If I retire in New Mexico and cash out a 401(k) I built up while living in another state, does New Mexico tax the whole thing?

Plain-English summary

A New Mexico resident who cashed out a 401(k) he had built up over years of working in Texas, Oklahoma, and New Mexico owed New Mexico income tax on the entire distribution — the tax follows where he lived when he received the money, not where he earned it. Protest DENIED.

DeWayne Maloy worked for the Hertz Corporation from 1982 to 1997, mostly in Texas, briefly in Oklahoma, and in New Mexico after moving there in October 1994. Throughout, he contributed to Hertz's 401(k) plan, which lets employees defer income tax on the contributions and their earnings until the money is paid out. In 1997 he changed jobs and cashed out the 401(k) while a New Mexico resident. His full federal adjusted gross income for 1997 was $84,046.85, but on his New Mexico return (Form PIT-A) he reported only $49,186 — leaving out the portion of the payout he believed was attributable to years he lived in Texas (which has no income tax) and Oklahoma (where he filed no return). A 2000 tape-match caught the gap, and the Department assessed $2,546 in additional tax, plus a penalty and interest.

Retirement income is taxed by the state you live in when you receive it

New Mexico's Income Tax Act piggybacks on the federal system: New Mexico taxable income starts from federal adjusted gross income. When income is taxable both inside and outside the state, a resident can use Form PIT-B to allocate it (Section 7-2-11) — but some categories go 100% to New Mexico no matter where they came from. Retirement income is one of them. Regulation 3.3.11.13(B) says a resident's retirement income is allocable to New Mexico "regardless of the source of the retirement income, where it is paid from or whether the resident was a resident of New Mexico at the time of the employment which gave rise to the income."

That regulation tracks federal law. 4 U.S.C. § 114, enacted in 1995, prohibits a state from taxing the retirement income of someone who is not a resident or domiciliary of that state, and it applies to qualified plans under Section 401(a) of the Internal Revenue Code — which includes 401(k) plans. The flip side is that the state where the recipient does reside when the distribution is paid may tax it in full. So Maloy's theory — that only the state where he lived when he made each contribution could tax the matching part of the payout — had no legal basis. Only New Mexico, where he lived when he received the 1997 distribution, could tax it.

States have long been able to tax residents on income from anywhere

The hearing officer added that a state's power to tax its own residents on income earned elsewhere is well settled. The U.S. Supreme Court recognized the states' wide latitude to tax their own people in Shaffer v. Carter, and in Lawrence v. State Tax Commission of Mississippi upheld Mississippi's tax on a resident's income earned from work in Tennessee, explaining that "domicile in itself establishes a basis for taxation."

Interest and the negligence penalty stood

Maloy argued the Department's two-year delay in notifying him should excuse interest and penalty. It did not. New Mexico is a self-reporting system (Section 7-1-13(B)), and the Department has three years from the end of the year the tax is due to assess (Section 7-1-18(A)) — the July 2000 assessment was well within that. Interest under Section 7-1-67 is mandatory ("shall"), compensates the state for the time value of unpaid tax, and does not depend on the reason for late payment (State v. Lujan). The negligence penalty under Section 7-1-69(A) applied because Maloy ignored the plain instruction on Line 6 of Form PIT-A to report his full federal adjusted gross income and instead devised his own calculation; if he disagreed with the instructions, he should have asked the Department or a tax advisor.

Result: protest DENIED; tax, penalty, and interest upheld.

What this means for you

If you live in New Mexico when a retirement plan pays out, New Mexico taxes the whole payout

For 401(k)s, pensions, and similar retirement income, what matters is your state of residence when you receive the distribution — not the states where you lived while contributing. A New Mexico resident's distribution is allocated 100% to New Mexico, even for years worked in a no-income-tax state like Texas.

The federal rule cuts both ways

4 U.S.C. § 114 stops other states from taxing your retirement income once you have moved away — so a former state cannot reach back to tax your pension after you leave. But it also confirms that your new state of residence can tax it in full.

Follow the form instructions; don't invent your own numbers

New Mexico's PIT return starts from your full federal adjusted gross income. Substituting a smaller, self-calculated figure — even in good faith — is treated as negligence and draws a penalty. If an instruction seems wrong for your situation, ask the Department or a qualified preparer before deviating.

Agency delay does not erase interest or the assessment

The Department has three years to assess and can be slow because of the tape-match lag. Interest keeps running the whole time and is mandatory, so a late notice does not reduce what you owe.

Common questions

Q: I earned most of that 401(k) money while living in Texas. Why does New Mexico tax it?
A: Because retirement income is taxed by the state where you reside when you receive it, not where you earned the contributions. You were a New Mexico resident when the 401(k) paid out, so New Mexico taxes the full distribution.

