I served in the military entirely while living outside New Mexico — is my military retirement pay taxable now that I live here?

Plain-English summary

John Schuller was a New Mexico resident throughout 1994, and that year he received military retirement pay. He included the pay on his 1994 New Mexico income tax return — self-assessing $42 of tax — but he didn't pay and instead sent a letter protesting that his military retirement income should not be taxed. His entire active-duty career had been served while he was a nonresident of New Mexico.

Schuller's argument was that the retirement pay was simply a delayed payout of a benefit he had earned while living outside New Mexico, so the state shouldn't be able to tax it now. He also felt it was inconsistent: in his 1993 divorce, a New Mexico court had treated the military retirement as community property (compensation for past services) and awarded half to his former wife. The Department moved for summary judgment; Schuller filed no formal response, but the Hearing Officer treated his protest letter as his response and decided the legal issue.

The Hearing Officer granted the Department summary judgment and denied the protest:

• Military retirement pay is deferred pay for past services. Under the U.S. Supreme Court's decision in Barker v. Kansas, the right to the pay accrues as military service is rendered, but the payment is deferred until after service ends.
• Income is taxed when it is realized, not when it is earned. For both federal and New Mexico income tax, income becomes taxable when it is received. Schuller earned the right to the pay during his service, but he realized the income only when he actually received the payments in 1994.
• He was a resident when he realized it. Because Schuller received the retirement pay in 1994 while a New Mexico resident, it was current 1994 income subject to New Mexico tax.
• The community-property treatment isn't inconsistent. Treating military retirement earned during marriage as divisible community property (LeClert v. LeClert; Section 40-3-8(C)) concerns when the pay was earned, which is a different question from when it becomes taxable. New Mexico measures income tax from federal adjusted gross income ("base income"), and the pay was properly included.

What this means for you

Military retirement pay is taxed when you receive it, based on where you live then

If you're a New Mexico resident when you receive military retirement pay, New Mexico can tax that pay as current income — regardless of where you lived while you served. The fact that you earned the underlying benefit as a nonresident doesn't keep the payments out of New Mexico income once you're a resident receiving them.

"Earned" and "taxable" are two different moments

A common misunderstanding — usually harmless because most income is earned and taxed in the same year — is that income is taxed when it was earned. For deferred pay like military retirement, income is generally taxed when it is realized (received), not when the right to it accrued. Plan for retirement pay to be taxable in the years you actually collect it.

Community-property treatment in divorce doesn't control income tax

New Mexico treating your military retirement as community property (so a share goes to a former spouse) doesn't mean the state has conceded anything about income tax. Those are separate legal questions. Don't assume divorce-law characterizations carry over to how the pay is taxed.

Filing a return self-assesses the tax — protest, but expect to owe if wrong

Schuller filed his return showing tax due, which self-assessed the $42, and he preserved the dispute by attaching a protest letter. That's the right way to contest an item you think shouldn't be taxed — but if the position loses, the self-assessed tax stands.

Common questions

Q: I served in the military entirely outside New Mexico. Can New Mexico still tax my retirement pay?
A: Yes, if you're a New Mexico resident when you receive it. The pay is deferred compensation that becomes taxable when realized (received), and residency at that time is what matters — not where you served.

Q: Isn't my retirement pay just a benefit I already earned before moving here?
A: You earned the right to it during service, but for income tax it's taxed when you actually receive it. Receiving it as a New Mexico resident makes it current New Mexico income.

Q: New Mexico split my military retirement in my divorce as community property. Doesn't that mean it was already 'earned' elsewhere and shouldn't be taxed?
A: No. The community-property rule is about when the pay was earned during marriage; income tax turns on when the pay is realized. The two rules address different questions and aren't inconsistent.

Q: I put the income on my return but didn't pay because I'm protesting. Is that allowed?
A: Filing the return self-assessed the tax, and attaching a protest letter preserved the dispute for a hearing. But if the protest fails, the self-assessed tax (and any interest) remains due.

Citations and references

Statutes:

• § 7-2-2(B) and (N) NMSA 1978 — New Mexico "net income" is based on "base income," defined as federal adjusted gross income with certain deductions not relevant here
• § 40-3-8(C) NMSA 1978 — military retirement pay earned during marriage is community property subject to division in divorce

Cases cited:

• Barker v. Kansas, 112 S. Ct. 1619 (1992) — military retirement pay is deferred pay for past services
• LeClert v. LeClert, 80 N.M. 235, 453 P.2d 755 (1969) — New Mexico treats military retirement pay as compensation for past services and, to the extent earned during marriage, as community property

Source

• Listing: New Mexico Decisions & Orders
• Decision post: John C. Schuller
• Decision PDF: D&O 96-07

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
JOHN C. SCHULLER,
PROTEST TO SELF ASSESSMENT OF TAX. NO. 96-07

DECISION AND ORDER

This matter came on for decision upon the Motion for Summary Judgment filed herein on

October 23, 1995 by the Taxation and Revenue Department. John C. Schuller (hereinafter

"Taxpayer") represented himself in this matter. The Taxation and Revenue Department

