Is a defaulted 401(k) loan taxable by New Mexico when the contributions came from Colorado employment but the deemed distribution occurred after moving to New Mexico?

Plain-English summary

A defaulted 401(k) loan became taxable New Mexico income when the deemed distribution occurred after Marcos Rayas moved from Colorado to New Mexico. The fact that the retirement contributions arose from Colorado employment did not change the result.

Rayas borrowed $33,084 from his employer-sponsored retirement account while he lived and worked in Colorado. He relocated and began working in New Mexico on July 21, 2014, stopped making loan payments that month, and made no later payments. The plan declared the loan in default and treated the unpaid balance as a $29,578.90 deemed distribution effective December 29, 2014.

Marcos and Cristina Rayas filed a 2014 New Mexico personal income tax return but did not report the distribution. After the IRS later assessed federal tax, penalty, and interest, Marcos acknowledged the federal tax and entered a payment plan. He did not recall paying Colorado tax on the distribution.

The hearing officer held that a participant-loan default can create a deemed distribution equal to the outstanding balance plus accrued interest. Such a distribution enters federal gross income in the year of distribution and, through New Mexico's starting point and allocation rules, becomes New Mexico income when received by a New Mexico resident.

December 29, 2014—not the earlier Colorado employment or contribution period—was the decisive date. Rayas was domiciled, employed, and residing in New Mexico then. Retirement income of a resident is allocated to New Mexico regardless of its source, and the taxpayers supplied no authority or evidence showing that Colorado instead taxed the distribution.

The assessment totaled $4,962.89: $3,549 of personal income tax, $709.80 of penalty, and $823.09 of interest, reduced by a $119 credit. The order made the balance subject to payments already made and continuing accruals.

Result: protest DENIED.

What this means for you

A 401(k) loan default can trigger taxable income

Borrowing from a retirement account is not always the final tax event. Failure to make required payments can cause the unpaid balance and accrued interest to be treated as a distribution.

Residency on the distribution date controls allocation

The source of the original wages or contributions did not control. The decision focused on where the taxpayer resided when the default produced the deemed distribution.

Federal resolution does not satisfy New Mexico liability

Entering an IRS payment plan addressed the federal obligation only. The unreported distribution also affected the New Mexico return.

Preserve proof of any other-state tax

Rayas suggested Colorado might tax the distribution but offered no authority or evidence that he reported or paid it there.

Common questions

Q: Why was the default treated as a distribution?
A: Rayas stopped making required payments and did not cure the default, so the plan treated the outstanding loan balance as distributed under the federal participant-loan rules cited in the decision.

Q: Did it matter that the 401(k) contributions came from Colorado wages?
A: No. Rayas was a New Mexico resident when the deemed distribution occurred, and resident retirement income was allocated to New Mexico.

Q: What amount was treated as distributed?
A: $29,578.90, effective December 29, 2014.

Q: Had the taxpayers reported the distribution on their New Mexico return?
A: No. Their 2014 return omitted it.

Q: What assessment was upheld?
A: $4,962.89 after a $119 credit, subject to payments already made and further interest and penalty accruals.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-2-3 — personal income tax on a resident individual's net income
• NMSA 1978, § 7-2-2(A), (B)(2), and (N) — base income and net income
• NMSA 1978, § 7-2-11(A) — allocation of resident income
• NMSA 1978, §§ 7-1-17(C) and 7-1-3(X) — assessment presumption and definition of tax
• NMSA 1978, §§ 7-1-67 and 7-1-69 — interest and civil negligence penalty
• NMSA 1978, § 7-1B-8 — hearing timing
• 26 U.S.C. §§ 62 and 408(d) — federal treatment of retirement contributions and distributions
• 26 C.F.R. § 1.72(p)-1 — deemed distributions from participant loans
• Regulations 3.3.11.11(A) and 3.3.11.13(B) NMAC — resident compensation and retirement-income allocation

