Could a new New Mexico resident claim a credit for Pennsylvania tax on gain that he allocated entirely outside New Mexico?

Plain-English summary

Clarence F. Garrett could not claim a credit for Pennsylvania tax on real-estate gain that he had allocated entirely outside New Mexico. The hearing officer upheld the resulting $662 of 2004 personal income tax, plus penalty and interest.

Garrett and his wife moved from Illinois to New Mexico in July 2004. His income for the year included Illinois wages, interest, and dividends; gain from Pennsylvania real estate sold before the move; and pension distributions, interest, and dividends received while he lived in New Mexico.

On his original New Mexico return, Garrett first calculated tax using total federal adjusted gross income, less deductions and exemptions. He then used Form PIT-B to multiply that tax by the percentage of income allocated to New Mexico.

After that calculation, he claimed a credit for tax paid to Pennsylvania on the property gain. None of that gain had been allocated to New Mexico on Form PIT-B. The Department disallowed the credit and assessed $662, plus penalty and interest.

The Pennsylvania gain was not taxed twice

Section 7-2-11 required income from inside and outside New Mexico to be allocated and apportioned. Under the statutory method described in the decision, tax was calculated using federal adjusted gross income and then reduced to reflect the percentage allocated outside New Mexico.

Garrett argued that including total income in the preliminary calculation unfairly taxed income earned elsewhere. The hearing officer rejected that argument. Citing federal and state cases, the decision explained that out-of-state income may be used to measure a graduated tax rate without itself being taxed.

Because the Pennsylvania gain was fully allocated outside New Mexico, it was not included in the percentage used to determine Garrett's New Mexico liability. There was no double taxation and therefore no credit for the Pennsylvania tax.

Garrett could not substitute his own calculation

Garrett filed an amended return using only income received after moving to New Mexico and one-half of his federal deductions and exemptions. That method produced a claimed $400 refund.

The hearing officer held that Garrett had to follow the Legislature's calculation method. A first-year resident could not replace it with a personally preferred allocation of income, deductions, and exemptions.

Penalty and interest also remained due

Interest under Section 7-1-67 was mandatory from the due date until payment. Garrett paid the assessment on June 27, 2005, stopping further accrual, but the state had lost the use of the $662 between the April 15 due date and payment.

Garrett argued that his credit claim was a good-faith mistake of law. The decision found the mistake was not made on reasonable grounds because the same page of the Department's instructions stated that income allocated outside New Mexico on Schedule PIT-B did not qualify for the other-state credit. His failure to read that instruction carefully or seek assistance constituted negligence.

Result: protest DENIED. The $662 tax assessment, penalty, and interest remained due.

What this means for you

Part-year and first-year residents

Follow New Mexico's prescribed allocation forms. Using total federal income to establish the graduated rate does not necessarily mean New Mexico taxes every item included in that starting figure.

Taxpayers claiming another-state credit

Confirm that the same income was actually allocated or apportioned to New Mexico. Income placed entirely outside New Mexico did not qualify for the credit in this decision.

Taxpayers making a good-faith mistake argument

Read all instructions addressing the claimed item. A general sentence supporting a credit did not establish reasonable grounds when the same page expressly excluded the taxpayer's facts.

Common questions

Q: Why did Garrett owe another $662?
A: The Department disallowed his credit for Pennsylvania tax on gain that was allocated entirely outside New Mexico.

Q: Did New Mexico tax the Pennsylvania property gain?
A: No. The gain affected the preliminary rate calculation but was excluded through the allocation percentage.

Q: Why use total federal income in the calculation?
A: The decision said the graduated-rate method placed taxpayers with the same total income in the same marginal bracket, while the allocation percentage limited a first-year resident's final liability.

Q: Could Garrett use only his post-move income and half his deductions?
A: No. That personal method was not the calculation adopted by the Legislature.

Q: Why did the good-faith mistake exception fail?
A: The Department's instructions expressly said income allocated outside New Mexico on PIT-B did not qualify for the credit.

Q: Why was interest upheld?
A: Section 7-1-67 made interest mandatory until the late tax was paid.

