Could William Midkiff reduce mandatory interest on 1990-1991 personal income tax deficiencies because the 15% statutory rate exceeded market rates, his children had overpaid tax on the shifted income, or the Department assessed him years later?

Plain-English summary

William Midkiff owed the full statutory interest on personal income tax deficiencies created by federal audit adjustments. The hearing officer could not reduce the 15% annual rate, credit tax paid by Midkiff's children against his separate liability, or start interest only when the Department issued its assessments.

Midkiff, a consultant, gave each of his two children 50% of the stock in his consulting company. The resulting income distributions went to the children, whose lower tax brackets produced tax savings. After auditing the 1990 and 1991 returns, the IRS disallowed the income reductions and increased Midkiff's taxable income. His children amended their returns and received refunds.

Using the IRS report, the Department assessed Midkiff:

• for 1990, $5,272.66 tax, $527.26 penalty, and $2,372.69 interest, totaling $8,172.61; and
• for 1991, $1,534 tax, $153.40 penalty, and $460.20 interest.

Midkiff paid the assessed tax principal and protested the penalties and interest. The Department abated the penalties because he had relied on his accountant. The only remaining issue was $2,832.89 of interest.

The statutory rate controlled

Section 7-1-67(A) required interest from the first day after unpaid tax became due until payment. Subsection B set the rate at 15% per year, computed at 1.25% per month or fraction of a month.

The Department acknowledged that this exceeded prevailing market rates and that it had sought legislation for an adjustable rate. The legislature had not enacted that change. The hearing officer therefore had no discretion to replace the statutory rate; the decision said the requested relief could come only from the legislature.

The children's payments could not offset Midkiff's debt

Midkiff argued that the state already held part of the money because his children had paid tax on income later reassigned to him.

The decision treated the father and children as three separate taxpayers filing under separate identification numbers. It found no statutory authority to offset one taxpayer's payment against another taxpayer's deficiency, even when the taxpayers were related and the first payments were later refunded.

Interest began on the original due dates

Midkiff also argued that his tax did not become due until the Department assessed it in April 1994.

Section 7-2-12 instead made calendar-year individual income tax due by April 15 of the following year. His 1990 and 1991 deficiencies were therefore due on April 15, 1991 and April 15, 1992, respectively. Interest ran from those original due dates until the tax was paid, not merely from the assessment date.

The decision distinguished interest from punishment. The Department had abated the negligence penalties, and the hearing officer said interest compensated the state for not receiving the correct tax on time.

Result: protest DENIED. The statutory interest assessments remained due.

What this means for you

Taxpayers receiving federal audit adjustments

An adjustment can produce state interest running from the original return due date, even when the state assessment arrives years later.

Families shifting income among separate taxpayers

Taxes paid by one family member do not automatically offset another family member's deficiency. The decision required statutory authority for any cross-taxpayer credit and found none here.

Taxpayers seeking a lower interest rate

The hearing officer treated the statutory rate as mandatory. Evidence that prevailing market rates were lower did not authorize an administrative reduction.

Taxpayers who relied on an accountant

Accountant reliance led the Department to abate Midkiff's penalties, but it did not eliminate mandatory interest on tax paid after its due date.

Common questions

Q: What interest rate applied?
A: Fifteen percent per year, computed at 1.25% per month or fraction of a month.

Q: How much interest was disputed?
A: $2,832.89 across the 1990 and 1991 assessments.

Q: Why could the children's tax payments not be credited?
A: They were separate taxpayers, and the decision found no statute authorizing their payments to offset Midkiff's liability.

Q: When did interest begin?
A: From the original income tax due dates—April 15, 1991 and April 15, 1992—not from the April 1994 assessment date.

Q: Were the penalties also upheld?
A: No. The Department had already abated them because Midkiff relied on his accountant; the decision resolved only the remaining interest dispute.