Cases:

• Shaffer v. Carter, 252 U.S. 37 (1919) — a state may tax its residents' income, including income connected to other states
• New Mexico Taxation & Revenue Department v. Casias Trucking, 2014-NMCA-099 — burden to establish entitlement to abatement
• MPC Ltd. v. New Mexico Taxation & Revenue Department, 2003-NMCA-021 — assessment presumption and burden shifting

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Marcos and Cristina Rayas
• Decision PDF: D&O 21-28

Original ruling text

1 STATE OF NEW MEXICO
2 ADMINISTRATIVE HEARINGS OFFICE
3 TAX ADMINISTRATION ACT

4 IN THE MATTER OF THE PROTEST OF
5 MARCOS A. & CRISTINA E. RAYAS
6 TO ASSESSMENT ISSUED UNDER
7 LETTER ID NO. L2104815280

8 v. AHO Case Number 21.05-034A, D&O 21-28

9 NEW MEXICO TAXATION AND REVENUE DEPARTMENT

10 DECISION AND ORDER

11 On November 9, 2021, Hearing Officer Chris Romero, Esq., conducted a hearing on the

12 merits of the protest of Marcos A. and Cristina E. Rayas (“Taxpayer”) pursuant to the Tax

13 Administration Act and the Administrative Hearings Office Act. Mr. Marcos A. Rayas appeared

14 representing himself and his former spouse (collectively referred to herein as “Taxpayer”). Mr.

15 Timothy Williams, Esq. appeared on behalf of the opposing party in the protest, the Taxation and

16 Revenue Department (“Department”) accompanied by Mr. Patrick Zeller, protest auditor

17 supervisor. Mr. Rayas testified on his own behalf. Mr. Zeller testified for the Department.

18 The hearing occurred by videoconference pursuant to NMSA 1978, Section 7-1B-8 (H)

19 under the circumstances of the public health emergency presented by COVID-19, as discussed in

20 greater detail in Standing Order 21-02, which is made part of the record of the proceeding.

21 Department Exhibits A – F were admitted as evidentiary exhibits. Taxpayer did not proffer

22 any exhibits nor reference any documents that were not already contained in the administrative file

23 or in Department Exhibits A – F.

24 The primary issue presented for consideration was whether income derived from a

25 retirement savings account (401(k)) as a result of a deemed distribution is taxable as personal

26 income in New Mexico. As explained in greater detail in the following discussion, the Hearing

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 Officer concluded that income derived from a retirement account by virtue of a deemed

2 distribution while Taxpayer was a resident of New Mexico was taxable as personal income

3 in New Mexico. IT IS DECIDED AND ORDERED AS FOLLOWS:

4 FINDINGS OF FACT

5 Procedural History

6 1. On September 28, 2020, the Department issued a Notice of Assessment of

7 Taxes and Demand for Payment under Letter ID No. L2104815280 (“Assessment”) in the

8 total amount of $4,962.89. The total amount due was comprised of $3,549.00 in personal

9 income tax, $709.80 in penalty, $823.09 in interest, plus a credit in the amount of

10 $119.00, for the period of January 1, 2014 to December 31, 2014. [Administrative File;

11 Department Ex A]

12 2. On October 28, 2020, Taxpayer submitted and the Department received a

13 protest of the Assessment. [Administrative File; Department Ex. B]

14 3. On November 19, 2020, the Department acknowledged the receipt of

15 Taxpayer’s protest under Letter ID No. L1034452656. [Administrative File]

16 4. On May 18, 2021, the Department submitted a Hearing Request seeking a

17 scheduling hearing on Taxpayer’s protest. A copy of the Hearing Request was copied to

18 Taxpayer and included New Mexico Taxation and Revenue Department’s Answer to

19 Protest. [Administrative File]

20 5. On May 19, 2021, the Administrative Hearings Office entered a Notice of

21 Telephonic Scheduling Hearing that set an initial scheduling hearing to occur on June 14,

22 2021. [Administrative File]

