If New Mexico's income tax forms confuse you and you invent your own way to split income between states, can you avoid penalty and interest when the state later corrects it?

Subject

Timothy & Diane Tuttle (D&O 99-13)

Plain-English summary

Timothy and Diane Tuttle moved to New Mexico from Washington and were first-year residents in 1994. Mr. Tuttle, a certified public accountant, found New Mexico's income tax forms and instructions confusing. Rather than call the Department, hire a preparer, or research the rules, he devised his own method of splitting income, exemptions, and deductions between New Mexico and Washington.

New Mexico's system works differently. The taxpayer is supposed to report the full federal adjusted gross income on Line 7 of Form PIT-1 and then claim a credit (under Section 7-2-11(C)) for the share of tax attributable to income earned outside the state. Instead, the Tuttles reported only their New Mexico income ($59,731 rather than their true federal AGI of $140,310) and a reduced exemption, and they did not tell the Department they had used their own method. A Department reviewer spotted the exemption error and — not knowing about the income problem — actually increased the refund by $497.68.

Two years later, a computer tape-match with the IRS revealed the income discrepancy. The Department recalculated the tax the correct way and issued Assessment No. 724568 for $1,170 in tax, $166.85 penalty, and $604.88 interest. At the hearing, Mr. Tuttle conceded the Department's method was right; he protested only the penalty and the interest. The Hearing Officer denied the protest:

• Interest is mandatory. Section 7-1-67(A) says interest "shall" be paid on tax not paid when due, which makes it non-discretionary. Interest is not a punishment — it compensates the state for the time value of money the Tuttles had the use of, including the erroneous refund. (The Department did agree to start the interest in July 1995 instead of April 1995, crediting three months.)
• The negligence penalty applies. Under Section 7-1-69(A) and Regulation 3 NMAC 1.11.10, negligence includes failing to exercise ordinary business care. In a self-reporting system (Section 7-1-13(B)), a taxpayer who does not understand the forms must ask for help — and a CPA all the more so. Inventing an unauthorized method instead met all three definitions of negligence.

What this means for you

• Report your full federal adjusted gross income, then take the out-of-state credit. New Mexico does not want you to pre-filter your income to just the in-state portion. You report everything on Line 7 and claim a credit for tax on non-New Mexico income under Section 7-2-11(C).
• If a form confuses you, ask — don't improvise. The negligence penalty here turned on the taxpayer's failure to contact the Department or a tax professional. "I found it confusing" is not a defense; it is close to the definition of negligence.
• Interest is automatic and not a penalty. Because the statute says "shall," interest runs on any underpayment (and on a refund you received but weren't entitled to) regardless of good faith. It compensates the state for the time it was out of the money.
• An unexpectedly large refund is a warning sign. The Tuttles noticed the refund was $497.68 higher than they claimed and did nothing. Had they asked why, the error would have surfaced immediately and stopped interest from piling up.
• Being a professional cuts against you. The Hearing Officer measured Mr. Tuttle against the care a reasonable taxpayer "much less a taxpayer who is also a CPA" would use.

Key questions answered

What was the taxpayer's mistake?
He reported only his New Mexico income (and a prorated exemption) instead of reporting his full federal adjusted gross income and claiming a credit for the tax attributable to his out-of-state Washington income. That understated his New Mexico tax.

Why did he have to pay interest on the refund the Department itself increased?
Because interest under Section 7-1-67(A) is mandatory and only compensates the state for money the taxpayer had use of. The definition of "tax" includes a refund paid "contrary to law," and the excess refund was traceable to the taxpayer's own erroneous reporting, not a Department mistake.

Why did the negligence penalty stand?
Negligence includes failing to use ordinary business care — here, not asking the Department or a tax professional and instead inventing an unauthorized calculation method. New Mexico's self-reporting system puts that duty on the taxpayer, and a CPA is held to at least the ordinary standard.

Did the taxpayers win anything?
Only a timing adjustment: the Department agreed interest should accrue from July 1995 (when the refund issued) rather than April 1995, crediting three months of interest. The tax, penalty, and remaining interest were upheld.

Verbatim citations

Interest is mandatory:

If any tax imposed is not paid on or before the day on which it becomes due, interest shall be paid to the state on such 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...

What counts as negligence (Regulation 3 NMAC 1.11.10):

1) failure to exercise that degree of ordinary business care and prudence which reasonable taxpayers would exercise under like circumstances; 2) inaction by taxpayers where action is required; 3) inadvertence, indifference, thoughtlessness, carelessness, erroneous belief or inattention.

