Could a mechanic treated as a 1099 contractor obtain the employee-wage gross receipts tax exemption by correcting only his New Mexico return after the IRS amendment period had expired?

Plain-English summary

Douglas Leach was an employee rather than an independent contractor, so his mechanic wages qualified for the employee-wage exclusion from gross receipts tax. Although his employer issued Form 1099 and arranged for accountants to report the compensation on Schedule C, New Mexico could correct its own income-tax treatment even after the IRS refused a late federal amendment.

The Department was ordered to accept $86.17 of additional 1994 New Mexico income tax and interest. Once paid, it had to abate the $1,108.74 gross receipts tax assessment in full.

The working relationship showed employee status

Leach worked fixed hours at an auto repair business in Las Cruces, was paid every Friday, and performed all work on the employer's premises.

A supervisor assigned and approved his jobs. The employer supplied parts, equipment beyond basic hand tools, and a required uniform. Leach worked for no other employer during 1994.

Those facts led both the Department and hearing officer to conclude he performed services as an employee, regardless of the Form 1099 label.

The employer's accountants reported the wages incorrectly

Leach questioned why he received Form 1099 instead of Form W-2. His employer then arranged for an El Paso accounting firm to prepare his returns.

The firm reported $11,360 as Schedule C business income and claimed $1,785 of business deductions. Leach signed the return without understanding that New Mexico would also treat the Schedule C receipts as subject to gross receipts tax.

The Department assessed $1,108.74 of gross receipts tax, penalty, and interest, then later abated the penalty.

Consistent reporting prevented double treatment

New Mexico required consistent treatment across its tax laws. A taxpayer could not simultaneously claim Schedule C business deductions as an independent contractor and exclude the same compensation from gross receipts tax as employee wages.

Here, however, Leach had not consciously selected contractor treatment to obtain an unfair advantage. The deductions were about 15 percent of his modest income and reduced state income tax by only $39.

A federal amendment was not required for the state correction

The Department initially offered to cancel the gross receipts assessment if Leach amended his federal return to report wages. The IRS told him the federal amendment period had expired.

At the hearing, the Department acknowledged that no New Mexico statute prevented a voluntary amended 1994 state return. Applying Holt v. New Mexico Department of Taxation and Revenue, the decision found that New Mexico was not bound by an obvious federal-return misclassification contradicted by the evidence.

Leach could therefore correct the New Mexico income-tax result without a corresponding federal amendment.

Paying the state difference restored consistent treatment

The Department calculated $39 of additional New Mexico income tax and $47.17 of interest, totaling $86.17. Leach offered to pay it.

That payment removed the state benefit of the Schedule C deductions and allowed the same compensation to receive employee-wage treatment under Section 7-9-17.

Result: the Department was ordered to accept the $86.17 tender and, after receipt, abate Assessment No. 2232477 in its entirety.

What this means for you

Workers given Form 1099 despite employee-like conditions

Classification depends on the actual working relationship, including schedule, supervision, workplace, equipment, and exclusivity—not only the form issued.

Taxpayers with inconsistent state reporting

Correct all affected New Mexico taxes together. Claiming employee treatment may require giving up state income-tax benefits taken under contractor reporting.

People barred from amending an old federal return

A closed federal amendment period did not necessarily prevent New Mexico from correcting its own return when the evidence established the proper state treatment.

Employers arranging tax preparation for workers

Workers remain exposed when an employer-selected preparer uses the wrong classification. Review the return before signing and preserve facts about the work relationship.

Common questions

Q: Why was Leach an employee?
A: The employer controlled his hours and assignments, supplied the workplace and equipment, required a uniform, and was his only employer.

Q: How much was reported on Schedule C?
A: $11,360 of compensation with $1,785 of business deductions.

Q: Why did New Mexico require another payment?
A: The $86.17 state payment reversed the income-tax benefit of contractor reporting and restored consistent treatment.

Q: Did the IRS accept an amended federal return?
A: No. The IRS office told Leach it was too late for 1994.

Q: What happened to the gross receipts assessment?
A: The Department was ordered to abate the full $1,108.74 after accepting the $86.17 payment.

