Are multi-level marketing commissions taxable New Mexico gross receipts when they are measured by the phone charges of out-of-state customers but earned for sales services performed in New Mexico?

Plain-English summary

A New Mexico marketer's multi-level marketing commissions were taxable gross receipts to the extent his sales and recruiting services were performed in New Mexico — the fact that the commissions were measured by out-of-state customers' phone charges did not change that. Protest DENIED.

From 1994 through 1996, Wayne Gaede promoted long-distance telephone service for Excel Telecommunications through a multi-level marketing program. He made direct sales, recruited new sales representatives down seven levels, and earned monthly commissions calculated as small percentages of the long-distance charges paid by his own customers and by the customers of representatives he had recruited. He also earned recruiting bonuses and separate in-state training fees. In 2000, a limited-scope audit found that his 1996 gross receipts reported to New Mexico were less than the business income he had reported on his federal Schedule C, and the Department assessed gross receipts tax, penalty, and interest.

The commissions were receipts from in-state marketing services

Gaede conceded that his recruiting bonuses, commissions from his own New Mexico customers, and training fees ($2,005 total) were taxable. He disputed the commissions measured by the phone charges of customers signed up by his lower-level representatives, arguing those were nontaxable receipts from out-of-state sales because many of those customers lived outside New Mexico.

The hearing officer rejected the argument. Gaede was not in the business of providing long-distance telephone service — Excel was. He was providing marketing and recruiting services, and the customers' phone charges were simply the yardstick Excel used to measure his pay. Section 7-9-3(F)(1)(b) defines "gross receipts" to include commissions earned "from the business of buying, selling or promoting the purchase, sale or leasing, as an agent or broker on a commission or fee basis." His commissions fit that definition, and to the extent his sales and recruiting services were performed in New Mexico, the receipts were taxable — regardless of where the end customers happened to live.

The Department's in-state percentage was reasonable

Because some of Gaede's selling and recruiting was done outside New Mexico, the Department agreed a portion of his commissions was not taxable. It calculated the in-state share by comparing the number of representatives he recruited in New Mexico (1994–1996) to the total number he recruited, arriving at 76.4706% taxable. Gaede argued only 1996 recruits should count, but the hearing officer noted his 1996 commissions flowed in part from representatives recruited in earlier years, so counting all recruits was reasonable. Under Section 7-1-17(C), a Department assessment — including the audit method used — is presumed correct, and the taxpayer must come forward with evidence to overcome it (Tipperary, Archuleta, Torridge). Gaede offered no evidence contradicting the auditor, so the presumption stood.

Excel's tax payments did not help him

Gaede argued that Excel's payment of gross receipts tax on its phone-service receipts relieved him of tax on the commissions measured by those receipts. He produced no evidence that Excel actually paid such tax, or that it even would be liable — and a burden cannot be met with hypothetical facts. The point was moot in any event, because the two are separate transactions: Excel's sale of phone service and Gaede's sale of marketing services.

Result: protest DENIED. Gaede's in-state marketing commissions were subject to gross receipts tax.

What this means for you

Commissions are taxed where you do the work, not where the end customer lives

If you earn commissions for selling or promoting someone else's product, New Mexico taxes the receipts based on where you perform your sales and recruiting services. The location of the ultimate customers — or the fact that your pay is calculated from their purchases — does not convert in-state service income into an out-of-state sale.

Multi-level marketing income is taxable gross receipts

Commissions, overrides, and recruiting bonuses from a multi-level or network-marketing program are gross receipts from promoting sales as an agent under Section 7-9-3(F)(1)(b). Register and pay gross receipts tax on the portion attributable to services you perform in New Mexico.

A mismatch between your federal Schedule C and your CRS returns invites an audit

The Department found this assessment by comparing federal Schedule C business income to New Mexico gross receipts reporting. If the two do not reconcile, expect a limited-scope audit — report consistently.

You must have evidence to beat an assessment

A Department assessment and its audit methodology are presumed correct. Arguing that customers were "probably" out of state, or that someone else paid tax, is not enough — you need documentation. Without it, the presumption of correctness decides the case against you.

Common questions

Q: What tax was assessed?
A: New Mexico gross receipts tax on Gaede's 1996 multi-level marketing commissions. The Department originally assessed $771.66 tax, $77.16 penalty, and $424.42 interest, then abated $174.80 of tax (plus related penalty and interest), leaving $596.78 of tax principal in dispute.

Q: Why weren't the commissions "out-of-state sales"?
A: Because Gaede was selling marketing and recruiting services, not telephone service. The customers' long-distance charges were only a way to measure his compensation; the taxable transaction was his in-state sales service, taxable under Section 7-9-3(F)(1)(b).