23 6. On June 14, 2021, the Administrative Hearings Office conducted an initial

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 scheduling hearing at which time neither party objected that the hearing would satisfy the 90-day

2 hearing requirement of NMSA 1978, Section 7-1B-8 (A). Taxpayer was notified of his right to

3 representation and the parties also agreed to attend a second scheduling conference on September

4 17, 2021. [Administrative File; Record of Hearing 6/14/2021]

5 7. The Administrative Hearings Office entered a Notice of Second Telephonic

6 Scheduling Hearing on June 18, 2021, which set another scheduling hearing for September 17,

7 2021. [Administrative File]

8 8. Mr. Rayas did not appear for the scheduling hearing on September 17, 2021. For

9 that reason, the Administrative Hearings Office entered a Notice of Third Telephonic Scheduling

10 Hearing on September 17, 2021, which set another scheduling hearing to occur on October 15,

11 2021. Taxpayer was also, again, notified of his right to representation. [Administrative File;

12 Record of Hearing 9/17/2021]

13 9. Mr. Rayas did not appear for the scheduling hearing on October 15, 2021. For that

14 reason, the Administrative Hearings Office entered and served a Notice of Remote Video

15 Administrative Hearing that set a hearing on the merits of Taxpayer’s protest for November 3,

16 2021, and notified Taxpayer of his right to representation. [Administrative File; Record of

17 Hearing 10/15/2021]

18 10. On October 15, 2021, Taxpayer submitted an email to the Administrative

19 Hearings Office requesting a continuance of the hearing on the merits that had been set to occur

20 on November 3, 2021.

21 11. On October 18, 2021, the Administrative Hearings Office entered a Notice of

22 Telephonic Hearing on Taxpayer’s Request for Continuance. [Administrative File]

23 12. A telephonic hearing on Taxpayer’s request for a continuance occurred on

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 October 19, 2021. At the conclusion of the hearing, the Administrative Hearings Office

2 entered an Amended Notice of Remote Video Administrative Hearing which continued

3 the hearing on the merits of Taxpayer’s protest to November 9, 2021. and notified

4 Taxpayer of his right to representation. [Administrative File; Record of Hearing

5 10/19/2021]

6 13. On November 4, 2021, the Department filed New Mexico Taxation and

7 Revenue Department’s Exhibit List. [Administrative File]

8 14. On November 9, 2021, the Department filed New Mexico Taxation and

9 Revenue Department’s Witness and Exhibit List. [Administrative File]

10 Material Facts

11 15. Marcos A. Rayas and Cristina E. Rayas were married at all times relevant

12 to the protest. They divorced in February of 2021. [Cross Examination of Mr. Rayas]

13 16. From the beginning of 2014 until approximately July 21, 2014, Mr. Rayas

14 was employed and residing in the State of Colorado. [Direct Examination of Mr. Rayas]

15 17. During his employment in Colorado, he participated in a retirement

16 savings account (401(k)) plan sponsored by his employer. [Direct Examination of Mr.

17 Rayas]

18 18. At some point during his employment in Colorado, and prior to relocating

19 to New Mexico, Mr. Rayas borrowed a sum of money from his retirement savings

20 account which he was to repay under specified terms and conditions. The original loan

21 amount was $33,084.00. [Direct Examination of Mr. Rayas; Cross Examination of Mr.