Citations and references

Statute:

• NMSA 1978, § 7-9-17 — employee wages excluded from gross receipts

Cases cited:

• Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d 420 (Ct. App. 1976)
• Co-Con, Inc. v. Bureau of Revenue, 87 N.M. 118, 529 P.2d 1239 (Ct. App. 1974)
• Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034, 133 N.M. 11, 59 P.2d 491

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Doug’s Mobile Service
• Decision PDF: D&O 03-08

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
DOUG’S MOBILE SERVICE No. 03-08
ID NO. 02-360754-00-8
ASSESSMENT NO. 2232477

DECISION AND ORDER

A formal hearing on the above-referenced protest was held May 13, 2003, before Margaret

B. Alcock, Hearing Officer. The Taxation and Revenue Department ("Department") was represented

by Javier Lopez, Special Assistant Attorney General. Doug’s Mobile Service was represented by

Douglas G. Leach (“Taxpayer”). Based on the evidence and arguments presented, IT IS DECIDED

AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. During 1994, the Taxpayer worked as a mechanic for an auto repair business in Las

Cruces, New Mexico.

2. The Taxpayer was required to work from 8:00 a.m. to 6:00 p.m. Monday through

Friday and from 8:00 a.m. to 5:00 p.m. every other Saturday.

3. The Taxpayer was paid every Friday.

4. All of the Taxpayer’s work was performed on the employer’s premises.

5. The Taxpayer received job assignments from a supervisor designated by the

employer. Any problems the Taxpayer encountered had to be reported to the supervisor.

6. The Taxpayer was not permitted to install parts or perform labor that had not been

approved by his supervisor.

7. With the exception of basic hand tools, the employer provided the Taxpayer with all

parts and equipment needed to perform his job assignments.

8. The employer provided the Taxpayer with a uniform that he was required to wear

while at work.

9. The Taxpayer did not perform work for any other employer during 1994.

10. At the end of the 1994 tax year, the employer gave the Taxpayer a federal Form 1099

reporting the wages he earned during the year as “nonemployee compensation.”

11. The Taxpayer did not understand why he received a Form 1099 instead of a Form W-

2 and told his employer that he did not know how his income should be reported.

12. The Taxpayer’s employer then arranged to have its accountants in El Paso, Texas,

prepare the Taxpayer’s federal and state income tax returns.

13. The 1994 federal income tax return prepared for the Taxpayer by the Texas

accounting firm reported the Taxpayer’s compensation as business income on Schedule C to federal

Form 1040 and listed business deductions in the total amount of $1,785.00.

14. The Taxpayer signed and filed the return prepared by his employer’s accountants.

15. The Taxpayer did not understand that income reported as business income for federal

income tax purposes is also subject to New Mexico gross receipts tax, and the Taxpayer did not

report or pay gross receipts tax on this income.

16. On March 13, 1998, the Department issued Assessment No. 2232477 to the Taxpayer

in the total amount of $1,108.74, representing gross receipts tax, penalty and interest due on the

business income reported on the Taxpayers 1994 federal income tax return.

17. April 2, 1998, the Taxpayer filed a written protest to the Department’s assessment.

18. The Department subsequently abated the penalty.

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19. The Department also determined that, except for the method used to report the

Taxpayer’s 1994 compensation for federal and state income tax purposes, the facts indicated that the

Taxpayer had performed services during 1994 as an employee and not as an independent contractor.

20. On May 2, 2001, the Department wrote the Taxpayer a letter stating that it would

cancel the assessment of gross receipts tax if the Taxpayer filed an amended federal income tax

return to report his 1994 compensation as wages, rather than as business income. The letter

explained that this would increase the Taxpayer’s federal adjusted gross income by $1,785.00, the

amount claimed as business deductions on Schedule C to the Taxpayer’s 1994 Form 1040.

21. The Taxpayer went to his local IRS office to obtain the forms needed to amend his

1994 federal return, but was told it was too late to file an amended return for 1994.

22. In the absence of an amended federal return, the Department refused to abate the

gross receipts tax assessment.

23. At the administrative hearing held May 13, 2002, the Department’s attorney

acknowledged that New Mexico does not have any statute that would prohibit the Taxpayer from

voluntarily filing an amended 1994 New Mexico income tax return to report his compensation as

wages and pay additional tax due.

