Can I use taxes I overpaid in earlier years to offset a later assessment if my refund claim for those years is now too late?

Plain-English summary

Wilson and Frances Lundy were New Mexico residents who received federal military retirement income. The tax treatment of that income changed sharply in this period:

• In 1987 and 1988, New Mexico gave a partial exemption for federal military retirement (and fully exempted certain state retirement benefits). The Lundys didn't claim the exemption and paid tax on all of their retirement income.
• In 1989, the U.S. Supreme Court decided Davis v. Michigan, holding that a state can't tax federal retirement more heavily than state retirement. New Mexico applied Davis retroactively and let affected taxpayers file refund claims.
• The Legislature then repealed both the state-retirement exemption and the federal-military exemption, so for the 1990 tax year everyone had to include their federal retirement income.

The Lundys did not include their federal retirement income on their 1990 return. An IRS information-sharing match revealed the omission, and in February 1994 the Department issued Assessment No. 564818: $2,379.57 in personal income tax, $1,011.31 interest, and $237.95 penalty for 1990. Meanwhile, the Lundys had (in 1993) asked for refunds of the tax they'd overpaid in 1987 and 1988 — and the Department badly mishandled that request, ignoring it and then repeatedly asking for documents they'd already sent. The Lundys wanted their 1987–88 overpayments applied to the 1990 bill.

Hearing Officer Julia Belles denied the protest:

• The 1990 assessment was timely. Section 7-1-18(A) gives the Department three years from the end of the year the tax was due. The 1990 tax was due April 15, 1991, so the deadline was December 31, 1994; the February 1994 assessment was in time.
• The refund claims were too late to offset anything. Under Section 7-1-26(B), a refund claim must be filed within three years of the end of the year the overpayment was made. The 1987 claim was due by the end of 1991 and the 1988 claim by the end of 1992, but the Lundys didn't request refunds until 1993 (amended returns came in 1995). Late claims can't be granted, so there was nothing to apply against 1990.
• The negligence penalty stood. Every taxpayer has a duty to determine the tax consequences of their actions (Tiffany Construction). The 1990 return instructions didn't authorize excluding federal retirement, the Lundys sought no advice, and the legal question was settled by the time the 1990 return was due — so the failure was negligent under Section 7-1-69 and Regulation TA 69:3.
• Interest was mandatory under Section 7-1-67 because the 1990 tax was due and unpaid.
• The Department's poor service didn't excuse the tax. The Hearing Officer was openly critical — the Department "created work for itself" and treated the Lundys "with indifference and carelessness" — and sympathized with their frustration, but held that mishandling the refund request could neither excuse the 1990 liability nor revive the expired refund claims.

What this means for you

Refund deadlines are strict — file within three years or lose the money

If you overpay New Mexico tax, you generally must file a refund claim within three years from the end of the calendar year you made the overpayment. Miss that window and the overpayment is gone — you can't get it back and you can't use it to offset a later assessment, no matter how legitimate the original overpayment was.

An overpayment in one year doesn't automatically cover a shortfall in another

Even where the same taxpayer clearly overpaid earlier and underpaid later, New Mexico won't net the two together unless the refund claim for the overpayment is still timely. Treat each year separately and protect your refund rights on their own schedule.

Poor service by the Department is not a defense to the tax you owe

The Hearing Officer strongly rebuked the Department's handling of the refund request but still enforced the statute. Frustration with the agency — even justified frustration — doesn't excuse a valid tax liability or extend a statutory deadline. Keep pressing your claim, in writing, and don't let the agency's delay run out your clock.

When the law changes, confirm your own obligations

The rules on taxing federal retirement changed through a Supreme Court case and a legislative repeal, and the question was resolved before the Lundys' 1990 return was due. Because they didn't check, the penalty applied. When a tax law is in flux, verify the current rule (or ask a professional) before you rely on the old treatment.

Common questions

Q: I overpaid tax a few years ago. Can I just apply it to a bill the Department sent me now?
A: Only if your refund claim for the overpayment is still within the three-year limit in Section 7-1-26(B). If that deadline has passed, the overpayment can't be refunded or used to offset the new assessment.