22 Rayas; Department Ex. F]

23 19. On July 21, 2014, Mr. Rayas relocated and began employment in New

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 Mexico. Mr. Rayas was domiciled and employed in New Mexico from the latter part of July

2 2014 through the remainder of that year, as well as through the date of the hearing. [Cross

3 Examination of Mr. Rayas; Direct Examination of Mr. Zeller]

4 20. Mr. Rayas stopped making payments on his retirement savings account loan in

5 July of 2014 and made no subsequent payments. Therefore, the loan was “declared in default”

6 and the outstanding balance was treated as a distribution “as stipulated by the Internal Revenue

7 Service regulations[.]” [Direct Examination of Mr. Rayas; Cross Examination of Mr. Rayas;

8 Department Ex. F]

9 21. Consequently, Mr. Rayas derived a total distribution in the total taxable amount of

10 $29,578.90 effective December 29, 2014 during which time Taxpayer was a New Mexico

11 resident. [Direct Examination of Mr. Rayas; Direct Examination of Mr. Zeller; Cross

12 Examination of Mr. Rayas; Department Ex. F]

13 22. In 2015, Taxpayer filed a New Mexico Personal Income Tax return for tax year

14 2014. [Cross Examination of Mr. Rayas; Department Ex. C]

15 23. Income reported on Taxpayer’s 2014 New Mexico Personal Income Tax return

16 did not include any income derived from Taxpayer’s retirement savings account distribution.

17 [Cross Examination of Mr. Rayas; Direct Examination of Mr. Zeller; Department Ex. C]

18 24. On or about December 5, 2016, the Internal Revenue Service notified Taxpayer of

19 an amount of tax, penalty, and interest due arising from the unreported income deriving from the

20 distribution from Mr. Rayas’ retirement savings account. [Cross Examination of Mr. Rayas;

21 Department Ex. D]

22 25. In response to the notification from the IRS that additional tax, penalty and

23 interest was due, Mr. Rayas acknowledged the amount of tax due and entered into a payment

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 plan with the IRS. [Cross Examination of Mr. Rayas]

2 26. Taxpayer has no recollection of paying taxes on the distribution to the

3 State of Colorado. [Cross Examination of Mr. Rayas]

4 DISCUSSION

5 The primary issue presented for consideration was whether income derived from a

6 retirement savings account (401(k)) is taxable as personal income in New Mexico. As explained in

7 greater detail in the following discussion, the Hearing Officer concluded that the income

8 distributed from a retirement savings account while Taxpayer was a resident of New Mexico was

9 taxable as personal income in New Mexico.

10 Presumption of Correctness

11 Pursuant to NMSA 1978, Section 7-1-17 (C) (2007), the Assessment of tax issued in this

12 case is presumed correct and unless otherwise specified, for the purposes of the Tax

13 Administration Act, “tax” includes interest and civil penalty. See NMSA 1978, Section 7-1-3 (X)

14 (2013). Therefore, under Regulation 3.1.6.13 NMAC, the presumption of correctness under

15 Section 7-1-17 (C) also extends to the Department’s assessment of penalty and interest. See

16 Chevron U.S.A., Inc. v. State ex rel. Dep’t of Taxation & Revenue, 2006-NMCA-050, ¶16, 139

17 N.M. 498, 134 P.3d 785 (agency regulations interpreting a statute are presumed proper and are to be

18 given substantial weight).

19 As a result, the presumption of correctness in favor of the Department requires that

20 Taxpayer carry the burden of presenting countervailing evidence or legal argument to show that

21 he is entitled to abatement of the Assessment. See N.M. Taxation & Revenue Dep’t v. Casias

22 Trucking, 2014-NMCA-099, ¶8, 336 P.3d 436. “Unsubstantiated statements that [an] assessment

23 is incorrect cannot overcome the presumption of correctness.” See MPC Ltd. v. N.M. Taxation &

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 Revenue Dep’t, 2003-NMCA-021, ¶13, 133 N.M. 217, 62 P.3d 308; See also Regulation 3.1.6.12

2 NMAC. If a taxpayer presents sufficient evidence to rebut the presumption, then the burden

3 shifts to the Department to re-establish the correctness of the assessment. See MPC, 2003-

4 NMCA-021, ¶13.

5 Distribution from a Retirement Savings Account

6 Taxpayer suggests that because the contributions to his retirement savings account, which

7 ultimately funded his loan, were earned in Colorado, the distribution deriving from his default

8 should not be taxable to New Mexico.