Citations and references

Statutes and regulation:

• NMSA 1978, § 7-1-3 — tax includes related interest and civil penalty
• NMSA 1978, § 7-1-13 — credit for tax paid to another state, as cited in the decision
• NMSA 1978, § 7-1-17(C) — presumption that an assessment is correct
• NMSA 1978, § 7-1-67 — interest on late-paid tax
• NMSA 1978, § 7-1-69 — negligence penalty and good-faith mistake-of-law exception
• NMSA 1978, § 7-2-11 — allocation and apportionment of income
• Regulation 3.1.11.10 NMAC — definition of negligence

Cases cited:

• Maxwell v. Bugbee, 250 U.S. 525 (1919)
• Walters v. State ex rel. Oklahoma Tax Commission, 935 P.2d 398 (Okla. Ct. App. 1996)
• Brady v. State of New York, 607 N.E.2d 1060 (N.Y. 1992)
• Peet v. Commissioner, 705 A.2d 497 (Pa. Commw. Ct. 1998)
• Holt v. New Mexico Department of Taxation & Revenue, 2002-NMSC-034, 133 N.M. 11, 59 P.3d 491
• Arco Materials, Inc. v. Taxation & Revenue Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Clarence F. Garrett
• Decision PDF: D&O 07-03

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
CLARENCE F. GARRETT TO ASSESSMENT No. 07-03
ISSUED UNDER LETTER ID L0385558016

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on March 21, 2007, before

Margaret B. Alcock, Hearing Officer. The Taxation and Revenue Department (“Department”)

was represented by Elizabeth K. Korsmo, Special Assistant Attorney General. Clarence F. Garrett

(“the Taxpayer”) represented himself. Based on the evidence and arguments presented, IT IS

DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer and his wife moved to New Mexico in July 2004 after the Taxpayer

retired from his job in Illinois.

2. For the 2004 tax year, the Taxpayer’s income included wages, interest and

dividends earned while he was a resident of Illinois; capital gain on Pennsylvania real estate he

sold prior to moving to New Mexico; and pension distributions, interest and dividends received

while he was a resident of New Mexico.

3. In completing his 2004 New Mexico personal income tax return, the Taxpayer

first calculated the amount of tax that would be due on his total federal adjusted gross income

(less deductions and exemptions) and then multiplied that amount by the percentage of income

allocated to New Mexico on Form PIT-B of his 2004 return.

4. After determining the amount of tax due on his New Mexico income, the

Taxpayer claimed a credit for taxes paid to Pennsylvania on the capital gain income he received

from the sale of Pennsylvania real estate. None of this income had been allocated to New

Mexico on Form PIT-B.

5. The Department disallowed the credit the Taxpayer claimed for taxes paid to

Pennsylvania and, on June 23, 2005, assessed him for $662 of additional personal income tax,

plus interest and penalty.

6. On June 27, 2005, the Taxpayer filed a written protest to the assessment. As

authorized by Department Regulation 3.1.7.9 NMAC, he subsequently paid the assessment in

order to stop the accrual of additional penalty and interest.

7. As part of his protest, the Taxpayer devised his own method of allocating income,

deductions, and exemptions between New Mexico and non-New Mexico sources and filed an

amended 2004 personal income tax return based on this methodology.

8. Although New Mexico's 2004 Form PIT-1 requires federal adjusted gross income

to be reported on Line 5 of the return, the Taxpayer’s amended return reflected only the income

he received after moving to New Mexico in July 2004. The Taxpayer then reduced this amount

by one-half of his federal deductions and exemptions and calculated New Mexico tax on the

resulting figure.

9. Based on the Taxpayer’s personal method of computing New Mexico income tax,

his amended return showed a refund due in the amount of $400.

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DISCUSSION

The issues to be determined are: (1) whether the Taxpayer is required to follow New

Mexico’s statutory method of calculating personal income tax on his 2004 income and is

therefore liable for the additional tax assessed by the Department; and (2) if additional tax is due,

whether the Department properly assessed penalty and interest on the underreported tax.

Burden of Proof. NMSA 1978, § 7-1-17(C) states that any assessment of taxes made by

the Department is presumed to be correct. Holt v. New Mexico Department of Taxation &

Revenue, 2002 NMSC 34, ¶ 4, 133 N.M. 11, 59 P.3d 491. NMSA 1978, § 7-1-3 defines tax to

include not only the amount of tax principal imposed but also, unless the context otherwise

requires, the amount of any interest or civil penalty relating thereto. El Centro Villa Nursing

Center v. Taxation and Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989).

Accordingly, it is the Taxpayer’s burden to come forward with evidence and legal argument to

establish that he is entitled to an abatement of the assessment, in full or in part.

Calculation of Personal Income Tax. Payment of New Mexico personal income tax is

governed by NMSA 1978, §§ 7-2-1, et seq. New Mexico is among the majority of states that use

the federal income tax system as the basis for calculating state income taxes. As reflected on the

Department’s 2004 Form PIT-1, New Mexico taxable income is calculated by starting with the

taxpayer's federal adjusted gross income, deducting the taxpayer's federal personal exemption and

deductions, and making certain adjustments reflected on Form PIT-ADJ. The amount of tax is then

drawn from the tax rate table or tax schedule.