Q: Texas has no income tax and I never filed in Oklahoma — doesn't that mean that part is tax-free?
A: No. The place you earned the contributions does not control. Federal law (4 U.S.C. § 114) blocks those states from taxing your retirement income once you are a New Mexico resident, and New Mexico taxes the whole payout.

Q: Can I use Form PIT-B to split the distribution between states?
A: Not for retirement income. Some categories must be allocated 100% to New Mexico regardless of source, and a resident's retirement income is one of them under Regulation 3.3.11.13(B).

Q: The Department took two years to bill me — why the penalty and interest?
A: New Mexico is self-reporting, and the Department has three years to assess. Interest is mandatory and runs until you pay. The penalty applied because he ignored the plain PIT-A instruction and used his own method, which is treated as negligence.

Citations and references

Statutes and regulations:

• NMSA 1978, §§ 7-2-1 et seq. — the Income Tax Act; New Mexico taxable income starts from federal adjusted gross income
• NMSA 1978, § 7-2-11 — allocation and apportionment of income taxable within and without New Mexico (Form PIT-B)
• 4 U.S.C. § 114 — prohibits a state from taxing the retirement income of a person who is not a resident or domiciliary, covering Section 401(a) plans (including 401(k))
• NMSA 1978, § 7-1-18(A) — three years from the end of the calendar year the tax is due to issue an assessment
• NMSA 1978, § 7-1-67 — interest "shall" be paid on tax not paid when due
• NMSA 1978, § 7-1-69(A) — negligence penalty (2% per month, up to 10%)
• NMSA 1978, § 7-1-13(B), (E) — self-reporting obligation; interest runs from the original due date even with an extension
• Regulation 3.3.11.13(B) NMAC — a resident's retirement income is allocable to New Mexico regardless of source, where paid, or residency during the employment that gave rise to it

Cases cited:

• Shaffer v. Carter, 252 U.S. 37, 51 (1919) — states have wide latitude to tax their own people
• Lawrence v. State Tax Commission of Mississippi, 286 U.S. 276 (1932) — a state may tax a resident on income earned out of state; "domicile in itself establishes a basis for taxation"
• State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977) — "shall" makes interest mandatory

Source

• Listing: New Mexico Decisions & Orders
• Decision post: DeWayne Maloy
• Decision PDF: D&O 01-12

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
DEWAYNE MALOY No. 01-12
ASSESSMENT 614060

DECISION AND ORDER

A formal hearing on the above-referenced protest was held July 16, 2001, before Margaret B.

Alcock, Hearing Officer. DeWayne Maloy (“Taxpayer”) represented himself. The Taxation and

Revenue Department ("Department") was represented by Bridget A. Jacober, Special Assistant

Attorney General. Based on the evidence and arguments presented, IT IS DECIDED AND

ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. Between 1982 and 1997, the Taxpayer worked for the Hertz Corporation in Texas,

Oklahoma and New Mexico.

2. During most of this 15-year period, the Taxpayer was employed in Texas. He

worked for a short time in Oklahoma and then moved to New Mexico in October 1994.

3. During his employment with Hertz, the Taxpayer participated in the company’s

401(k) retirement plan.

4. The term “401(k)” refers to the section of the Internal Revenue Code that sets out the

rules for this type of retirement plan. The terms of the plan allow an employee to defer payment of

income tax on the portion of the employee’s salary contributed to the plan, as well as on the

investment income earned on those contributions. Any payments the employee receives from the

plan are taxed as ordinary income at the time of distribution and also may be subject to a 10 percent

penalty for early withdrawal.

5. In 1997, the Taxpayer changed jobs and went to work for another employer.

6. As a result of his change in employment, the Taxpayer cashed out the money in his

401(k), which was distributed to him in 1997 while he was a resident of New Mexico.

7. In April 1998, the Taxpayer filed his 1997 federal income tax return, Form 1040. As

required by federal law, the income reported included the distribution the Taxpayer received from

his 401(k) plan. The federal government subsequently assessed the Taxpayer an additional 10

percent early withdrawal penalty on the distribution.

8. In April 1998, the Taxpayer filed a 1997 New Mexico income tax return, Form PIT-

A. As reflected on the PIT-A, New Mexico taxable income is calculated by starting with the taxpayer's

federal adjusted gross income and then deducting the taxpayer's federal personal exemptions and

itemized deductions.

9. Line 6 of the PIT-A instructs taxpayers to report the federal adjusted gross income

shown on Line 32 of their federal Form 1040.