9 However, it is undisputed that at the time of the distribution, on December 29, 2014,

10 Taxpayer was residing and employed in New Mexico. The Hearing Officer perceives this fact as

11 dispositive.

12 It has long been recognized that states reserve the right to tax the income of their

13 residents, including income derived from employment in other states. See Shaffer v. Carter, 252

14 U.S. 37 (1919). Accordingly, New Mexico imposes a tax on the net income of every resident

15 individual. See NMSA 1978, Section 7-2-3 (1981). Net income includes distributions from

16 retirement savings accounts, among other sources and categories of income. See NMSA 1978,

17 Section 7-2-2 (N) (2014); Section 7-2-2 (B)(2); Section 7-2-2 (A).

18 Contributions to individual retirement accounts, including 401(k) plans, are deductible

19 from adjusted gross income. See 26 U.S.C. Sec. 62. On the other hand, distributions from those

20 same plans, with exception for circumstances not applicable under these facts, are included in

21 federal gross income and are taxable in the year of the distribution. See 26 U.S.C. Sec. 408 (d)

22 (“any amount paid or distributed out of an individual retirement plan shall be included in gross

23 income by the payee or distributee”).

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 A distribution, or in this case, a “deemed distribution” may occur under various

2 circumstances, including the situation existing in this protest in which Taxpayer failed to adhere

3 to the terms and conditions for making payments on his loan. See 26 C.F.R. Sec. 1.72(p)-1. In

4 other words, as simply stated by the IRS, “If the participant failed to make any installment

5 payment when due in accordance with the terms of the loan, then the deemed distribution is the

6 amount of the outstanding balance of the loan, plus accrued interest.” See

7 https://www.irs.gov/retirement-plans/deemed-distributions-participant-loans (accessed

8 12/29/2021). Therefore, unless the default is cured, which did not occur in this case, the

9 distribution is included in Taxpayer’s gross income in the year of the distribution.

10 The Hearing Officer observed that when the IRS brought this issue to Taxpayer’s

11 attention, he did not dispute that the distribution occurred or that it was taxable. Taxpayer merely

12 initiated a payment plan. However, this did not satisfy Taxpayer’s personal income tax

13 obligation to the State of New Mexico.

14 New Mexico imposes a personal income tax “upon the net income of every resident

15 individual.” See NMSA 1978, Section 7-2-3. The net income that is taxed in New Mexico

16 begins with federal adjusted gross income meaning a taxpayer’s “base income” less any

17 applicable federal exemptions and deductions. See Section 7-2-2 (N).

18 Retirement income, even if initially derived from out-of-state employment, is allocated to

19 New Mexico if the taxpayer is a New Mexico resident. See NMSA 1978, Section 7-2-11 (A);

20 Regulation 3.3.11.11 (A) NMAC (12/14/00) (“All compensation received while a resident of

21 New Mexico shall be allocated to this state whether or not such compensation is earned from

22 employment in this state.”); see also Regulation 3.3.11.13 (B) (NMAC) (12/14/00) (“Retirement

23 income of a resident is allocable to New Mexico, regardless of the source of the retirement

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 income…”); see also The protest of Joy Odom, Decision and Order # 11-04 (Taxation and

2 Revenue Department Hearings Bureau, February 10, 2011, non-precedential).

3 There is no dispute that Taxpayer was a resident of New Mexico as of December 29,

4 2014, which is the date of the distribution. Since Taxpayer was a resident of New Mexico on that

5 date, the income derived as a result of the default on the loan and resulting deemed distribution

6 declared on that same date is taxable to New Mexico. 1

7 Taxpayer also stated some disagreement with the characterization of the distribution as a

8 “distribution.” Having carefully contemplated the testimony and exhibits, particularly

9 Department Ex. F in reference to this specific point, as well as the relevant authority cited in this

10 Decision and Order, the Hearing Officer fails to see any mischaracterization or confusion of

11 terms. The taxable event central to the protest is the distribution. Department Ex. F clearly

12 establishes that the distribution was declared effective December 29, 2014 at which time

13 Taxpayer was a New Mexico resident. Any assertion that this event did not qualify as a

14 “distribution” fails for lack of legal authority and supporting evidence, especially given the

15 substantial weight of evidence to the contrary.