When a taxpayer has income from sources within and without New Mexico, NMSA 1978, §

7-2-11(A) directs the taxpayer to allocate and apportion this income between New Mexico and

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non-New Mexico sources. This is done by completing the Department’s Form PIT-B. Pursuant

to § 7-2-11(C), the amount of tax previously calculated on federal adjusted gross income is then

reduced by a credit computed by multiplying the tax by the percentage of income allocated or

apportioned outside New Mexico.1

In this case, the Taxpayer completed Forms PIT-1 and PIT-B in accordance with the

Department’s instructions and determined the amount of tax due on the income he received after

moving to New Mexico in July 2004. The Taxpayer then claimed a credit for taxes paid to

Pennsylvania on the income from his sale of Pennsylvania real estate in May 2004. This credit

was disallowed by the Department, resulting in the assessment at issue in this protest.

Credit for Taxes Paid to Another State. Pursuant to NMSA 1978, § 7-1-13, a New

Mexico resident may claim a credit for taxes paid to another state “with respect to income that is

required to be either allocated or apportioned to New Mexico.” (emphasis added). The purpose

of this provision is to prevent two states from taxing the same income. Here, however, none of

the income the Taxpayer received from the sale of Pennsylvania real estate was allocated to New

Mexico on his Form PIT-B and that income was not included in the New Mexico percentage

used to calculate the Taxpayer’s New Mexico tax liability. For this reason, the Taxpayer was not

entitled to claim a credit for the tax he paid to Pennsylvania.

Taxpayer’s Objections to New Mexico’s Income Tax Laws. The Taxpayer believes

that requiring him to calculate tax on his total federal adjusted gross income before determining

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As a shortcut, New Mexico’s Form PIT-B determines the tax due New Mexico by multiplying the tax
calculated on total income by the percentage of income allocated or apportioned to New Mexico. The result of
this calculation is the same as that reached by the statutory method of multiplying the tax by the non-New
Mexico percentage and then taking a tax credit in this amount.

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the percentage of tax attributable to New Mexico unfairly inflates his New Mexico tax liability.

Accordingly, he devised his own method of calculating his tax liability by including only New

Mexico income on his amended tax return, reduced by one-half of the federal deduction and

exemption amounts. Whatever logic there may be to the Taxpayer’ methodology, it is not the

methodology adopted by the New Mexico Legislature. The Taxpayer is required to follow the

state’s tax laws as written and is not entitled to make up his own rules based on his personal

circumstances and beliefs.

New Mexico’s income tax laws are not unique, nor do they result in the taxation of out-

of-state income. In Maxwell v. Bugbee, 250 U.S. 525 (1919), decided almost ninety years ago,

the United States Supreme Court upheld a New Jersey inheritance tax that required the inclusion

of the decedent’s entire estate, wherever located, to determine the rate at which the estate’s

property in New Jersey would be taxed. Similar to the income tax scheme at issue here, the

inheritance tax was calculated by first determining the amount of tax that would be due on the

entire estate and then reducing the tax to reflect only the percentage of estate assets located in

New Jersey. The Supreme Court upheld the constitutionality of this approach:

When the state levies taxes within its authority, property not in itself taxable by
the state may be used as a measure of the tax imposed.... In the present case the
state imposes a privilege tax, clearly within its authority, and it has adopted as a
measure of that tax the proportion which the specified local property bears to the
entire estate of the decedent.... The transfer of certain property within the state is
taxed by a rule which considers the entire estate in arriving at the amount of the
tax. It is in no just sense a tax upon the foreign property, real or personal.

250 U.S. at 539. Since Maxwell, courts in a number of states have upheld the calculation of tax

on in-state income as a percentage of the tax that would be due on total income. See, e.g.,

Walters v. State ex rel. Oklahoma Tax Commission, 935 P.2d 398 (Okl.App. 1996), cert. denied,

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522 U.S. 908 (1997); Brady v. State of New York, 607 N.E.2d 1060 (N.Y. 1992), cert. denied,

509 U.S. 905 (1993); Stevens v. State Tax Assessor, 571 A.2d 1195 (Me.), cert. denied, 498 U.S.

819 (1990); Wheeler v. State, 249 A.2d 887 (Vt.), appeal dismissed, 396 U.S. 4 (1969); United

States v. Kansas, 810 F.2d 935 (10th Cir.1987).