10. The federal adjusted gross income on Line 32 of the Taxpayer’s 1997 Form 1040 was

$84,046.85; the federal adjusted gross income the Taxpayer reported on Line 6 of his New Mexico

PIT-A was only $49,186.00.

11. The Taxpayer reduced his federal adjusted gross income when filling out his PIT-A

because he did not believe he should have to pay New Mexico income tax on the portion of his

401(k) distribution attributable to contributions made during the period when the Taxpayer lived and

worked in Texas and Oklahoma.

12. Texas does not impose a state income tax. Although Oklahoma does impose a state

income tax, the Taxpayer did not file a 1997 Oklahoma income tax return to report that portion of his

401(k) distribution attributable to contributions made when he worked in Oklahoma.

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13. In 2000, the Department conducted a tape-match which compared the adjusted gross

income reported on the Taxpayer’s federal income tax return to the adjusted gross income reported

on his New Mexico income tax return.

14. Based on the discrepancy between these amounts, the Department issued Assessment

No. 614060 to the Taxpayer on July 17, 2000 assessing him an additional $2,546.00 personal income

tax, $254.60 penalty and $859.27 interest for tax year 1997.

15. On August 15, 2000, the Taxpayer filed a protest to the Department’s assessment.

DISCUSSION

The primary issued to be addressed is whether the Taxpayer is liable for New Mexico

income tax on a 401(k) distribution the Taxpayer received while he was a resident of New Mexico,

but which was attributable to contributions made during a period when the Taxpayer lived and

worked in another state. If it is determined that New Mexico has the right to tax the entire amount of

the Taxpayer’s 401(k) distribution, a secondary issue is whether the Taxpayer is liable for interest

and penalty on the tax due.

Taxation of Retirement Income. The Taxpayer maintains that only the state where a

person resides when he earns the income contributed to a 401(k) plan has the right to tax

distributions attributable to those contributions. It is the Department’s position that the state where a

person resides at the time he receives a 401(k) distribution has the right to tax the total amount of the

distribution, without regard to the source of the contributions made to the plan.

Payment of New Mexico personal income taxes is governed by the Income Tax Act, Sections

7-2-1, et seq., NMSA 1978. New Mexico is among the majority of states that "piggy-back" or use the

federal income tax system as the basis for calculating state income taxes. New Mexico taxable income

is calculated by starting with the taxpayer's federal adjusted gross income, deducting the taxpayer's

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federal personal exemption and itemized deductions, and certain additional adjustments reflected on

Schedule A to the PIT-1. The amount of tax is then drawn from the tax rate table or tax schedule.

When a taxpayer has income that is taxable both within and without New Mexico, Section 7-2-

11 NMSA 1978 allows the taxpayer to file a Form PIT-B to allocate and apportion certain categories

of income between New Mexico and non-New Mexico sources. The percentage of total income

allocated or apportioned to New Mexico is then applied to the tax previously calculated to determine

the tax due. Even when a PIT-B is filed, however, there are some categories of income that must be

allocated 100 percent to New Mexico, regardless of the source of the income. With regard to

retirement income, Department Regulation 3.3.11.13(B) NMAC to Section 7-2-11 NMSA 1978

states as follows:

B. Retirement income of a resident is allocable to New Mexico, regardless of
the source of the retirement income, where it is paid from or whether the
resident was a resident of New Mexico at the time of the employment which
gave rise to the income....

The Department’s regulation is based on federal law 4 U.S.C. § 114, which specifically prohibits a

state from imposing income tax on the retirement income of an individual who is not a resident or

domiciliary of that state. The statute was enacted in 1995 and applies to all payments received from

qualified pension plans as defined in § 401(a) of the Internal Revenue Code, which includes plans

established under § 401(k) of the Code.

Although Regulation 3.3.11.13(B) NMAC was not adopted by the Department until

December 1999, the Department’s 1997 personal income tax instructions notified taxpayers of the

provisions of 4 U.S.C. § 114 (1996). See, page 12 of 1997 Form PIT-1 instructions and pages 2B-3B

of instructions for Form PIT B. The instructions for allocating and apportioning income on Form

PIT-B specifically directs full-year New Mexico residents that the total amount of pension and

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retirement income reported on the resident’s federal income tax return must be allocated to New

Mexico. The instructions also contain the following note (pages 2B-3B):

NOTE: Effective for retirement income received after December 31, 1995,
federal law prohibits any state from imposing an income tax on certain
retirement income (primary pension income) of an individual, unless that
person is a resident of or domiciled in that state imposing the tax. For
example, if you receive a pension from your former California employer, but
you have established your domicile in New Mexico, California is barred from
attempting to impose their income tax on that retirement income.