24. At the Hearing Officer’s request, the Department’s auditor determined that as of May

13, 2003, the additional income tax the Taxpayer would owe New Mexico on such an amended

return would be $39.00, plus interest of $47.17, for a total of $86.17.

25. The Taxpayer then offered to pay the $86.17 that would be due if an amended 1994

New Mexico personal income tax return were filed and accepted by the Department.

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DISCUSSION

The Department concedes that all of the facts presented in this case support the conclusion that

the Taxpayer worked as an employee during 1994 and not as an independent contractor. Accordingly,

the Taxpayer should be entitled to claim the exemption from gross receipts tax provided for employee

wages in NMSA 1978, § 7-9-17. The Department’s only basis for refusing to abate its gross receipts

tax assessment is the Taxpayer’s failure to amend his 1994 federal income tax return to correctly report

those wages and pay additional tax due on the $1,785.00 of deductions taken on Schedule C to his 1994

Form 1040. The Department’s May 2, 2001 letter expressly states that if the Taxpayer amended his

federal return, the assessment would be cancelled.

It is true that New Mexico law requires taxpayers to treat transactions uniformly for all

purposes within the tax laws. See, Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d

420 (Ct. App. 1976), cert. denied, 90 N.M. 254, 561 P.2d 1347 (1977). See also, Co-Con, Inc., v.

Bureau of Revenue, 87 N.M. 118, 529 P.2d 1239 (Ct. App., 1974), cert. denied, 87 N.M. 111, 529

P.2d 1232 (1974). In the context of the gross receipts tax, the purpose behind this rule is to prevent a

taxpayer from “double-dipping” by simultaneously claiming to be an independent contractor entitled

to offset his income with business deductions on his federal income tax return and an employee

exempt from tax on his New Mexico gross receipts tax returns.

Under the facts of this case, the Department’s rigid adherence to the rule of consistent

reporting fails to take the policy behind that rule into account. From the testimony presented at the

administrative hearing, it is clear that the Taxpayer had no understanding of the tax laws and made

no conscious election to file as an independent contractor in order to claim undeserved business

deductions. The deductions themselves were minimal, representing only 15 percent of the

Taxpayer’s relatively modest income of $11,360. When the Department’s auditor calculated the

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effect of the deductions claimed, he determined that the Taxpayer’s incorrect reporting netted him a

“windfall” of only $39.00. Although the federal time limit to amend the Taxpayer’s 1994 federal

income tax return had passed, the Taxpayer offered to amend his 1994 New Mexico income tax

return to repay the additional $39.00 due to the state, with interest.

The Department apparently believes that the Taxpayer’s New Mexico income tax return

cannot be adjusted without a corresponding adjustment to his federal return. This is incorrect. In

Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034, ¶ 24, 133 N.M. 11, 59

P.2d 491, the New Mexico Supreme Court recognized the Department’s authority to recalculate New

Mexico income tax owed by taxpayers who failed to report their wages as taxable income, even

though no change had been made to the taxpayers’ federal return, stating: “It would be untenable for

this Court to hold that the Department is bound by a taxpayer's obvious miscalculation on a federal

tax form that is directly contradicted by required documentary evidence.” Here, the Taxpayer

attempted to amend his 1994 federal income tax return, but was turned away by the IRS. Given

these circumstances, and the clear evidence that the Taxpayer’s 1994 income should have been

reported as employee wages rather than business income, it is well within the Department’s authority

to accept the Taxpayer’s offer to amend his 1994 New Mexico income tax return and pay additional

tax due to the state. Once payment is received, New Mexico’s requirement for consistent reporting

will be met.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to Assessment No. 2232477, and

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

2. During the 1994 tax year, the Taxpayer performed services as an employee and not as

an independent contractor.

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3. The Taxpayer will be entitled to claim the gross receipts tax deduction provided in

NMSA 1978, § 7-1-17 once the Taxpayer pays the additional New Mexico income tax, plus interest,

due on his 1994 employee wages.

For the foregoing reasons, the Department is ordered to accept the Taxpayer’s tender of

additional tax due for tax year 1994 and, upon receipt of such payment, is ordered to abate Assessment

No. 2232477 in its entirety.

DATED May 19, 2003.

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