If I don't file a return or hand over my records, how does New Mexico figure out what income tax I owe?

Plain-English summary

Robert and Carol Welsh were New Mexico residents who ran a coin-operated laundry in 1989–1991. They reported and paid gross receipts tax on the business, but they never filed personal income tax returns for those years. When the Department asked them to file, they didn't; they also refused to provide their business records, and the Department couldn't get their income figures from the IRS either (the Welshes apparently hadn't filed federal returns).

Left with only the gross receipts figures from the laundry's monthly tax returns, the Department used its estimation policy — treating 10% of gross receipts as net income — and issued three estimated assessments (Nos. 563705–563707), totaling roughly $21,043, $27,642, and $20,957 in personal income tax, interest, and penalty for 1989, 1990, and 1991. The Welshes protested, and Hearing Officer Gerald B. Richardson denied the protest on every ground:

• You can't withhold the records and then attack the estimate. The Welshes argued New Mexico income tax must start from federal adjusted gross income, not gross receipts. That's true in general (§ 7-2-2(B), (N)) — but they declined to provide their federal income information and refused to let the Department examine their records. A taxpayer who won't supply the records "cannot complain of the best methods used" by the Department (Archuleta v. O'Cheskey).
• The assessment is presumed correct, and they offered nothing to rebut it. Under § 7-1-17(C), the burden was on the Welshes to come forward with evidence that the assessments were wrong. They presented no evidence of their actual income, so the assessed amounts stood as established.
• Keeping and sharing records is a legal duty. Section 7-1-10(A) requires every taxpayer to keep records permitting accurate computation of taxes, and § 7-1-11(C) requires making them available on request. When a taxpayer refuses, the Department may use other reasonable means to determine liability.
• States can tax their residents' income. The Welshes' constitutional argument (that states need an express federal grant to tax income) was rejected: the Tenth Amendment reserves to the states any power not delegated to the federal government or prohibited to the states, and the U.S. Supreme Court confirmed the states' power to tax residents' income in Maguire v. Trefry (1920).

What this means for you

Not filing doesn't make the tax go away — the state will estimate it

If you don't file an income tax return, the Department can build an assessment from whatever information it has. Where it knows your gross receipts (because you filed gross receipts tax returns) but nothing else, its policy is to estimate net income at 10% of gross receipts. Filing an accurate return is almost always better than letting the Department estimate for you.

If you won't share records, you lose the right to challenge the method

The estimate may be rough, but a taxpayer who refuses to provide records or file returns cannot complain that the Department's method was imprecise. The way to attack an estimated assessment is with your own books and figures — withholding them forecloses the argument.

An assessment is presumed correct — you must produce evidence to beat it

Under § 7-1-17(C) the burden is on you. General objections and legal theories won't do it; you need concrete evidence of your actual income. The Welshes offered none, so the numbers stood.

You have a legal duty to keep records and make them available

Sections 7-1-10 and 7-1-11 require you to maintain records that allow accurate tax computation and to let the Department inspect them on request. This isn't optional, and refusing to comply hands the Department wide latitude to estimate your liability.

States clearly have the power to tax residents' income

Arguments that a state can't constitutionally tax income go nowhere. The Tenth Amendment reserves that power to the states, and it's been settled law since at least 1920. Don't rely on constitutional "no power to tax" theories to avoid a New Mexico income tax bill.

Common questions

Q: I never filed an income tax return. How can the state assess me?
A: It can estimate your liability from whatever information it has. If it knows your gross receipts but nothing else, its policy is to treat 10% of those receipts as net income and assess on that basis.

Q: The estimate is too high. How do I fix it?
A: Provide your actual records and file correct returns. An assessment is presumed correct (§ 7-1-17(C)), so you must come forward with evidence of your real income. If you refuse to share records, you can't challenge the Department's method (Archuleta v. O'Cheskey).

Q: New Mexico income tax is based on federal adjusted gross income, so isn't a gross-receipts estimate improper?
A: It normally starts from federal AGI, yes — but only if you provide that information. The Welshes withheld their federal figures and records, so the Department reasonably used the one data source it had (gross receipts) to estimate.

Q: Can New Mexico even tax my income?
A: Yes. The Tenth Amendment reserves that power to the states, and the U.S. Supreme Court upheld a state's power to tax its residents' income in Maguire v. Trefry (1920). There is no federal prohibition on state income taxes.