The taxpayer's duty in a self-reporting system:

When Mr. Tuttle realized he did not understand the Department's 1994 income tax forms and instructions, it was his obligation to seek advice from the Department or from a tax preparer who was familiar with the state's tax laws.... Instead of pursuing either of these alternatives, Mr. Tuttle devised his own unauthorized method of calculating his New Mexico income tax.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Timothy & Diane Tuttle
• Decision PDF: D&O 99-13

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
TIMOTHY AND DIANE L. TUTTLE No. 99-13
ASSESSMENT NO. 724568

DECISION AND ORDER

A formal hearing on the above-referenced protest was held February 9, 1999, before

Margaret B. Alcock, Hearing Officer. Timothy Tuttle appeared on behalf of himself and his wife,

Diane L. Tuttle ("Taxpayers"). The Taxation and Revenue Department ("Department") was repre-

sented by Bruce J. Fort, Special Assistant Attorney General. Based on the evidence and arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. Timothy and Diane Tuttle filed joint federal and New Mexico personal income tax

returns for calendar year 1994.

2. The Tuttles were first-year residents of New Mexico in 1994, having moved to New

Mexico from the state of Washington.

4. For tax year 1994, payment of New Mexico personal income taxes was governed by

the Income Tax Act, Sections 7-2-1, et seq., NMSA 1978 (1990 Repl. Pamp.). Section 7-2-3 of the

Act imposes a tax on the "net income of every resident individual...."

5. Section 7-2-11(C) allows taxpayers such as the Tuttles, who have net income from both

New Mexico and non-New Mexico sources, to claim a credit for that portion of tax attributable to

income earned outside the state.

6. When filling out his 1994 New Mexico income tax return, Mr. Tuttle found the forms

and instructions confusing and did not understand the statutory method used to calculate tax due on his

New Mexico income.

7. Mr. Tuttle, who is a certified public accountant, did not consult any of the national

publications available on state income tax to clarify New Mexico's reporting requirements.

8. Mr. Tuttle did not contact anyone at the Taxation and Revenue Department to ask

about the specific parts of the forms and instructions he found confusing.

9. Instead of seeking outside advice, Mr. Tuttle devised his own personal method of

allocating income, exemptions and deductions between New Mexico and non-New Mexico income.

10. New Mexico's 1994 Form PIT-1 directs taxpayers to report their federal adjusted gross

income on Line 7. The Tuttles' federal adjusted gross income was $140,310. They reported only

$59,731, which represented the the Tuttles' New Mexico income and did not include the income they

earned in Washington.

11. New Mexico's 1994 Form PIT-1 directs taxpayers to report their federal exemption

amount on Line 12. The Tuttles' federal exemption amount was $12,250. They reported only $5,202,

which represented Mr. Tuttle's allocation of the federal exemption between New Mexico and

Washington based on the number of days he lived in each state.

12. On April 17, 1995, the Tuttles filed their 1994 state income tax return reporting an

income tax liability of $2,092 and New Mexico state withholding of $3,210. The return requested a

refund in the amount of $1,118.

13. The Tuttles did not notify the Department, either on the return itself or by a separate

memorandum or letter, that they had devised their own method of calculating their income tax liability

to New Mexico

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14. The Department employee who reviewed the Tuttles' 1994 return noticed the federal

exemption amount was incorrect based on the number of dependents shown on the return. The

Department recalculated the Tuttles' tax liability based on the correct exemption amount, which

increased their refund by $497.68.

15. At the time the refund adjustment was made, the Department had no way of knowing

that the incorrect exemption amount reflected Mr. Tuttle's attempt to allocate the federal exemption

between New Mexico and Washington. Nor did the Department have any way of knowing that Mr.

Tuttle had improperly excluded income earned in Washington from the federal adjusted gross income

reported on Line 7 of his New Mexico PIT-1.

16. In July 1995, the Department sent the Tuttles a refund check in the amount of

$1,594.24, together with a recomputation notice showing the adjustment made in the federal exemption

amount.

17. Mr. Tuttle received the refund check but does not remember receiving the

recomputation notice. Although Mr. Tuttle noticed the refund was $497.68 higher than he had claimed

on his return, he did not call the Department or make any other attempt to determine the basis for the

increased refund.

18. In 1997, the Department discovered the discrepancy between the federal adjusted

gross income the Tuttles reported to the IRS on their 1994 federal income tax return and the federal

adjusted gross income shown on their New Mexico income tax return. This discovery was made

through a computer tape-match program that compares information reported to state and federal tax

authorities.

19. Based on the information received from the IRS, the Department recalculated the

Tuttles' tax liability using the tax rate applicable to the Taxpayers' net income from both New

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Mexico and non-New Mexico sources and then giving the Taxpayers a credit for that portion of the

tax attributable to the out-of-state income.

20. On September 28, 1997, the Department issued Assessment No. 724568 to the

Tuttles in the amount of $1,170.00 tax principal, representing the underreporting created by the

Taxpayers' erroneous method of computing their 1994 state income taxes, plus $166.85 penalty and

$604.88 interest. The interest and penalty was computed from April 16, 1995.

21. On October 14, 1997, the Taxpayers filed a protest to the Department’s assessment.

DISCUSSION

In their original protest, the Tuttles questioned the method the Department used to

recalculate their 1994 income tax liability. At the February 9, 1999, hearing on the protest, Mr.