16 For the reasons stated, Taxpayer’s protest is DENIED.

17 CONCLUSIONS OF LAW

18 A. Taxpayer filed a timely, written protest to the Assessment. Jurisdiction lies over the

19 parties and the subject matter of this protest.

20 B. The Department made a timely request for hearing and the Administrative Hearings

21 Office conducted a hearing within 90 days of Taxpayer’s protest under NMSA 1978, Section 7-1B-

1
Although Taxpayer suggests that the State of Colorado, instead of New Mexico, could be entitled to tax the
distribution, Taxpayer presents no authority in support of that contention, nor did he present evidence to establish
that he actually reported or paid taxes on the distribution to the State of Colorado.

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 8 (2015) (amended 2019).

2 C. Taxpayer carries the burden to present countervailing evidence or legal argument

3 to show entitlement to an abatement of an assessment. See Casias Trucking, 2014-NMCA-099,

4 ¶8.

5 D. If a taxpayer presents sufficient evidence to rebut the presumption, then the

6 burden shifts to the Department to re-establish the correctness of the assessment. See MPC Ltd.,

7 2003-NMCA-021, ¶13.

8 E. Taxpayer did not overcome the presumption of correctness that attached to the

9 Assessment. See Section 7-1-17(C).

10 F. Under NMSA 1978, Section 7-2-3, a tax is imposed upon the net income of every

11 resident individual employed in New Mexico.

12 G. Under NMSA 1978, Section 7-1-67 (2007), Taxpayer is liable for accrued interest

13 under the assessment, which shall continue to accrue until the tax principal is satisfied.

14 H. Under NMSA 1978, Section 7-1-69 (2007), Taxpayer is liable for civil negligence

15 penalty and there is no basis under the facts of the protest to permit an abatement.

16 For these reasons, Taxpayer’s protest should be, and hereby is, DENIED. Taxpayer shall

17 remit payment to the Department for the assessed amount of tax, interest, and penalty, subject to

18 any adjustments for payments already made and for accrual of interest and penalty.

19 DATED: December 30, 2021

21 Chris Romero
22 Hearing Officer
23 Administrative Hearings Office
24 P.O. Box 6400
25 Santa Fe, NM 87502

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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1 NOTICE OF RIGHT TO APPEAL

2 Pursuant to NMSA 1978, Section 7-1-25 (2015), the parties have the right to appeal this

3 decision by filing a notice of appeal with the New Mexico Court of Appeals within 30 days of the

4 date shown above. If an appeal is not timely filed with the Court of Appeals within 30 days, this

5 Decision and Order will become final. Rule of Appellate Procedure 12-601 NMRA articulates

6 the requirements of perfecting an appeal of an administrative decision with the Court of Appeals.

7 Either party filing an appeal shall file a courtesy copy of the appeal with the Administrative

8 Hearings Office contemporaneous with the Court of Appeals filing so that the Administrative

9 Hearings Office may begin preparing the record proper. The parties will each be provided with a

10 copy of the record proper at the time of the filing of the record proper with the Court of Appeals,

11 which occurs within 14 days of the Administrative Hearings Office receipt of the docketing

12 statement from the appealing party. See Rule 12-209 NMRA.

13 CERTIFICATE OF SERVICE

14 INTENTIONALLY BLANK

15

In the Matter of the Protest of Marcos A. & Cristina E. Rayas
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