Citations and references

Statutes:

• § 7-1-17(C) NMSA 1978 — an assessment of tax is presumed correct; the taxpayer must come forward with evidence to show it is incorrect
• § 7-2-2(B), (N) NMSA 1978 — definitions of "base income" and "net income"; New Mexico income tax is computed starting from federal adjusted gross income
• § 7-1-10(A) NMSA 1978 — every taxpayer must maintain books or records permitting the accurate computation of state taxes
• § 7-1-11(C) NMSA 1978 — taxpayers must, on request, make their records and books of account available for inspection

Cases cited:

• Archuleta v. O'Cheskey, 84 N.M. 428, 504 P.2d 638 (Ct. App. 1972) (Sutin, J., specially concurring) — a taxpayer who fails to provide books and records cannot complain of the best methods the Department uses to determine tax
• Maguire v. Trefry, 253 U.S. 12, 40 S. Ct. 417, 64 L. Ed. 739 (1920) — a state has the power to tax the income of its residents

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Robert & Carol Welsh
• Decision PDF: D&O 96-11

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 ROBERT AND CAROL WELSH,
PROTEST TO ASSESSMENT NOS. 563705, 563706
AND 563707. No. 96-11

DECISION AND ORDER

This matter came on for formal hearing on February 26, 1996 before Gerald B.

Richardson, Hearing Officer. Robert and Carol Welsh (hereinafter "Taxpayers") were

represented by their son, Robin Welsh. The Taxation and Revenue Department (hereinafter

"Department") was represented by Bruce J. Fort, Esq.

Based upon the evidence and arguments presented, IT IS DECIDED AND ORDERED AS

FOLLOWS:

FINDINGS OF FACT

1. The Taxpayers were residents of New Mexico during tax years 1989, 1990 and

1991.

2. The Taxpayers operated a coin operated laundry business in New Mexico during

tax years 1989-1991.

3. The Taxpayers reported and paid gross receipts taxes to the Department upon their

coin operated laundry business during tax years 1989-1991.

4. The Department has requested of the Taxpayers that they file personal income tax

returns for tax years 1989-1991.

5. The Taxpayers have not filed New Mexico personal income tax returns with the

Department for tax years 1989-1991.

6. The Taxpayers are unwilling to provide their business records to the Department
   for tax years 1989-1991 for purposes of determining their actual personal income tax liability for

those tax years.

7. The Department was unable to obtain any information from the Internal Revenue

Service as to the amount of the Taxpayers' federal adjusted gross income for tax years 1989-1991.

8. It is the policy of the Department to try to get taxpayers to self-report their personal

income taxes. In cases where a taxpayer will not self report, the Department will try to obtain

information from the Internal Revenue Service as to what income was reported to the Internal

Revenue Service for income tax purposes.

9. When the Department has been unsuccessful at getting taxpayers to self-report for

personal income tax purposes, and when the Department has been unsuccessful at obtaining

information from the Internal Revenue Service as to a taxpayer's federal adjusted gross income,

the Department will estimate a taxpayer's New Mexico income tax liability. In cases where the

Department has information about a taxpayer's gross receipts, the Department will use ten percent

of gross receipts as an estimate of a taxpayer's net income from the operation of the business for

purposes of calculating a taxpayer's personal income taxes.

10. Assessment Nos. 563705, 563706 and 563707 are estimated assessments which

estimated that ten percent of the Taxpayers' gross receipts from the operation of their coin

operated laundry business was net income to the Taxpayers from the operation of their business

during tax years 1989-1991.

11. On December 20, 1993, the Department issued Assessment Nos. 563705, 563706

and 563707 to the Taxpayers in the respective amounts of $21,042.66, $27,641.77 and $20,957.32

of personal income tax, interest and penalty for tax years 1989, 1990 and 1991.

12. On January 18, 1994, the Taxpayers timely filed a written protest with the

Department to Assessment Nos. 563705, 563706 and 563707.

DISCUSSION

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This case involves the propriety of the Department's estimated assessments of the

Taxpayers' 1989-1991 personal income taxes. The Department had contacted the Taxpayers and

requested that they file their income tax returns, but the Taxpayers have failed to do so. The

Department was also unable to obtain information from the Internal Revenue Service which

would have provided a basis to calculate New Mexico personal income taxes based upon the

Taxpayers' federal income tax filings. The Taxpayers also refused to provide their business tax

records so that the Department could audit them to determine their income tax liability. The only

remaining information the Department had available to determine the Taxpayer's taxable income

were the monthly gross receipts tax returns filed by the Taxpayers for their coin operated laundry

business during the years in question. Using this information, the Department estimated that ten

percent of the Taxpayer's gross receipts were received by the Taxpayers as income from their

business and issued estimated assessments on this basis.