Q: How did the Department decide how much was taxable?
A: It compared the sales representatives Gaede recruited in New Mexico to the total he recruited over 1994–1996, yielding 76.4706% attributable to in-state services. The hearing officer found that method reasonable.

Q: Did it matter that Excel may have paid gross receipts tax?
A: No. Gaede offered no proof Excel paid such tax or would even be liable, and in any event Excel's phone-service sales and Gaede's marketing-service sales are separate transactions, each potentially taxable.

Q: Why did Gaede lose even on the disputed portion?
A: A Department assessment is presumed correct under Section 7-1-17(C). Gaede presented no evidence to show where the end customers were located or that the audit method was wrong, so he failed to overcome the presumption.

Citations and references

Statutes:

• NMSA 1978, § 7-9-3(F)(1)(b) — "gross receipts" includes commissions or fees from the business of buying, selling, or promoting sales as an agent or broker
• NMSA 1978, § 7-1-17(C) — a Department assessment is presumed correct; the protesting taxpayer bears the burden of overcoming it

Cases cited:

• Tipperary Corp. v. New Mexico Bureau of Revenue, 93 N.M. 22, 595 P.2d 1212 (Ct. App. 1979)
• Archuleta v. O'Cheskey, 84 N.M. 428, 504 P.2d 638 (Ct. App. 1972)
• Torridge Corp. v. Commissioner of Revenue, 84 N.M. 610, 506 P.2d 354 (Ct. App. 1972), cert. denied, 84 N.M. 592, 506 P.2d 336 (1973)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Wayne Gaede
• Decision PDF: D&O 01-27

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
WAYNE A. GAEDE No. 01-27
ID NO. 02-308200-00 3
ASSESSMENT NO. 2540741

DECISION AND ORDER

A formal hearing on the above-referenced protest was held October 9, 2001, before Margaret

B. Alcock, Hearing Officer. Wayne A. Gaede (“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. From 1994 through 1996, the Taxpayer was engaged in marketing and promoting the

sale of long distance telephone services on behalf of Excel Telecommunications.

2. Pursuant to Excel’s multi-level marketing program, the Taxpayer engaged in two types

of activities: (1) making direct sales of Excel’s long distance telephone services to individual

customers; and (2) recruiting new sales representatives (referred to as 1st level representatives) who

signed up their own long distance customers and also recruited additional sales representatives

(referred to as 2nd level representatives).

3. For purposes of compensation, this process of direct sales and recruitment of new sales

representatives continued down seven levels, with the Taxpayer receiving the following monthly

commissions:

2% of long distance charges paid by the Taxpayer’s own customers;
1% of long distance charges paid by customers of the Taxpayer’s 1st level representatives;

0.25% of long distance charges paid by customers of the Taxpayer’s 2nd through 6th level
representatives; and

5% of long distance charges paid by customers of the Taxpayer’s 7th level representatives.

In addition, the Taxpayer received a cash bonus of $185.00 for each sales representative he recruited

and a smaller bonus for each sales representative recruited at subsequent levels.

4. Separate from his marketing activities for Excel, the Taxpayer conducted training

activities for which he received additional compensation. All of the Taxpayer’s training activities

took place within New Mexico.

5. During 1996, the Taxpayer was registered with the Department for payment of gross

receipts, compensating and withholding taxes, which are paid under the Department’s combined

reporting system (“CRS”).

6. In April 2000, the Department conducted a limited scope audit of the Taxpayer’s 1996

gross receipts tax reporting, during which it discovered a discrepancy between the business income

reported on Schedule C of the Taxpayer’s 1996 federal income tax return and the gross receipts

reported on the Taxpayer’s 1996 CRS returns.

7. On June 11, 2000, the Department issued Assessment No. 2540741 to the Taxpayer for

tax periods January-December 1996 in the amount of $771.66 gross receipts tax, $77.16 penalty and

$424.42 interest, representing tax on the discrepancy between his federal and state reporting.

8. On July 10, 2000, the Taxpayer filed a written protest to the Department’s assessment.

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9. In the course of correspondence and discussions with the Department’s protest office,

the Taxpayer conceded that the following unreported receipts were subject to New Mexico gross

receipts tax:

$ 925.00 Bonuses for recruiting 1st level sales representatives in New Mexico;
$ 240.00 Commissions from long-distance telephone calls made by the Taxpayer’s
New Mexico customers; and
$ 840.00 Compensation from performing training services in New Mexico.
$2,005.00

Based on this concession, the only issue remaining in dispute concerned the taxability of commissions

based on the long-distance telephone charges of customers of the Taxpayer’s 1st through 7th level

representatives. The Taxpayer maintained that most of the customers of lower level representatives

were located outside New Mexico and that commissions based on those customer’s long-distance

telephone charges were nontaxable receipts from out-of-state sales.

