Could New Mexico use IRS information reports to assess unreported income when the federal reports were unsigned and the taxpayer disputed only the procedure?

Plain-English summary

New Mexico properly used IRS information to assess Salomon Rael for unreported wages and nonemployee compensation in 2000 and 2001. Unsigned federal Revenue Agent Reports and Rael's procedural objections did not invalidate the state assessments when he did not deny earning the income or offer contrary evidence.

The IRS examination identified:

• $19,789 of nonemployee compensation and $9,893 of wages omitted for 2000.
• $28,045 of nonemployee compensation omitted for 2001.

New Mexico assessed $808 of personal income tax for 2000 and $664 for 2001, plus penalty and interest.

Federal disclosure and unsigned reports were valid

Rael argued that the federal reports were deficient because they were not signed under penalty of perjury and that the Department needed an individual written request before receiving his IRS information.

The decision relied on a recent New Mexico Court of Appeals case rejecting the same arguments under 26 U.S.C. §§ 6065 and 6103(d). Information transmitted by the IRS to state tax officials did not require an agent's penalty-of-perjury signature, and the disclosure was proper under the federal-state coordination arrangement.

This was not an unsupported “naked assessment”

Rael cited a federal case where the IRS arbitrarily preferred one person's sworn income statement over another's without supporting evidence.

The decision distinguished cases where a taxpayer actually disputes the third-party amount from cases where the taxpayer files no contrary return or evidence. Here, Rael did not deny receiving the reported income.

New Mexico law presumed the assessment correct and required the taxpayer to produce countervailing evidence tending to dispute its factual basis. Rael had direct knowledge of his own income but offered no evidence that the IRS information was wrong.

Result: protest DENIED. The 2000 and 2001 tax assessments, penalty, and interest stood.

What this means for you

Taxpayers receiving an IRS adjustment

Procedural objections alone may not defeat a state assessment based on federal information. Address the underlying income amounts with records and specific evidence.

Independent contractors and wage earners

Reconcile Forms 1099 and W-2 with both federal and state returns. Federal-state information sharing can surface omissions years later.

Tax professionals handling an assessment protest

Identify whether the taxpayer genuinely disputes the third-party report and document why. The “naked assessment” theory did not apply where the taxpayer never denied the income.

Common questions

Q: What income did the IRS report for 2000?
A: $19,789 of nonemployee compensation and $9,893 of wages.

Q: What income did it report for 2001?
A: $28,045 of nonemployee compensation.

Q: Did the IRS reports need to be signed under penalty of perjury?
A: No, not for transmission to the state taxing authority under the rule applied here.

Q: Did Rael deny earning the income?
A: No.

Q: What evidence did he provide that the amounts were wrong?
A: None, so he did not overcome the presumption of correctness.

Citations and references

Federal and state authorities:

• 26 U.S.C. § 6065 — verification of federal returns and documents
• 26 U.S.C. § 6103(d) — federal disclosure to state tax officials
• NMSA 1978, § 7-1-17(C) — presumption that an assessment is correct
• Regulation 3.1.6.12(A) NMAC — evidence needed to overcome an assessment

Cases cited:

• Stockton v. State, Taxation and Revenue Department, N.M. Ct. App. Docket No. 26,041 (filed April 20, 2007)
• Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991)
• Parker v. Commissioner, 117 F.3d 785 (5th Cir. 1997)
• Grogan v. New Mexico Taxation & Revenue Department, 133 N.M. 354, 62 P.3d 1236 (Ct. App. 2002)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Salomon L. Rael
• Decision PDF: D&O 07-11

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
SALOMON L. RAEL, TO ASSESSMENTS OF 2000 No. 07-11
& 2001 PERSONAL INCOME TAX ISSUED UNDER
LETTER ID NOs. L1396921600 & L0340497664

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on June 7, 2007, before

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

was represented by Elizabeth K. Korsmo, Special Assistant Attorney General. Salomon L. Rael

represented himself. Based on the evidence and arguments presented, IT IS DECIDED AND

ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. In 2004, the IRS notified Salmon L. Rael via federal forms 4549, titled “Income

Tax Examination Changes” (which is generally referred to as a Revenue Agent Report) that it

had conducted an examination of his 2000 and 2001 tax reporting and determined that he failed

to report $19,789 of nonemployee compensation and $9,893 of wages for the 2000 tax year and

$28,045 of nonemployee compensation for the 2001 tax year.

2. The Revenue Agent Reports (“RAR”) were not signed, but identified the federal

agent who made the adjustments as “Mr. Parizek” and provided his employee identification

number.

3. In 2006, pursuant to a 1988 Agreement on Coordination of Tax Administration

(which is a public record of the Department), the IRS provided the Department with information
concerning the unreported wages and nonemployee compensation Mr. Rael received during the

2000 and 2001 tax years.

4. On September 8, 2006, the Department assessed Mr. Rael for $808 of New

Mexico personal income tax, plus interest and penalty, for the 2000 tax year and $664 of New

Mexico personal income tax, plus interest and penalty, for the 2001 tax year.

5. Mr. Rael filed a written protest to the assessments, raising various legal challenges

to the method by which the Department obtained the information used to determine his tax

liability for the 2000 and 2001 tax years. Mr. Rael did not deny that he earned the income on

which the Department’s assessments were based.