Q: How long does New Mexico have to assess me, and how long do I have to claim a refund?
A: Both are generally three years. The Department has three years from the end of the year the tax was due to assess (Section 7-1-18(A)); you have three years from the end of the year you overpaid to claim a refund (Section 7-1-26(B)).

Q: The Department ignored my refund request and lost time. Doesn't that toll the deadline?
A: Not here. The Hearing Officer criticized the Department's conduct but held it neither excused the tax owed nor extended the statutory refund deadline. File your claim early and in writing so agency delay can't consume your window.

Q: I honestly thought my federal military retirement was still exempt. Why the penalty?
A: Because the exemption had been repealed and the legal issue was settled by the time the 1990 return was due, and the taxpayer didn't check the instructions or seek advice. That inattention met the definition of negligence, so the penalty applied.

Citations and references

Statutes and regulation:

• § 7-1-18(A) NMSA 1978 — the Department may assess tax within three years from the end of the calendar year in which the tax was due
• § 7-1-26(B) NMSA 1978 — a claim for refund must be made within three years from the end of the calendar year in which the overpayment was made; an amended return can act as a refund claim but must still meet this deadline
• § 7-1-69 NMSA 1978 and Regulation TA 69:3 — negligence penalty; negligence includes failure to exercise ordinary business care, inaction where action is required, and inadvertence, indifference, carelessness, erroneous belief, or inattention
• § 7-1-67 NMSA 1978 — interest is imposed on tax not paid when due
• § 7-2-5.1 NMSA 1978 (1986 Repl.) — the former up-to-$3,000 exemption for federal military retirement, repealed so that federal retirement was included in income for 1990
• § 7-1-24 NMSA 1978 — timely written protest of an assessment

Cases cited:

• Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 109 S. Ct. 1500, 103 L. Ed. 2d 891 (1989) — states must treat federal and state retirement benefits equally for income tax purposes
• Tiffany Construction Co. v. Bureau of Revenue, 90 N.M. 16 (Ct. App. 1976), cert. denied, 90 N.M. 255 (1977) — every person has a reasonable duty to ascertain the possible tax consequences of their actions

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Wilson T. & Francis J. Lundy
• Decision PDF: D&O 96-15

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 WILSON T. AND FRANCES J. LUNDY,
PROTEST TO ASSESSMENT NO. 564818. No. 96-15

DECISION AND ORDER

This matter was heard on March 27, 1996 by Julia Belles, Hearing Officer. Mr. and Mrs.

Wilson Lundy, (Taxpayers), were represented by Mr. Wilson Lundy. Frank D. Katz, Special

Assistant Attorney General, represented the Taxation and Revenue Department (Department).

Based upon the evidence and arguments presented, IT IS DECIDED AND ORDERED as

follows:

FINDINGS OF FACT

1. The Taxpayers were a residents of New Mexico who paid personal income tax in

1987, 1988, 1989 and 1990 .

2. In 1987 and 1988, the Taxpayers included federal military retirement income in

determining their tax liability.

3. The Taxpayers did not include their federal military retirement income when

determining their 1989 tax liability.

4. In 1989, the United States Supreme Court ruled that states could not treat state

and federal retirement benefits differently for income tax purposes.

5. The New Mexico Legislature amended the law in 1990 to eliminate the disparate

treatment of state and federal retirement income and required both state and federal retirement

benefits be included as income for the 1990 tax year.

6. The Taxpayers did not include their federal retirement benefits when they

calculated their 1990 tax and filed their 1990 PIT return. The Taxpayers 1990 PIT return was

timely filed on or before April 15, 1991.

7. In 1993, the Taxpayers received Notice of Assessment No. 530430 assessing

taxes, interest and penalty for tax year 1989. The assessment was based on the deduction of

federal retirement income. The Taxpayers timely protested Assessment No. 530430 and it was

later abated.

8. Around April or May of 1993, the Taxpayers requested a refund for the taxes they

incorrectly paid on their federal military retirement income for the 1987 and 1988 tax years.

The Department did not respond to the request for a refund.

