Is a corporate officer who controls wage payments personally liable for withholding tax the company deducted but never remitted, and does the seven-year audit period reach him individually?

Plain-English summary

A corporate officer who controlled which bills the company paid was personally liable for the withholding taxes it deducted from employees but never remitted, and the seven-year audit period reached him — though the Department's estimate for three years was reduced to the amounts shown in the company's actual records. Protest GRANTED IN PART and DENIED IN PART.

Dean/Krueger & Associates (DKA), an architecture firm, stopped reporting and paying its New Mexico combined-reporting (CRS) taxes — including withholding deducted from its employees' wages — starting in 1991. Eugene Baker was DKA's vice-president, treasurer, and secretary; he ran the firm's day-to-day operations, had signature authority on its accounts, signed its tax returns and checks, and decided which bills to pay. He used the withheld amounts to pay other creditors he considered more urgent, intending to catch up on the taxes once business improved. It never did. After a 1999 field audit, the Department assessed DKA and issued a separate "personal audit assessment" to Baker for the withholding portion. It later abated the 1992 year (it could not prove that assessment was mailed within the limitations period), leaving about $55,028 of withholding tax for January 1993 through April 1999 in dispute.

Baker was personally liable as a "withholder"

Under Section 7-3-5, "every withholder" is liable for the amounts required to be withheld, whether or not they were actually withheld. A "withholder" includes an "employer," which Section 7-3-2(C) defines to include an officer or agent "having control of the payment of wages." Baker admitted he was the officer primarily responsible for operations, could sign returns and checks, and consciously chose to divert the withheld money to other creditors. That made him personally liable for DKA's unpaid withholding tax.

The assessment was valid despite sharing a number

Baker argued the assessment was invalid because it reused DKA's assessment numbers instead of carrying a unique number the Department's computer could track. The hearing officer disagreed: Section 7-1-17(B)(2) makes an assessment effective when a "notice of assessment" stating the tax and demanding payment is mailed to the taxpayer, and nothing in the Tax Administration Act requires unique numbers. Numbering is for the Department's convenience; assigning the same number to multiple parties jointly and severally liable for the same tax actually prevents double collection. The limits of the Department's computer system do not control the legal validity of an assessment.

The seven-year period applies to the tax, not just the original filer

Baker argued the three-year limit in Section 7-1-18(A) applied to him because he was not the "taxpayer" required to file the CRS returns. The hearing officer rejected this reading. Section 7-1-18(C) gives the Department seven years to assess "the tax" for any period in which a required return was not filed — the period runs against the tax, so any person liable for that tax can be assessed within it. And Baker was a "taxpayer": Section 7-1-3(W) defines that term to include a person responsible for withholding and payment of tax, not just someone who has already been assessed. The seven-year period properly reached him.

The Department's estimate gave way to actual records

For years without records, the Department had estimated withholding at $8,688.69 per year (the average of 1997–1998). At the hearing, Baker produced the CPA's payroll records showing the actual withholding for 1994 ($4,647.79), 1995 ($7,287.25), and 1996 ($9,719.10). The Department objected that this was a "last-minute surprise," but the hearing officer found that unpersuasive — Baker's protest had challenged the "erroneous calculation" for eighteen months, and the Department had ample time to conduct discovery. Those records overcame the presumption of correctness for 1994–1996, and the assessment for those years was ordered adjusted to the actual figures. Baker offered no records for 1992, 1993, or 1999, so the estimate stood for those.

Result: protest GRANTED IN PART (1994–1996 estimate reduced to actual amounts) and DENIED IN PART (personal liability, valid assessment, and the seven-year period all upheld).

What this means for you

Withholding is "trust fund" money — diverting it makes you personally liable

Amounts withheld from employee paychecks belong to the state, not the business. A corporate officer who controls the company's payments and uses withholding to cover other bills becomes personally liable for the unpaid tax under Section 7-3-5, no matter how good the reason for the diversion seemed.