10. The Department disagreed with the Taxpayer’s argument, but did agree that some of

the Taxpayer’s commissions were attributable to sales services the Taxpayer performed outside New

Mexico. Based on documentation provided by the Taxpayer, the Department determined that 76.4706

percent of the disputed commissions were attributable to the Taxpayer’s in-state services and 23.5294

percent were attributable to services performed outside the state. The Department made this

determination by comparing the number of sales representatives the Taxpayer recruited in New

Mexico during 1994 through 1996 to the total number of representatives the Taxpayer recruited during

that period.

11. The Department subsequently abated $174.80 of the $771.66 of tax principal originally

assessed against the Taxpayer, plus related penalty and interest. The amount of tax principal

remaining in dispute is $596.78.

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DISCUSSION

This protest raises the following issues: (1) whether the Taxpayer is liable for gross receipts

tax on sales commissions based on long-distance telephone charges paid by customers of the

Taxpayer’s 1st through 7th level sales representatives; (2) whether the Department’s method of

calculating the percentage of commissions subject to gross receipts tax was reasonable; and (3)

whether Excel’s payment of gross receipts tax on its receipts from the sale of long-distance telephone

services relieved the Taxpayer from liability for gross receipts tax on commissions measured by those

receipts.

(1) Taxability of the Taxpayer’s Commissions. During the period at issue, Excel used a

multi-level marketing program to promote direct sales of its long-distance telephone services. Under

the program, Excel’s sales representatives engaged in two types of activities: making direct sales of

Excel’s long distance services to individual customers; and recruiting new sales representatives

(referred to as 1st level representatives) who signed up their own long distance customers and also

recruited additional sales representatives (referred to as 2nd level representatives). For compensation

purposes, this process of direct sales and recruitment continued down seven levels, with each

representative receiving the following monthly commissions: 2% of long distance charges paid by the

representative’s own customers; 1% of long distance charges paid by customers of 1st level

representatives; 0.25% of long distance charges paid by customers of 2nd through 6th level

representatives; and 5% of long distance charges paid by customers of 7th level representatives.

The issue presented in this case is whether the 1996 commissions the Taxpayer received under

Excel’s marketing program are subject to New Mexico gross receipts tax. The Taxpayer argues that

his commissions are nontaxable receipts from out-of-state sales because they were based on long-

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distance telephone charges incurred by Excel customers located outside New Mexico.1 The problem

with the Taxpayer’s argument is that the telephone charges were simply a means of calculating or

measuring the compensation he received. There is no contention that the Taxpayer was engaged in

providing long-distance telephone services to Excel or its customers. The Taxpayer was engaged in

providing marketing services to Excel, which included selling Excel’s telephone services directly to

new customers and promoting the further expansion of Excel’s customer base by recruiting additional

sales representatives.

Section 7-9-3(F)(1)(b) NMSA 1978 of the Gross Receipts and Compensating Tax Act defines

“gross receipts” to include:

(b) the total commissions or fees derived from the business of buying, selling or
promoting the purchase, sale or leasing, as an agent or broker on a commission or fee
basis, of any property, service, stock, bond or security;

The commissions the Taxpayer received from Excel come within this definition of gross receipts. To

the extent his sales and promotional services were performed in New Mexico, his receipts are subject

to gross receipts tax. The fact that part of the Taxpayer’s commissions were measured by the long-

distance charges paid by customers of his 1st through 7th level representatives—some of whom may

have been located outside New Mexico—does not change the underlying transaction from an in-state

sale of promotional services to an out-of-state sale of long-distance telephone services. The

commissions still represent compensation for sales services performed by the Taxpayer: if the

Taxpayer recruited effective sales people who generated a lot of new customers and sales

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At the October 9, 2001 hearing, the Taxpayer was unable to provide any evidence to show how many customers
recruited by his 1st through 7th level representatives were located outside New Mexico. The Taxpayer attempted to
remedy this lack of evidence with speculative arguments concerning the likely distribution of Excel customers
throughout the country. In light of the following discussion, which concludes that the Taxpayer’s commissions were
receipts from his individual marketing services and not receipts from providing long-distance service to Excel’s
customers, these arguments need not be addressed.

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representatives for Excel, the Taxpayer’s commissions increased; if the sales people the Taxpayer

recruited were not effective and failed to generate much new business, the Taxpayer’s commissions

decreased.

In summary, Excel’s multi-level marketing program created the potential for the Taxpayer to

receive a continuing stream of commissions based on the success of his own direct sales efforts and

his success in recruiting effective representatives to expand Excel’s marketing program. To the extent

the Taxpayer’s commissions were attributable to sales and recruitment services he performed in New

Mexico, they are subject to gross receipts tax.