Courts have also held that a credit for taxes paid to another state does not apply simply

because a taxpayer’s entire gross income is used to calculate the rate of tax applied to the other

state’s income. See, e.g., Peet v. Commissioner, 705 A.2d 497 (Pa. Cmwlth 1998), where the

court disallowed the taxpayer’s claim to a credit for tax paid to Delaware, finding that the

taxpayers’ Pennsylvania income was not subject to tax in Delaware. As the court explained:

[T]he Peets posit that their entire income is taxed by the State of Delaware
because the Peets' entire income, from both inside and outside of Delaware, is
used to compute their Delaware tax rate. Therefore, the Peets argue, they are
entitled to a credit for the entire amount of taxes paid to Delaware. We must
disagree. We believe that the Delaware system, like those systems in other
graduated income tax states, uses out-of-state income merely as a measure of the
tax rate, rather than actually taxing that income. The Peets' Pennsylvania income,
therefore, was not subject to tax by Delaware. (emphasis in the original).

Id., 705 A.2d at 501. See also, Comptroller of the Treasury v. Hickey, 689 A.2d 1316 (Md. App.

1997) (disallowing credit claimed by Maryland residents for tax paid to New York); Torpy v.

Department of Revenue, 2004 WL 3119002 (Ore. Tax Court 2004) (disallowing credit claimed

by Oregon resident for tax paid to Colorado); Chin v. Director, Division of Taxation, 14 N.J. Tax

304 (N.J. Tax Ct.1994), aff'd sub nom., Carroll v. Director, Division of Taxation, 15 N.J. Tax

177 (N.J. Super.Ct.App.Div. 1995) (disallowing credit claimed by New Jersey residents for tax

paid to New York). In this case, the capital gain the Taxpayer recognized from the sale of his

Pennsylvania real estate was not allocated to New Mexico on Form PIT-B. As established in the

court cases cited above, the fact that New Mexico took this income into account when calculating

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the rate of tax applied to other income that was allocated to New Mexico does not constitute a

tax on the capital gain derived from Pennsylvania. Because there was no double taxation, the

credit for taxes paid to Pennsylvania was properly disallowed.

Rationale for New Mexico’s Taxation of First-Year Residents. Although the

Taxpayer perceives New Mexico’s tax system as unfair, it is intended to insure that taxpayers

with the same income pay tax at the same graduated tax rate, regardless of the source of their

income.2 For example, a single taxpayer who was a full-year resident of New Mexico in 2004

and had taxable income (i.e., federal adjusted gross income less applicable deductions and

exemptions) of $50,000, would be in the 5.4% marginal tax bracket. A first-year resident who

had the same income—one-half earned in New Mexico and one-half earned in another state—

would also be in the 5.4% tax bracket. The difference is that the full-year resident would pay the

full amount of tax computed on his income while the first-year resident would pay only 50

percent of the tax, which is the percentage of his income allocated to New Mexico. For states

with a graduated tax system, which apportions liability based on a taxpayer’s ability to pay, this

methodology insures that similarly situated taxpayers pay tax at the same marginal rate. As both

state and federal courts have consistently held, this methodology does not result in the taxation of

income earned outside the state.

Assessment of Interest. NMSA 1978, § 7-1-67 governs the imposition of interest on late

payments of tax and provides, in pertinent part:

2
The Taxpayer believes that Illinois’ method of calculating tax based solely on the income earned in that state
is more equitable than New Mexico’s system. Unlike New Mexico, however, Illinois has a flat tax system.
Under those circumstances, a taxpayer with income from another state would pay tax at the same rate whether
the tax is calculated on the income earned in Illinois or is first applied to total income and then adjusted to
reflect the percentage of income earned in Illinois.

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A. If a tax imposed is not paid on or before the day on which it becomes
due, interest shall be paid to the state on that 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 provisions of the statute are

mandatory rather than discretionary. State v. Lujan, 90 N.M. 103, 105, 560 P.2d 167, 169

(1977). See also, NMSA 1978, § 12-2A-4(A) of the Uniform Statute and Rule Construction Act

(the words “shall” and “must” express a duty, obligation, requirement or condition precedent).

With limited exceptions that do not apply here, § 7-1-67 directs the Department to assess interest

whenever taxes are not timely paid. 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. See,

NMSA 1978, § 7-1-13(E).

