.

The exhibits submitted showed that the 2011 and 2012 PIT instructions specifically

excluded the PHS from the definition of “armed forces”. However, the 2010 PIT instructions do

not contain the same explicit exclusion. The Taxpayer did not see the PIT instructions for any

tax year as she was using a tax software program. The Taxpayer believed military service to be

exempt, and so claimed the exemption. See 5 U.S.C. § 8331 (2012) (defining military service to

Tracy Sanchez
Letter ID Nos. L0974228944; L2047970768; L0101813712
page 4 of 6
include service in the armed forces as well as in the PHS). A taxpayer may be entitled to

abatement of penalty when the taxpayer relied on advice of counsel or an accountant, or in

various other circumstances. See 3.1.11.11 NMAC (2001). The Taxpayer was not willfully

attempting to defraud the Department or to evade taxation. The Taxpayer made an

understandable mistake based on her reliance on a tax software program and on her employer’s

assurances. However, neither of those situations falls within the definition of nonnegligence.

See id. Nor can the Taxpayer’s situation be said to be a mistake of law. See NMSA 1978, § 7-1-

69 (B) (2007). A mistake of law is a mistake about the legal effect of a fact. See State v.

Hubble, 2009-NMSC-014, ¶ 22, 146 N.M. 70. The Taxpayer’s mistake was a factual mistake,

that her services for PHS were services for the “armed forces”. Consequently, the assessment of

penalty was appropriate.

Assessment of Interest.

Interest “shall be paid” on taxes that are not paid on or before the date on which the tax is

due. NMSA 1978, § 7-1-67 (A). The word “shall” indicates that the assessment of interest is

mandatory, not discretionary. See State v. Lujan, 1977-NMSC-010, ¶ 4, 90 N.M. 103. The

assessment of interest is not designed to punish taxpayers, but to compensate the state for the

time value of unpaid revenues. Because the PIT was not paid when it was due, interest was

properly assessed.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely written protest to the Notice of Assessment of 2010,

2011, and 2012 personal income taxes issued under respective Letter ID numbers L0974228944,

L2047970768, and L0101813712, and jurisdiction lies over the parties and the subject matter of this

protest.

Tracy Sanchez
Letter ID Nos. L0974228944; L2047970768; L0101813712
page 5 of 6

2. The Taxpayer conceded that she was properly assessed for personal income taxes

and that she was not entitled to the exemption for the armed forces.

3. The Taxpayer was properly assessed for penalty and interest.

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

DATED: June 11, 2014.

Dee Dee Hoxie
DEE DEE HOXIE
Hearing Officer
Taxation & Revenue Department
Post Office Box 630
Santa Fe, NM 87504-0630

Tracy Sanchez
Letter ID Nos. L0974228944; L2047970768; L0101813712
page 6 of 6