"Control of the payment of wages" is what triggers officer liability

You do not have to be the majority owner or the president. If you run operations, sign the checks and returns, and decide which creditors get paid, you are a "withholder" who can be assessed individually.

Not filing returns opens a seven-year window that reaches responsible people

When a business fails to file, the Department has seven years — not three — to assess the tax, and that longer window applies to every person liable for it, including responsible officers assessed years later.

Bring your records to the hearing — good documentation can cut an estimate

When the Department has to estimate tax because records were missing, producing the actual payroll or accounting records can overcome the estimate. Here, the CPA's records reduced three years of the assessment. Raise the calculation issue early in your protest so the Department cannot credibly claim surprise.

Common questions

Q: What tax was at issue?
A: New Mexico withholding tax that DKA deducted from employees' wages but never remitted, assessed against Baker personally. About $55,028 of withholding tax (plus penalty and interest) for January 1993 through April 1999 remained in dispute after the 1992 year was abated.

Q: Why was Baker personally liable when the tax was the company's?
A: Section 7-3-5 makes "every withholder" liable, and Section 7-3-2(C) defines a withholder/employer to include an officer with control of the payment of wages. Baker controlled DKA's payments and chose to divert the withholding, so he was personally liable.

Q: Didn't the assessment need a unique number to be valid?
A: No. Under Section 7-1-17(B)(2) an assessment is effective when the notice is mailed to the taxpayer stating the tax and demanding payment. Nothing requires a unique number; the Department may tie one number to a single tax liability owed by several parties.

Q: Why did the seven-year period apply to him?
A: Section 7-1-18(C) gives the Department seven years to assess "the tax" for unfiled periods. The period runs against the tax, and any person liable for it — including a responsible officer — can be assessed within it.

Q: How did Baker win part of the case?
A: He produced the company's actual payroll records at the hearing, which showed lower withholding than the Department's estimate for 1994, 1995, and 1996. Those records overcame the presumption of correctness, and the assessment for those years was reduced.

Citations and references

Statutes:

• NMSA 1978, § 7-3-5 — every withholder is liable for amounts required to be deducted and withheld, whether or not actually withheld
• NMSA 1978, § 7-3-2(C) — "employer" (a withholder) includes an officer, agent, or employee having control of the payment of wages
• NMSA 1978, § 7-3-2(N) — "withholder" includes an employer
• NMSA 1978, § 7-1-17(B)(2) — an assessment is effective when a notice of assessment is mailed or delivered to the taxpayer
• NMSA 1978, § 7-1-18(A) — general three-year assessment period
• NMSA 1978, § 7-1-18(C) — seven-year assessment period where a required return was not filed
• NMSA 1978, § 7-1-3(W) — "taxpayer" includes a person responsible for withholding and payment, or collection and payment, of any tax

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Eugene K. Baker
• Decision PDF: D&O 01-30

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
EUGENE K. BAKER No. 01-30
ASSESSMENT NOS. 2462271 and 2490193

DECISION AND ORDER

A formal hearing on the above-referenced protest was held August 28, 2001, before Margaret

B. Alcock, Hearing Officer. Eugene K. Baker was represented by Wayne G. Chew, Esq. The

Taxation and Revenue Department ("Department") was represented by Bruce J. Fort, Special Assistant

Attorney General. At the end of the hearing, the parties agreed to submit closing argument in the form

of written briefs. The briefing scheduled ended October 19, 2001, at which time the matter was

submitted for decision. Based on the evidence and arguments presented, IT IS DECIDED AND

ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. From January 1992 through April 1999, the audit period at issue in this case,

Dean/Krueger & Associates, Inc. (“DKA”) was engaged in the business of providing architectural

services in New Mexico.

2. DKA was registered with the Department under taxpayer identification number 01-

775004-00-0 for payment of gross receipts, compensating and withholding taxes, which are required

to be paid monthly under the Department’s combined reporting system (“CRS”).

3. During the audit period, Hal M. Dean and Eugene K. Baker were the sole

shareholders and officers of DKA: Mr. Dean, who owned over 50 percent of DKA’s stock, served as

president; Mr. Baker served as vice-president, treasurer and secretary.