DISCUSSION

The issue to be decided is whether Salomon Rael is liable for the assessments of New

Mexico personal income tax issued against him for the 2000 and 2001 tax years. Mr. Rael

challenges the Department’s assessments on the following grounds: (1) the RARs issued by the

IRS were legally deficient because they were not signed under penalties of perjury as required by

26 U.S.C. § 6065; (2) the Department acted illegally in obtaining information concerning his

2000 and 2001 income because the Department failed to submit an individual, written request for

that information as required by 26 U.S.C. § 6103(d); and (3) the Department cannot rely on the

IRS’s “naked assessment” of federal tax to support the assessment of state tax.

In Stockton v. State, Taxation and Revenue Department, Ct. App. Docket No. 26,041 (filed

April 20, 2007), the New Mexico Court of Appeals addressed and rejected the same arguments Mr.

Rael raises concerning the requirements of 26 U.S.C. §§ 6065 and 6103(d). This decision is

binding law in New Mexico and no further discussion of these issues is required.

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Mr. Rael also argues that the Department cannot rely on the IRS’s “naked assessment” of

federal tax to support the assessment of state tax. In support of his argument, Mr. Rael relies on

statements in federal case law that the usual presumption of correctness does not apply to notices of

deficiency involving unreported income when the IRS introduces no direct evidence to support its

determination and the taxpayer challenges the deficiency on the grounds that it is arbitrary. See,

e.g., Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir.1991). In Portillo, a subcontractor

filed a tax return reporting income that was substantially lower than the income attributed to him

on the general contractor’s Form 1099. Although neither party was able to fully document the

payments at issue, the IRS assessed the subcontractor on the higher income figure, taking the

position that it was the subcontractor’s burden to establish that the assessment was incorrect.

The Fifth Circuit Court of Appeals disagreed, finding that the IRS acted arbitrarily when it issued

the assessment without any factual basis for accepting the sworn statement of the general

contractor over the sworn statement of the subcontractor.

In the later case of Parker v. Commissioner, 117 F.3d 785 (5th Cir. 1997), the Fifth

Circuit refused to apply the holding in Portillo to a situation where the taxpayers failed to file

income tax returns based on “tax protester rhetoric and legalistic gibberish.” Id. at 787. There,

the court upheld the IRS’s assessment of more than $80,000 in back taxes and penalties based on

1099 and W-2 forms submitted by third-party payors. In rejecting the taxpayers’ argument that

the IRS was not entitled to rely on this third-party information and had issued a “naked

assessment,” the court clarified the scope of its holding in Portillo as follows:

Portillo did not hold that the IRS must conduct an independent investigation in all
tax deficiency cases. In this case, the Commissioner has not arbitrarily found the
third-party forms credible: the Parkers never filed a Form 1040 or any other
document in which they swore that they did not receive the payments in question.

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The Commissioner has no duty to investigate a third-party payment report that is
not disputed by the taxpayer. (Emphasis in the original).

Id. See also, Miner v. Commissioner, 2003 WL 403060 (U.S.Tax Ct. 2003) (IRS reasonably

determined nonfiler taxpayer’s income based on information returns received from third-parties);

White v. Commissioner of Internal Revenue, 1997 WL 617036 (U.S.Tax Ct. 1997) (taxpayer’s

assertion that IRS erred in relying on reports from third-party payors in determining the

deficiencies in dispute, standing alone, carries no weight).

The federal court’s analysis in Parker is similar to that applied under New Mexico law.

As the Court of Appeals found in Grogan v. New Mexico Taxation & Revenue Department, 133

N.M. 354, 357-358 (Ct. App. 2002):

The Department's assessment is presumed to be correct. NMSA 1978, § 7-1-
17(C) (1992); Carlsberg, 116 N.M. 247 at 249, 861 P.2d at 290. "The effect of
the presumption of correctness is that the taxpayer has the burden of coming
forward with some countervailing evidence tending to dispute the factual
correctness of the assessment made by the secretary. Unsubstantiated statements
that the assessment is incorrect cannot overcome the presumption of correctness."
3.1.6.12(A) NMAC 2001.

See also, MPC Ltd. v. New Mexico Taxation and Revenue Department, 2003-NMCA-021, ¶ 13,

133 N.M. 217, 62 P.3d 308. Mr. Rael’s repeated assertions that it is the Department’s burden to

prove the correctness of its assessments against him have no support in New Mexico law. Mr.

Rael has the most accurate and direct knowledge concerning the nature and source of his income

during the years at issue. By failing to come forward with any evidence to dispute the factual

basis for the Department’s assessments, he failed to meet his burden of proof in this case.

CONCLUSIONS OF LAW

A. The Taxpayer filed a timely protest to the Department’s assessments of personal

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

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B. Information concerning Mr. Rael’s 2000 and 2001 income was properly disclosed to

the Department by the Internal Revenue Service.

C. There is no requirement that information transmitted by the IRS to state taxing

authorities be signed by an IRS agent under penalty of perjury.

D. Mr. Rael failed to meet his burden of proving that the information the Department

received from the IRS concerning his 2000 and 2001 income is incorrect.

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

DATED June 12, 2007.

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