The Taxpayers argued that the Department's assessments were improper because the
starting point for calculating New Mexico taxable income is federal adjusted gross income1 and

not the Taxpayers' gross receipts. While it is true that New Mexico's

income tax scheme does piggyback on federal adjusted gross income,

the Taxpayers have declined to provide that information to the

Department and apparently have not filed tax returns with the IRS

either, since that information was not available from the IRS. It
was explained to Mr. Welsh at the hearing that there is a presumption

of correctness which attaches to any assessment of tax by the
Department pursuant to Section 7-1-17(C) NMSA 1978 and that this

placed the burden on the Taxpayers to come forward with some evidence

1
this is a correct characterization. See, definitions of "base income" and "net income", Section 7-2-2(B) and
(N) NMSA 1978.

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as to why the assessments were incorrect. In spite of this, Mr.

Welsh provided no factual evidence whatsoever concerning his income

or lack thereof, and testified that he would not allow the examination

of his business records by the Department for purposes of establishing

what income he and his wife received from their business. Thus,

at this juncture, the correctness of the amount of taxes assessed

by the Department remains unrebutted and is therefore established.

Additionally, Section 7-1-10(A) NMSA 1978 provides that "every

taxpayer shall maintain books of account or other records in a manner

that will permit the accurate computation of state taxes . . ."

Section 7-1-11(C) NMSA 1978 provides that, "taxpayers shall upon

request make their records and books of account available for

inspection at reasonable hours to the secretary or the secretary's

delegate . . ." In applying these provisions, Judge Sutin noted

that:

The taxpayer has a duty to provide the commissioner with books
and records upon which to establish a standard for taxation
as provided by law. If he fails to do so, he cannot
complain of the best methods used by the commissioner.

Archuleta v. O'Cheskey, 84 N.M. 428, 504 P.2d 638 (Ct.App. 1972),

Sutin, J., specially concurring. Thus, having failed to provide

evidence as to the amount of the Taxpayer's federal adjusted gross
income for the tax years at issue, the Taxpayer may not argue with

the method used by the Department to estimate its income for New

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Mexico tax purposes.

The Taxpayers also argue that states have no power to tax the

income of residents because this power would be repugnant to the

federal constitution and laws. The Taxpayer has cited to no cases

in support of this position, but cites to Amendment XVIII of the

United States Constitution, which established the prohibition on

the manufacture, sale of transportation of intoxicating liquors as

an example where the power to enforce the amendment was specifically

given to the states in Section 2 of the Amendment. The Taxpayer

argues that the implication of the express grant of power in the

Eighteenth Amendment is that for states to have an enumerated power,

the power must be expressly granted in federal law.

This inference is simply incorrect and is rebutted by the express

language of Amendment X of the federal constitution. Specifically,

it provides:
[T]he powers not delegated to the United States by the
Constitution, nor prohibited by it to the States, are
reserved to the States respectively, or to the people.

Thus, unless there is an express prohibition on the State's

power to impose an income tax, the Tenth Amendment preserves the
power to the States. The Taxpayer has not pointed out any such

prohibition on the power of states to impose an income tax nor is
this decision maker aware of any. Additionally, the power of states

to impose an income based tax upon their residents has been
established in the jurisprudence of the federal courts since at least
1920, when the U.S. Supreme Court upheld that power in Maguire v.

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Trefry, 253 U.S. 12, 64 L. Ed. 739, 40 S. Ct. 417 (1920).

Having failed to present evidence or legal argument to rebut

the presumption of correctness which attaches to the Department's

assessments, the Taxpayers' protest is hereby denied.
CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protest to

Assessment Nos. 563705, 563706 and 563707 and jurisdiction lies over

both the parties and the subject matter of this protest.

2. The Taxpayers have the obligation to maintain adequate

records upon which the Department can determine their tax liability

and to make such records available to the Department.

3. When a Taxpayer refuses to make such records available

to the Department, the Department may use other reasonable means

to determine the Taxpayer's liability.

4. The Taxpayers failed to rebut the presumption of

correctness which attached to the Department's assessments of tax.

5. New Mexico has the power to impose a tax upon the income

of its residents domiciled in New Mexico.

For the foregoing reasons, THE TAXPAYERS' PROTEST IS HEREBY
DENIED.

DONE, this 28th day of March, 1996.

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