4. Mr. Dean and Mr. Baker were the only persons who had signature authority on

DKA’s bank accounts.

5. Mr. Baker was primarily responsible for the day-to-day business operations of DKA

and routinely signed DKA’s tax returns and checks, although Mr. Dean signed such documents on

occasion.

6. During the 1990s, DKA had cash flow problems resulting from the cyclical nature of

the firm’s business.

7. At times, DKA had to reduce the number of employees working for the firm and both

Mr. Baker and Mr. Dean contributed their own funds to keep the business going.

8. Mr. Baker was the person who decided which of DKA’s bills would be paid first,

although he usually made these decisions in consultation with Mr. Dean.

9. Beginning in 1991, Mr. Baker stopped reporting and paying New Mexico CRS taxes,

including withholding taxes that had been deducted from the wages of DKA’s employees.

10. Mr. Baker used the amounts deducted as withholding taxes from employee

paychecks to cover other bills that Mr. Baker considered to be more urgent.

11. Although Mr. Baker planned to pay the delinquent CRS taxes once DKA’s business

improved, the business never generated enough cash to cover all of DKA’s liabilities, and the CRS

taxes due for the period 1991 forward were never paid.

12. In July 1999, the Department began a field audit of DKA.

13. Because DKA had not filed CRS returns since 1991, the Department extended the

audit period back to January 1992 pursuant to the seven-year limitation period set out in Subsection

C of Section 7-1-18 NMSA 1978.

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14. The only withholding tax records DKA provided to the auditors were for the 1997

and 1998 tax years. For the 1992-1996 and 1999 tax years, the Department estimated the

withholding taxes at $8,688.69 per year, based on the average of the taxes due for 1997 and 1998.

15. At the hearing on his protest, Mr. Baker introduced additional records that were in

the possession of Charles W. Orr, DKA’s certified public accountant. These records, along with the

records provided during the audit, established that the withholding taxes deducted from employee

paychecks during each of the years 1994 through 1998 were as follows:

1994: $4,647.79
1995 $7,287.25
1996: $9,719.10
1997: $9,836.41
1998: $7,765.94

Mr. Baker did not provide any evidence concerning withholding taxes due for tax years 1992, 1993

or 1999.

16. Following the audit, the Department’s computer system generated Assessment No.

2462271 to DKA in the total amount of $144,990.51, representing CRS taxes, penalty and interest

due for the period January through December 1992. At the hearing, the Department was unable to

present evidence to establish whether—or when—Assessment No. 2462271 was mailed to DKA.

17. On February 18, 2000, the Department mailed Assessment No. 2490193 to DKA in

the total amount of $414,934.39, representing CRS taxes, penalty and interest for tax periods January

1993 through April 1999.

18. On February 18, 2000, the Department mailed an assessment to Eugene K. Baker in

the total amount of $112,043.62, representing the withholding tax portion (including related penalty

and interest) of Assessment Nos. 2462271 and 2490193.

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19. The assessment issued to Mr. Baker was not assigned a new number, but reflected the

same numbers previously used in the assessments issued to DKA. The assessment issued to Mr.

Baker referenced both his social security number and DKA’s taxpayer identification number and

included the following explanation: “Personal Audit Assessment: Withholding Tax Portion of

Assessment Numbers 2462271 and 2490193 for Dean\Kruger and Associates.”

20. The Department’s computer system is programmed in such a way that assessment

numbers can be assigned to only one taxpayer. In order to issue an assessment to a taxpayer using a

number already assigned to another taxpayer, the Department must generate the assessment manually

and that assessment will not be reflected in the Department’s computer system.

21. On February 28, 2000, Mr. Baker filed a written protest to the personal audit

assessment issued against him.

22. During the August 28, 2001 hearing, the Department acknowledged that it could not

determine whether Assessment No. 2462271 had been issued to DKA or Mr. Baker within the seven-

year statute of limitations for assessing nonfiled periods. Based on the absence of such evidence, the

Department stated that it would abate the 1992 portion of withholding tax, penalty and interest

assessed against Mr. Baker.