(hereinafter "Department") was represented by Frank D. Katz, Chief Counsel. Pursuant to

Regulation TA 24:12, parties are given 20 days after the mailing of a motion to respond to the

motion or they shall be deemed to have consented to the granting of the relief asked for in the

motion. Mr. Schuller filed no response to the Department's motion. The Taxpayer's position on

the legal issues presented was quite well set forth in the Taxpayer's protest, however, and so rather

than simply ruling against the Taxpayer for failing to respond, the Taxpayer's protest will be

treated as the Taxpayer's response and the matter will be determined upon that basis. It does

appear that there are no material facts in dispute and that this matter is thus appropriate for

determination on the legal issues presented by way of summary judgment.
Based upon the uncontested facts and the legal arguments presented by the parties, IT IS

DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer was a resident of New Mexico throughout the 1994 tax year.

2. For the 1994 tax year the Taxpayer received of military retirement income.

3. On April 17, 1995, the Taxpayer filed a 1994 New Mexico Personal Income Tax

return which took the Taxpayer's military retirement income into account in calculating the

Taxpayer's income tax due to the Department.

4. The Taxpayer's 1994 New Mexico Personal Income Tax return indicated that the

Taxpayer owed the Department $42 in tax. Although the Taxpayer filed his return with the

Department, effectively self-assessing $42 in tax, the Taxpayer did not include payment of the

$42, but included a letter with his return protesting the inclusion of his military retirement income

in the calculation of tax due.

5. The Taxpayer's entire active duty in the military service was served as a

non-resident of New Mexico.

DISCUSSION
The issue to be determined is whether the Taxpayer's military retirement income may

properly be included as income for New Mexico personal income tax purposes. The Taxpayer

contends that it cannot on the basis that it is a payment of a previously earned benefit and the

Taxpayer was a non-resident during his military service career when the benefit was earned. The

Department contends that the military retirement pay is deferred pay for past services and as such

it is current income subject to tax if the recipient is a New Mexico resident.

What apparently has the Taxpayer upset is what he believes to be inconsistent treatment of

his military retirement pay. In 1993, the District Court for Curry County awarded one half of the

Taxpayer's military retirement pay to his former wife. New Mexico treats military retirement pay

as compensation for services rendered in the past and it treats the portion earned during marriage

as community property subject to division in divorce proceedings. See, LeClert v. LeClert 80

N.M. 235, 453 P.2d 755 (1969) and Section 40-3-8(C) NMSA 1978. The Taxpayer argues that it

is inconsistent for New Mexico to now take the position that it can tax the income since he asserts

that it was earned while the Taxpayer was a non-resident of New Mexico.

Recently, the United States Supreme Court clarified the nature of military retirement pay.

In Barker v. Kansas, 112 S.Ct. 1619 (1992), the Court ruled that military retirement pay for

retired military personnel is deferred pay for past services. Thus, the right to military retirement

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pay arises as military service is rendered, but payment of the retirement pay is deferred until a date

after the service has been rendered.

The Taxpayer's argument confuses when the right to receive future income accrues with

when that income becomes taxable. The Taxpayer's confusion is understandable because usually,

income is both earned and taxable at the same time and there is no differential in tax treatment.

That, however, is not the case with respect to the Taxpayer's military retirement pay.
For federal income tax purposes, and for New Mexico income tax purposes as well1,

income becomes taxable when it is realized. In this case, the

Taxpayer earned the right to receive future retirement pay during

the period of time he was rendering service to his country in the

military. The actual payment of that retirement pay was deferred,

however, until he met all of the criteria for military retirement

and he actually retired. It was only at the point that he actually

received the payments of military retirement pay that he realized

the income. It was only then that it became subject to income

taxation. Thus, the military retirement pay that the Taxpayer

received during 1994 was current income of the Taxpayer in 1994 and

since the Taxpayer was a resident of New Mexico in 1994, the income

was subject to tax by the Department.
CONCLUSIONS OF LAW

1. The Taxpayer self-assessed income tax for the tax year
   1994 when he filed his 1994 New Mexico personal income tax return

with the Department reflecting tax due in the amount of $42.

2. The Taxpayer timely protested the self-assessment of tax
   1
   New Mexico bases its definition of "net income" subject to tax upon "base income" which is defined as federal adjusted
   gross income with some deductions which are not pertinent to this matter. Section 7-2-2 (B) and (N) NMSA 1978.

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when he accompanied his 1994 New Mexico personal income tax return

with a letter protesting the inclusion of the Taxpayer's military

retirement pay received during the tax year in the calculation of

the Taxpayer's 1994 New Mexico income tax liability.

3. The Taxpayer's military retirement pay is deferred

compensation for services rendered in the past, which is realized

for purposes of imposition of New Mexico personal income tax when

the retirement pay is received by the Taxpayer.

4. The military retirement pay received by the Taxpayer

during 1994 while he was a resident of New Mexico was properly included

in income subject to tax by the Department for the tax year 1994.

For the foregoing reasons, the Taxpayer's protest IS HEREBY

DENIED.

DONE, this 17th day of February, 1996.

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