Citations and references

Statutes:

• NMSA 1978, § 7-1-67(A)-(B) — mandatory interest from the tax due date and the 15% annual rate
• NMSA 1978, § 7-2-12 — due date for individual income tax returns and payments
• NMSA 1978, § 7-1-69(B) — penalty for knowingly claiming an improper deduction, discussed to distinguish penalty from interest

Source

• Listing: New Mexico Decisions & Orders
• Decision post: William S. Midkiff
• Decision PDF: D&O 94-03

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
WILLIAM S. MIDKIFF,
PROTEST TO
ASSESSMENT NOS. 568744 & 568745 No. 94-03

DECISION AND ORDER

This matter came on for hearing on November 22, 1994 before Gerald B. Richardson,

Hearing Officer. William S. Midkiff, hereinafter, Taxpayer, represented himself at the hearing. The

Taxation and Revenue Department, hereinafter, Department, was represented by Bridget A. Jacober,

Special Assistant Attorney General. Based upon the evidence and arguments presented, it is decided

and ordered as follows:

FINDINGS OF FACT

1. The Taxpayer is a consultant. With the advice of his accountant and in an effort to

lower his tax liability, the taxpayer gave 50% of the stock in his consulting company to each of his

two children. This resulted in a distribution of the income from the corporation to his children rather

than the Taxpayer and tax savings occurred because the children were in a lower tax bracket than the

Taxpayer.

2. For the tax years 1990 and 1991, the Taxpayer reported and paid income tax to the

IRS and the Department excluding the income reported to those entities by his children.

3. The Taxpayer was audited by the IRS for the 1990 and 1991 tax years. The IRS

disallowed the deductions from income caused by the transfer of income to the Taxpayer's children,

resulting in an increase in the Taxpayer's taxable income.

4. The IRS determination occurred in approximately February of 1994. As a result of

this determination, the Taxpayer paid the additional taxes he owed to the IRS, and the Taxpayer's

children filed amended returns and obtained a refund of overpaid taxes from the IRS.

5. Pursuant to its reciprocal agreement on the exchange of taxpayer information with the

IRS, the Department received a revenue agents report from the IRS showing the IRS adjustments to

the Taxpayer's taxable income for tax years 1990 and 1991.

6. Based upon the information the Department received from the IRS, on April 13,

1994 the Department issued to the Taxpayer Assessment No. 568744 in the total amount of

$8,172.61, representing taxes in the amount of $5,272.66 in taxes, $527.26 penalty and $2,372.69 in

interest, for the 1990 tax year. Additionally, on the same date the Department issued to the Taxpayer

Assessment No. 568745 for the 1991 tax year, assessing $1534 in tax, $153.40 in penalty and $460.20

in interest.

7. On April 15, 1994 the Taxpayer paid the Department the taxes assessed by the two

aforementioned assessments and filed a written protest to the penalty and interest assessed.

8. The Department has abated the penalty assessed on the grounds that the Taxpayer was

relying upon the advice of his accountant concerning the handling of his taxes for 1990 and 1991.

9. Although the Taxpayer's children applied for and received a refund from the

Department of the taxes which they overpaid for the 1991 and 1990 tax years, the Department

refunded no interest on such claims for refund which would compensate the Taxpayer's children for

the time-value of having those overpaid taxes in the state's possession for the years prior to the refund

claim.

10. The Department's interest assessment represents interest at a rate of 15% per annum

or 1.25% per month, computed from the date the taxes were originally due, to the date the taxes were

actually paid.

DISCUSSION

The sole issue to be determined herein is whether interest was properly assessed against the

Taxpayer. The Taxpayer's arguments are, essentially, that interest at the rate of 15% per annum is

excessive to compensate the state for the value of the money which the state forewent in not having

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the taxes paid properly when they were originally due, since it is far higher than prevailing interest

rates during the relevant time periods. Additionally, in this case, the state had at least part of the tax

money in its possession, representing the taxes which it was ultimately determined were overpaid by

the Taxpayer's children. Finally, the Taxpayer argues that the taxes were not actually due until the

Department assessed the taxes, and so interest should only run from the date of the Department's

assessment.