Tuttle conceded that the Department's methodology was correct. Mr. Tuttle continues to dispute the

Department's assessment of penalty, as well as its assessment of interest on $497.68, the amount by

which the Department increased the refund the Tuttles originally claimed on their 1994 income tax

return.

Assessment of Interest. Section 7-1-67(A) NMSA 1978 (1995 Repl.Pamp.) governs the

imposition of interest on late payments of tax1 during the period at issue:

A. If any tax imposed is not paid on or before the day on which it
becomes due, interest shall be paid to the state on such 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 legislature’s use of the word “shall” indicates that the assessment of interest is mandatory rather

than 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

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revenues. Although Mr. Tuttle argues he should not have to pay interest on the portion of the refund

resulting from the Department's adjustment, the fact remains that the Tuttles—not the state—had the

use of these funds from July 1995 forward.2

It should also be noted that the increase in the Tuttles' refund was directly attributable to Mr.

Tuttle's failure to either follow the instructions set out in the Department's forms or notify the

Department that he had devised his own method of calculating tax on his New Mexico income. At

the time the refund adjustment was made, the Department had no way of knowing that the incorrect

exemption amount reflected Mr. Tuttle's decision to allocate the federal exemption between New

Mexico and Washington. Nor did the Department have any way of knowing that Mr. Tuttle had

improperly excluded income earned in Washington from the federal adjusted gross income reported on

Line 7 of his New Mexico PIT-1.

When Mr. Tuttle received his refund check, he did not question the reason for the $497.68

increase in the refund requested on his return. Had Mr. Tuttle made inquiry of the Department, his

erroneous reporting methodology would have been brought to light. This would have resulted in an

immediate adjustment to the Taxpayers' 1994 tax liability and avoided the accrual of additional interest.

Responsibility for the Taxpayers' liability for interest on the erroneous refund of 1994 income tax rests

solely with Mr. Tuttle. No adjustment is warranted.

Assessment of Penalty. Section 7-1-69 NMSA 1978 (1995 Repl. Pamp.) governs the

imposition of penalty during the period at issue in this protest. Subsection A imposes a penalty of two

percent per month, up to a maximum of ten percent:

1
Section 7-1-3(U) NMSA 1978 (1995 Repl. Pamp.) defines the term "tax" to include "any amount of any credit,
rebate or refund paid...to any person contrary to law."
2
At the hearing, the Department acknowledged that interest should accrue from July 1995, not April 1995 as shown
on the assessment. The Department agreed to credit the Tuttles for the three months additional interest.

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in the case of failure, due to negligence or disregard of rules and
regulations, but without intent to defraud, to pay when due any amount
of tax required to be paid...

Taxpayer "negligence" for purposes of assessing penalty is defined in Regulation 3 NMAC 1.11.10 as:

1) failure to exercise that degree of ordinary business care and
prudence which reasonable taxpayers would exercise under like
circumstances;

2) inaction by taxpayers where action is required;

3) inadvertence, indifference, thoughtlessness, carelessness,
erroneous belief or inattention.

In this case, Mr. Tuttle's failure to properly calculate his 1994 state income tax meets all three

definitions of negligence.

New Mexico has a self-reporting tax system. It is the obligation of taxpayers, who have the

most accurate and direct knowledge of their activities, to determine their tax liabilities and accurately

report those liabilities to the state. See, Section 7-1-13(B) NMSA 1978 (1995 Repl. Pamp.). When Mr.

Tuttle realized he did not understand the Department's 1994 income tax forms and instructions, it was

his obligation to seek advice from the Department or from a tax preparer who was familiar with the

state's tax laws. Alternatively, given Mr. Tuttle's training as a CPA, he could have done additional

research on his own. Instead of pursuing either of these alternatives, Mr. Tuttle devised his own

unauthorized method of calculating his New Mexico income tax. In doing so, he ignored the

Department's instructions to report federal adjusted gross income on Line 7 of the New Mexico PIT-1

and reported only his New Mexico income, resulting in an underpayment of tax.

The facts establish that Mr. Tuttle failed to exercise the ordinary business care and prudence a

reasonable taxpayer—much less a taxpayer who is also a CPA—would exercise in like circumstances.

He failed to take action to obtain professional tax advice when it was needed. As a direct result of his

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indifference to the requirements of New Mexico law, Mr. Tuttle adopted an erroneous reporting

method that led to an underpayment of his tax liability to the state. The negligence penalty was

properly imposed.

CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protest to Assessment No. 724568, and

jurisdiction lies over the parties and the subject matter of this protest.

2. Pursuant to Section 7-1-67(A) NMSA 1978 (1995 Repl.Pamp.), interest was properly

assessed against the Taxpayers on the underpayment of their 1994 state income taxes.

3. Pursuant to Section 7-1-69(A) NMSA 1978, the Taxpayers were negligent in

underreporting their 1994 state income taxes and penalty was properly imposed.

For the foregoing reasons, the Taxpayers' protest IS DENIED.

February 12th, 1999.

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