23. The amount remaining in dispute is the $55,028.36 of withholding tax (plus penalty

and accrued interest) assessed against Mr. Baker for tax periods January 1993 through April 1999.

DISCUSSION

The issue to be decided is whether Eugene K. Baker is personally liable for withholding

taxes that were deducted from the wages of DKA’s employees during the period January 1993

through April 1999 but were never reported or paid to the Department. Mr. Baker raises the

following arguments in support of his protest: (1) the manual assessment issued to him on February

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18, 2000 was not a valid assessment because it did not have a unique assessment number that could

be identified by the Department’s computer; (2) Section 7-1-18 limits the period for which he can be

assessed to three years because he did not have the initial duty to file withholding tax returns and

only became a “taxpayer” after he was assessed by the Department; and (3) the Department’s

estimate of withholding tax due should be adjusted to reflect the actual withholding tax shown on

business records introduced at the hearing.

Liability for Withholding Tax. Before addressing the specific issues raised by Mr. Baker, a

brief overview of New Mexico’s withholding tax statutes will be useful. Payment of withholding

taxes is governed by the Withholding Tax Act, Sections 7-3-1, et seq., NMSA 1978. Section 7-3-5 is

the specific statute relied upon by the Department to hold Mr. Baker liable for DKA’s unpaid

withholding taxes. During the period at issue, that section read as follows:

Every withholder shall be liable for amounts required to be deducted and
withheld by the Withholding Tax Act regardless of whether or not the amounts
were in fact deducted and withheld, except that:

A. if the withholder fails to deduct and withhold the required amounts
and if the tax against which the required amounts would have been credited is
paid, the withholder shall not be liable for those amounts not deducted and
withheld; or

B. if the withholder’s failure to deduct and withhold the required
amounts was due to reasonable cause, the withholder shall not be liable for
amounts not deducted and withheld.

Section 7-3-5 imposes liability for withholding taxes on "every withholder". A "withholder" is

defined in Section 7-3-2(N) to include an “employer”, which is defined in Section 7-3-2(C) as

follows:

C. "employer" means a person, or an officer, agent or employee of that
person having control of the payment of wages, doing business in or deriving
income from sources within the state for whom an individual performs or
performed any service as the employee of that person except that if the person

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for whom the individual performs or performed the services does not have
control over the payment of the wages for such services, "employer" means the
person having control of the payment of wages.

Based on this statutory language, a corporate officer who has control of the payment of wages is

personally liable for payment of the corporation's withholding taxes. In this case, Mr. Baker

admitted that he was the corporate officer primarily responsible for DKA’s business operations, that

he had authority to sign tax returns and checks on behalf of DKA, and that he made a conscious

decision not to pay the amounts withheld from employee paychecks over to the state but to use the

money to pay other creditors of the corporation. Based on these facts, there is no question that Mr.

Baker is personally liable for the withholding taxes DKA failed to pay to the state. The only issue is

whether the Department's assessment against Mr. Baker met the statutory requirements set out in the

Tax Administration Act.

Use of the Same Assessment Number to Assess Different Taxpayers. The assessment the

Department issued to Mr. Baker in his individual capacity was not assigned a new number, but

reflected the same numbers previously used in the assessments issued to DKA. The assessment

issued to Mr. Baker referenced both his social security number and DKA’s taxpayer identification

number and included the following explanation: “Personal Audit Assessment: Withholding Tax

Portion of Assessment Numbers 2462271 and 2490193 for Dean\Kruger and Associates.” The

Department’s computer system is programmed in such a way that assessment numbers can be

assigned to only one taxpayer. In order to issue an assessment using a number already assigned to

another taxpayer, the Department must generate the assessment manually. Accordingly, the

assessment will not show up in the Department’s computer system. Based on these facts, Mr. Baker

argues that the manual assessment issued to him in February 2000 was not a valid assessment

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because it did not have a unique assessment number that could be identified by the Department’s

computer.