The assessment of interest is designed to compensate the state for the time value of

unpaid revenues. In this case, the Taxpayer made an error in completing his 2004 income tax

return. As a result of this error, the Taxpayer—rather than the state—had the use of his $662 of

underreported tax for the period between April 15, 2005, the original due date of the tax, and

June 27, 2005, the postmark date of the Taxpayer’s payment. Although the Taxpayer questioned

whether the state’s 15 percent interest rate is excessive, that is a matter within the discretion of

the Legislature. See, State ex rel. Taylor v. Johnson, 1998-NMSC-015, ¶ 22, 125 N.M. 343, 961

P.2d 768 (an administrative agency may not alter, modify or extend the reach of a law created by

the Legislature).

Assessment of Penalty. NMSA 1978, § 7-1-69(A) provides that when a taxpayer fails to

pay taxes due to the state as a result of negligence or disregard of rules and regulations, a penalty

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“shall be added” to the amount of the underpayment. The term negligence as used in § 7-1-69(A)

is defined in Regulation 3.1.11.10 NMAC as:

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

B. inaction by taxpayers where action is required;

C. inadvertence, indifference, thoughtlessness, carelessness, erroneous
belief or inattention.

In this case, the Taxpayer maintains that he did not act negligently or in disregard of the

Department’s rules and regulations, but made a good faith mistake of law that qualifies for the

exception provided in NMSA 1978, § 7-1-69(B), which states:

No penalty shall be assessed against a taxpayer if the failure to pay an
amount of tax when due results from a mistake of law made in good faith
and on reasonable grounds.

The facts indicate, however, that while the Taxpayer may have made a mistake concerning his right

to claim a credit for taxes paid to Pennsylvania, that mistake was not made “on reasonable

grounds.”

In determining that he qualified for the credit for taxes paid to another state, the Taxpayer

relied on the following paragraph on page 26 of the Department’s instructions to Form PIT-ADJ

(Taxpayer Exhibit A):

A resident of New Mexico who must pay tax to another state on income that
is also taxable in New Mexico may take a credit against New Mexico tax for
tax owed to the other state.

The Taxpayer argues that because his Pennsylvania income was used in preliminary calculations of

his New Mexico tax, he reasonably believed that this income was “taxable in New Mexico” and

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qualified for the credit provided in NMSA 1978, § 7-1-13. The problem with this argument is that

the same page of the Department’s instructions specifically advise taxpayers that:

Income that is allocated or apportioned outside New Mexico on Schedule
PIT-B, does not qualify for credit for taxes paid to another state on that same
income.

As the Taxpayer acknowledged at the administrative hearing, and as clearly shown on the Form

PIT-B attached to his original 2004 return (Department Exhibit 2), all of his Pennsylvania income

was allocated outside New Mexico. Based on the Department’s instructions, quoted above, this

income “does not qualify for credit for taxes paid to another state on that same income.”

The Taxpayer’s error in completing his 2004 New Mexico income tax return was the result

of his failure to carefully read the Department’s instructions or to seek help from the Department or

a professional tax advisor to assist him in understanding New Mexico’s tax laws. Instead, the

Taxpayer completed his return based on his understanding of the tax laws of Illinois (where he

formerly lived) and his own personal belief as to what was “fair.” This constitutes negligence as

defined in the Department’s regulations and in New Mexico case law. See, Arco Materials, Inc. v.

Taxation & Revenue Department, 118 N.M. 12, 17, 878 P.2d 330, 335 (Ct. App.) rev'd on other

grounds by Blaze Const. Co. v. Taxation & Revenue Department, 118 N.M. 647, 647-48, 884

P.2d 803, 803-804 (1994) (New Mexico case law is clear that penalties may properly be assessed

even when the failure to pay is based on inadvertent error or unintentional failure to pay the tax

due); see also, El Centro Villa Nursing Center v. Taxation & Revenue Department, 108 N.M.

795, 797, 779 P.2d 982, 984 (Ct. App. 1989); Phillips Mercantile Co. v. New Mexico Taxation &

Revenue Department, 109 N.M. 487, 490-91, 786 P.2d 1221, 1224-25 (Ct. App. 1990). For this

reason, penalty was properly imposed.

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CONCLUSIONS OF LAW

A. The Taxpayer filed a timely, written protest to the assessment issued under Letter ID

L0385558016, and jurisdiction lies over the parties and the subject matter of this protest.

B. The Taxpayer was not entitled to claim a credit against his 2004 New Mexico

income taxes for taxes paid to Pennsylvania, and he is liable for the $662 of tax principal assessed

by the Department.

C. The Taxpayer did not pay his 2004 New Mexico tax liability by the statutory due

date, and he is liable for the interest assessed by the Department.

D. The Taxpayer was negligent in underreporting his 2004 New Mexico income taxes,

and he is liable for the penalty assessed by the Department.

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

DATED March 26, 2007.

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