(2) Method of Calculating Percentage of Taxable Receipts. Based on information

provided by the Taxpayer, the Department agreed that some of the Taxpayer’s sales and recruiting

services were performed outside New Mexico and that commissions attributable to those services

were not subject to New Mexico gross receipts tax. The Department determined the percentage of

taxable commissions attributable to in-state services by comparing the number of sales representatives

the Taxpayer recruited in New Mexico from 1994 through 1996 to the total number of representatives

the Taxpayer recruited during that period. This methodology resulted in 76.4706 percent of the

Taxpayer’s commissions being subject to gross receipts tax.

The Taxpayer argues that the Department should have included only those sales

representatives recruited during 1996 to calculate the percentage of 1996 commissions subject to tax

(this methodology would reduce the Taxpayer’s in-state percentage to 71.4286 percent). The

Taxpayer reasons that since only 1996 commissions are at issue, the Department should only consider

the Taxpayer’s 1996 recruiting activity in computing the portion of those commissions subject to tax.

What the Taxpayer’s argument overlooks is the fact that some of the commissions the Taxpayer

received during 1996 were attributable to the Taxpayer’s recruitment activities in earlier years. For

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example, a number of the Taxpayer’s November 1996 commissions were based on long-distance

telephone calls made by customers of Bryant & Associates, a sales representative the Taxpayer

recruited in 1994 (see, Exhibits 1 and 2). Given the residual nature of the Taxpayer’s commissions, it

was reasonable for the Department to calculate the New Mexico percentage of 1996 receipts based on

the total number of sales representatives whose recruitment could have generated commissions for the

Taxpayer during 1996.

The method used to calculate the New Mexico percentage was devised by the Department’s

protest auditor, who is a certified public accountant and has also taken courses in statistics. At the

hearing, the auditor gave his opinion that the method used to compute the Taxpayer’s 1996 gross receipts

taxes was reasonable given the limited information provided by the Taxpayer. Section 7-1-17(C)

NMSA 1978 states that any assessment of tax by the Department is presumed to be correct, and it is

the burden of the taxpayer protesting an assessment to overcome this presumption. Tipperary Corp. v.

New Mexico Bureau of Revenue, 93 N.M. 22, 24, 595 P.2d 1212, 1214 (Ct. App. 1979); Archuleta v.

O'Cheskey, 84 N.M. 428, 431, 504 P.2d 638, 641 (Ct. App. 1972). As illustrated by the court’s

decision in Torridge Corp. v. Commissioner of Revenue, 84 N.M. 610, 613, 506 P.2d 354, 357 (Ct. App.

1972), cert. denied, 84 N.M. 592, 506 P.2d 336 (1973) the presumption of correctness encompasses the

audit methods employed by the Department to determine the amount of tax assessed:

The "test months" method was used for the audit period.... There is evidence that
the test months method is acceptable practice. Although there is conflicting
evidence, the Commissioner could draw the inference from the evidence of the
auditor, that the gross receipts were the amount computed by use of the test months
and bank deposit methods. See Archuleta v. O'Cheskey, 84 N.M. 428, 504 P.2d
638 (Ct. App.), decided November 30, 1972. The Commissioner's decision, that the
taxpayers failed to establish the inaccuracy of the gross receipts ascertained by the
audit, is supported by evidence. Accordingly, the presumption of correctness of the
assessments for January 1, 1968 to March 31, 1971, has not been overcome.

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In this case, the Taxpayer failed to present any evidence to contradict the auditor’s testimony or to show

that the audit method used by the Department was unreasonable or invalid. Accordingly, the Taxpayer

has failed to overcome the presumption of correctness that attaches to the Department’s assessment.

(3) Excel’s Payment of Gross Receipts Tax. The Taxpayer argues that Excel’s payment

of gross receipts tax on its receipts from the sale of long-distance telephone services relieved the

Taxpayer from liability for gross receipts tax on commissions measured by those receipts. The

Taxpayer failed, however, to present any evidence that Excel paid gross receipts tax on the long-

distance telephone charges used to calculate the Taxpayer’s 1996 commissions. The Taxpayer failed

to establish that Excel would even be liable for gross receipts tax on these charges. As discussed

under Point (2), above, it is the Taxpayer’s burden to come forward with evidence to show that the

Department’s assessment is incorrect. This burden cannot be met by raising arguments based on

unproven or hypothetical facts. Accordingly, there is no need to address the Taxpayer’s arguments on

this issue.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to Assessment No. 2540741, and jurisdiction

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

2. To the extent the Taxpayer’s commissions from performing marketing services for

Excel were attributable to services the Taxpayer performed in New Mexico, they are subject to gross

receipts tax.

3. The Department’s method of calculating the percentage of commissions subject to

New Mexico gross receipts tax was reasonable.

4. The Taxpayer failed to overcome the presumption of correctness that attaches to the

Department’s assessment.

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

DATED October 29, 2001.

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