Section 7-1-17(B)(2) NMSA 1978 provides that assessments of tax are effective:

when a document denominated “notice of assessment of taxes”, issued in the
name of the secretary, is mailed or delivered in person to the taxpayer against
whom the liability for tax is asserted, stating the nature and amount of the
taxes assertedly owed by the taxpayer to the state, demanding of the taxpayer
the immediate payment of the taxes and briefly informing the taxpayer of the
remedies available to the taxpayer;

The assessment mailed to Mr. Baker in February 2000 meets these statutory requirements. There is

nothing in Section 7-1-17—or any other section of the Tax Administration Act—that requires the

Department to assign numbers to the assessments it issues. The numbering of assessments is done

purely for the Department’s convenience. While an assessment number is usually identified to a

specific taxpayer, nothing prohibits the Department from identifying an assessment number to a

specific tax liability instead.

Mike Giles, an auditor in the Department’s protest office, explained that the same assessment

number is used to assess different taxpayers in situations where more than one taxpayer is liable for

the same tax. Assigning one assessment number to taxpayers who are jointly and severally liable for

the same tax liability insures that all payments received are credited to that liability and prevents the

possibility of collecting the tax more than once. The fact that the Department’s computer system is

programmed in such a way that assessments to additional taxpayers must be manually created off-

line is completely irrelevant. The validity of an assessment is determined by statute, not by the

constraints of the Department’s computer system. In this case, the February 2000 assessment issued

to Mr. Baker met all the requirements of Section 7-1-17 NMSA 1978 and was a valid assessment.

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Limitation Periods for Issuing Assessments. Mr. Baker argues that Subsection A of

Section 7-1-18 NMSA 1978 limits the period within which the Department could issue an

assessment to him in his individual capacity to three years from the end of the calendar year in which

DKA’s withholding taxes were due. The Department contends that the seven-year period provided

in Subsection C of Section 7-1-18 NMSA 1978 is applicable to Mr. Baker and to all persons who

qualify as “withholders” under the Withholding Tax Act. The pertinent portions of Section 7-1-18

read as follows:

A. Except as otherwise provided in this section, no assessment of tax
may be made by the department after three years from the end of the calendar
year in which payment of the tax was due, ....
B. ...
C. In case of failure by a taxpayer to complete and file any required
return, the tax relating to the period for which the return was required may be
assessed at any time within seven years from the end of the calendar year in
which the tax was due, ....

There is no dispute that DKA failed to file CRS returns from 1991 through 1999 and that the

Department had seven years from the end of the calendar year in which taxes for that period were

due to issue an assessment to DKA. Mr. Baker maintains that the seven-year limitation period in

Subsection C does not apply to him in his individual capacity because he was not a “taxpayer”

required to file CRS returns and did not become a taxpayer until after he was assessed by the

Department.

Mr. Baker’s reading of the statute is too narrow. Section 7-1-18(C) gives the Department

seven years to assess “the tax” relating to any period for which required returns were not filed. The

seven-year limitation period applies to the assessment of tax, not to the assessment of a particular

taxpayer. Any taxpayer liable for tax relating to a nonfiled period may be assessed within seven

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years from the end of the calendar year in which the tax was originally due. Section 7-1-3(W)

NMSA 1978 defines a “taxpayer” as:

a person liable for payment of any tax, a person responsible for withholding
and payment or for collection and payment of any tax or a person to whom an
assessment has been made, if the assessment remains unabated or the amount
thereof has not been paid.

Mr. Baker focuses on the last part of Subsection W, which defines a taxpayer to mean a person to

whom an assessment of tax has been made. He ignores the preceding language which defines a

taxpayer to include “a person responsible for withholding and payment or for collection and payment

of any tax.” Mr. Baker also confuses the meaning of “delinquent taxpayer” in Section 7-1-16 NMSA

1978 with the meaning of “taxpayer” in Section 7-1-3(W) NMSA 1978. Whether a taxpayer is

“delinquent” is relevant only in the context of collection actions. At the present time, Mr. Baker is

not a delinquent taxpayer and cannot become one until after this protest is finally resolved. This has

no bearing, however, on whether he qualified as a “taxpayer” liable for payment of DKA’s

withholding taxes during the nonfiled periods at issue. Pursuant to Sections 7-1-3(W) and 7-3-5

NMSA 1978, Mr. Baker was a taxpayer personally liable for payment of withholding tax deducted

from the paychecks of DKA’s employees but never reported or paid to the Department.