Interest on tax deficiencies is imposed pursuant to Section 7-1-67(A) NMSA 1978, which

provides in pertinent part:
If any tax imposed is not paid on or before the day on which it becomes due, interest
shall be paid to the state on such 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.

Pursuant to subsection B of Section 7-1-67, interest is imposed at the rate of 15% per year, computed

at the rate of one and one-fourth percent per month or fraction of a month.

The Department acknowledged that charging interest at the rate of 15% per annum

represented higher than market interest rates during the relevant time period. The Department even

acknowledged that it had, on more than one occasion, sought legislation tying the interest rate to some

measureby which the interest rate would be adjusted automatically and be more representative of

market rates. The legislature, however, never enacted such legislation. Unfortunately for the

Taxpayer, this is not an area where the Department has the discretion to make adjustments to the rate

of interest. It is a legislative prerogative, and the Department (and this Taxpayer) are bound to follow

the mandates of the statute. The relief the Taxpayer seeks can only be granted in a legislative forum.

Thus, the rate of interest is no defense to the present assessment of interest.

The Taxpayer next argues that the Department or the state was already compensated for some

part of the interest due to the fact that the Taxpayer's children had erroneously paid taxes which were

not actually owing. The problem with this argument is that we are dealing with three separate

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taxpayers here, even if they do happen to be related. The children filed under their own taxpayer

identification number. A payment of taxes by one taxpayer, even if it is later determined to be

erroneous, does not amount to a payment of taxes by another taxpayer. There is simply no statutory

authority which would allow the Department to offset one taxpayer's liability with a tax payment

made by a separate taxpayer.

The Taxpayer's final argument, that interest should only be computed from the date of the

assessment, finds no support in the statutes. As noted above, Section 7-1-67 imposes interest upon

the amount due "from the first day following the day on which the tax becomes due". Section 7-2-12

NMSA 1978 addresses when income taxes are due and provides in pertinent part:
...The return required and the tax imposed on individuals under the Income Tax Act are
due and payment is required on or before the fifteenth day of the month following the end
of the taxable year. (emphasis added).

In the case of individuals such as the Taxpayer who file on a calendar year basis, income taxes are due

on or before April 15th of the following year. Thus, the Taxpayer's taxes were due, respectively upon

April 15, 1991 and April 15, 1992, and the interest on any tax deficiency runs from those dates until

the full amount of tax is paid.

Finally, I would like to address the Taxpayer's perception that he is somehow being punished

for wrongdoing by the imposition of what he believes to be an exhorbitant amount of interest. In this

case, the Taxpayer has not been acused of knowlingly claiming an improper deduction from income.

There is a 50% of the tax liability penalty for such actions. See, Section 7-1-69(B) NMSA 1978. In

fact, even the negligence penalty of 10% of the tax was abated by the Department when the Taxpayer

demonstrated that his actions had been based upon the advice of his accountant. While the Taxpayer

does have some basis to be concerned with the interest rate, which is much higher than market rates,

this is something that can only be addressed by the ultimate policy maker on this issue, the legislature.

Actually, the most significant factor in the amount of interest due is the fact that two to three years

passed from when the Taxpayer filed its original returns claiming the improper deductions from

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income to the date when the deductions were disallowed by the taxing authorities. Although the

Taxpayer can quibble with the interest rate imposed, nonetheless, the taxing agencies were entitled to

receive the proper amount of taxes on the original due dates for the 1990 and 1991 income tax returns.

It is for this, that interest is imposed and no injustice has been done to the Taxpayer in this instance

by the imposition of interest from the date the proper amount of taxes were due.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely written protest to the assessments at issue and jurisdiction

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

2. The Department has no authority to offset a tax payment by one taxpayer against a tax

deficiency of another taxpayer in order to abate the accrual of interest on the tax deficiency.

3. Taxes are due by the due date established by statute, not the date that the Department

issues an assessment for such taxes.

4. The Department has no authority to impose interest at a rate or in any manner that

does not conform to the rate and manner required Section 7-1-67 NMSA 1978.

For the foregoing reasons, the Taxpayer's protest is hereby denied.

Done, this 22nd day of December, 1994.

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