Given the clear mandate of 4 U.S.C. § 114 (1996), and the provisions of New Mexico law as

reflected in its tax regulations and instructions, there is no basis for the Taxpayer to argue that

taxation of his 401(k) distribution is determined by his state of residence at the time contributions

were made to the plan. Only New Mexico, the state where the taxpayer resided at the time he

received distributions from his 401(k) plan, has jurisdiction to tax that income.

The right of a state to impose income tax on all income received by its residents, including

income attributable to activities in other states, is one of long-standing. More than 70 years ago, the

United States Supreme Court recognized the rights of the several states “to exercise the widest

liberty with respect to the imposition of internal taxes” noting that “states have full power to tax their

own people....” Shaffer v. Carter, 252 U.S. 37, 51 (1919). In Lawrence v. State Tax Commission of

Mississippi, 286 U.S. 276 (1932), the Court confirmed that this power includes the right to tax

residents on income earned outside the state, holding that Mississippi had the right to tax a

Mississippi resident on income earned from services performed on a construction project in the state

of Tennessee. As stated by the Court:

The obligation of one domiciled within a state to pay taxes there, arises from
the unilateral action of the state government in the exercise of the most
plenary of sovereign powers, that to raise revenue to defray the expenses of
government and to distribute its burdens equably among those who enjoy its
benefits. Hence, domicile in itself establishes a basis for taxation.

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286 U.S. at 279. In this case, the Taxpayer was a resident of New Mexico when he received the

1997 distribution from his 401(k) plan, and New Mexico has the right to impose its income tax on

the total amount of those distributions.

Assessment of Interest and Penalty. The Taxpayer maintains that even if tax is due on his

401(k) distribution, he should not be liable for interest and penalty because the Department took

more than two years to notify him of the deficiency. The Taxpayer’s argument is based on a

misunderstanding of New Mexico’s self-reporting tax system. It is the obligation of taxpayers, who

have the most accurate and direct knowledge of their activities, to determine their liability for tax and

accurately report that liability to the state. See, Section 7-1-13(B), NMSA 1978. There are insufficient

government resources available for the Department to continually audit every citizen to determine

whether he or she has fully complied with state tax laws. Although the Department performs periodic

"tape matches" that compare information reported to the IRS with information reported to New

Mexico, there is some delay before the federal tape match information is made available to the

Department. Under the Tax Administration Act, the Department has three years from the end of the

calendar year in which a tax is due to issue an assessment. Section 7-1-18(A) NMSA 1978. The

July 2000 assessment issued to the Taxpayer was well within the statutory limitations period

provided by the New Mexico Legislature.

Interest. Section 7-1-67 NMSA 1978 (1996) governs the imposition of interest during the

period at issue and states, in pertinent part:

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).

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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

revenues. The reason for a late payment of tax is irrelevant to the imposition of interest. Even

taxpayers who obtain a formal extension of time to pay tax are liable for interest from the original

due date of the tax to the date payment is made. Section 7-1-13(E) NMSA 1978.

Penalty. Section 7-1-69 NMSA 1978 (1996) 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:

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 3.1.11.10 NMAC 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, the Taxpayer’s failure to properly calculate his 1997 New Mexico income tax was due to

his lack of knowledge of New Mexico law and his erroneous belief that the portion of his 401(k)

distribution attributable to income earned in other states was only taxable by those states. The

Taxpayer’s underpayment of tax also was attributable to his failure to follow the plain language of

the Department's income tax forms. Line 6 of Form PIT-A instructs taxpayers to report the federal

adjusted gross income shown on Line 32 of their federal Form 1040. Although the federal adjusted

gross income on Line 32 of the Taxpayer’s 1997 Form 1040 was $84,046.85, he reported only

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$49,186.00 of this amount to New Mexico. If the Taxpayer did not agree with the instructions on the

PIT-A, he should have contacted the Department for clarification or sought the advice of a qualified

tax advisor. The Taxpayer’s decision to simply ignore the instructions and devise his own method of

calculating his New Mexico income tax clearly justifies imposition of the negligence penalty.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely written protest to Department Assessment 614060, and

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

2. New Mexico has the right to require the Taxpayer to pay New Mexico income tax on

the total amount of 401(k) distributions he receives while a resident of New Mexico, even when a

portion of that income is attributable to contributions made to the 401(k) plan while the Taxpayer was a

resident of another state.

3. Pursuant to Section 7-1-67 NMSA 1978, interest was properly assessed against the

Taxpayer on the underpayment of his 1997 state income taxes.

4. Pursuant to Section 7-1-69 NMSA 1978, the Taxpayer was negligent in underreporting

his 1997 state income taxes and penalty was properly imposed.

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

DATED July 18, 2001.

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