Accordingly, the Department correctly assessed Mr. Baker under the seven–year limitation period set

out in Section 7-1-18(C) NMSA 1978.

Tax Base Used to Assess Withholding Tax. During the audit of DKA, the only withholding

tax records provided to the Department’s auditors were for the 1997 and 1998 tax years. For the

1992-1996 and 1999 tax years, the Department estimated the withholding taxes at $8,688.69 per

year, based on the average of the taxes due for 1997 and 1998. At the August 28, 2001 hearing on

his protest, Mr. Baker introduced general ledger pages, payroll earnings statements and W-2s that

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had been in the possession of Charles W. Orr, DKA’s certified public accountant. Mr. Baker

testified that he had seen the documents before and that they were the type of documents Mr. Orr

maintained on behalf of DKA. The Department’s auditor testified that they were the type of business

records the auditors would have relied upon during the audit. These records, together with the

records produced during the audit, established that the following taxes were deducted from employee

paychecks during 1994 through 1998:

1994: $4,647.79
1995 $7,287.25
1996: $9,719.10
1997: $9,836.41
1998: $7,765.94

Mr. Baker did not provide any evidence concerning withholding taxes due for the years 1992, 1993

or 1999.

In its written closing, the Department objected to the admission of the additional records,

arguing that the “hearing officer should not adjust the amount found to be due by the Department

where the taxpayer was afforded every opportunity to submit its documents to verification prior to

the hearing. To rule otherwise would be to send a signal to the tax bar that last-minute surprises are

welcome and effective.” The Department’s claim of prejudicial surprise is unconvincing. Mr.

Baker’s February 28, 2000 protest letter clearly stated that he was challenging the “erroneous

calculation of the taxes due and assessed.” If the Department wished to determine the basis for Mr.

Baker’s challenge, it had eighteen months to conduct discovery and request production of documents

the taxpayer intended to introduce to dispute the correctness of the Department’s assessment. There

is no indication that the Department conducted any formal discovery prior to the date of the hearing.

That being the case, the Department is in no position to claim surprise or ask the hearing officer to

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prohibit the taxpayer from introducing additional evidence to support the issues raised in his protest.

CONCLUSIONS OF LAW

1. Eugene K. Baker filed a timely, written protest to Assessment No. 2490193, issued to

him in his individual capacity as a corporate officer of DKA on February 18, 2000, and jurisdiction lies

over the parties and the subject matter of this protest.

2. The February 2000 assessment issued to Mr. Baker met all the requirements of

Section 7-1-17 NMSA 1978 and was a valid assessment.

3. Mr. Baker was a taxpayer personally liable for payment of DKA’s withholding taxes

during periods when no returns were filed, and the Department correctly assessed Mr. Baker for

these taxes under the seven–year limitations period set out in Section 7-1-18(C) NMSA 1978.

4. The additional withholding tax records Mr. Baker introduced at the administrative

hearing were sufficient to overcome the presumption of correctness of the Department’s estimate of

taxes due for 1994, 1995 and 1996 and provide a reasonable basis for adjusting the Department’s

assessment for those years.

For the foregoing reasons, Mr. Baker’s protest IS GRANTED IN PART AND DENIED IN

PART. Mr. Baker’s protest is granted with respect to the Department’s estimate of tax for the 1994,

1995 and 1996 tax years, and the Department is ordered to adjust the assessment for those years to

reflect the amount of withholding tax shown on Taxpayer Exhibit A. With regard to all other issues,

Mr. Baker’s protest is denied.

DATED November 1, 2001.

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