9. The Taxpayers continued to write to the Department to request a hearing on their

claim for refunds. The Department finally responded with continual requests for documents the

Taxpayer had already sent to the Department.

10. On February 7, 1994, the Department issued Notice of Assessment No. 564818

which assessed $2,379.57 in personal income tax, $1,011.31 in interest and $237.95 penalty for

the 1990 tax year.

11. The Assessment was based upon information the Department received from the

Internal Revenue Service pursuant to an information sharing agreement. That information

revealed that the Taxpayers received federal retirement benefits which were not reported as

income when they filed their 1990 New Mexico Personal Income Tax (PIT) return.

12. On March 4, 1994, the Taxpayers timely filed a written protest to Assessment No.

564818.

13. On January 28, 1995 the Taxpayers amended their 1987, 1988, 1989 and 1990 tax

returns. They asked that the taxes incorrectly paid in 1987 and 1988 be used to pay Assessment

No. 564818.

DISCUSSION
The Taxpayers do not dispute the correctness of Assessment No. 564818 but argue that

the taxes they overpaid in 1987 and 1988 should be applied to the underpayment of their 1990

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taxes. The reason there was a hearing on this assessment was because of the way the

Department mishandled the Taxpayer's claim for a refund. The Taxpayers requested a refund

for their 1987 and 1988 taxes in 1993. Initially, The Department did not respond to the request.

When prompted by the Taxpayers to respond, the Department responded with repeated requests

for information and documents the Taxpayers had already provided to the Department. It is

likely that had the Department courteously, diligently and quickly responded to the Taxpayers's

claim for a refund there would not have been a hearing on Assessment No. 564818.

The Taxpayers argued, in their March 4, 1994 protest letter, that the assessment was not

timely and that interest and penalty should be abated because of the change in how federal

retirement benefits were treated. At the hearing, the Taxpayers also argued that the taxes

incorrectly paid in 1987 and 1988 should be used to pay the assessment.

Assessment No. 564818 was issued on February 7, 1994, after the Department received

information from the IRS indicating that the Taxpayers received federal retirement benefits in

1990 but did not include that income when filing their 1990 PIT return. Section 7-1-18(A)

NMSA 1978 (1995 Repl.) allows the Department to assess taxes three years from the end of the

calendar in which the tax was due. The 1990 tax was due on April 15, 1991 so the Department

had until December 31, 1994 to issue the assessment. Assessment No. 564818 was timely

issued.

The Taxpayers argued that the penalty and interest should not be assessed because of the

confusion over how states taxed federal retirement benefits. In 1987 and 1988, New Mexico

allowed an exemption of up to $3,000 for taxpayers who received federal military retirement.

See, Section 7-2-5.1 NMSA 1978 (1986 Repl.). It also exempted from taxation retirement

benefits paid to New Mexico retirees under the Public Employees Retirement Act and the

Educational Retirement Act. The Taxpayers' did not take the deduction but included all their

retirement benefits when calculating the tax due. In 1989, the United States Supreme Court held

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that states must treat federal and state retirement benefits equally for taxation purposes. Davis v.

Michigan Dept. of Treasury 489 U.S. 803, 103 L.Ed.2 891, 109 S.Ct. 1500 (1989). The

Department decided to give the Davis decision retroactive effect and allowed taxpayers to file

claims for refunds for tax years within the statutory limitation period for claiming refunds of tax

if those taxpayers had included federal retirement benefits when calculating their taxable income.

In response to Davis, the New Mexico Legislature amended the state's tax law to eliminate the

disparate treatment of state and federal retirement income. It did this by repealing the

exemption for state retirement benefits and repealing the $3,000 exemption for federal military

retirement benefits. Thus, for the 1990 tax year, the Taxpayers were required to include their

federal military retirement benefits as income when determining tax liability.

Penalty is assessed when the failure to pay a tax is due to a taxpayer's negligence.

Section 7-1-69 NMSA 1978 (1995 Repl.) Taxpayer "negligence" is defined in Regulation TA

69:3 to mean:
1) failure to exercise that degree of ordinary business care and prudence which
reasonable taxpayers would exercise under like circumstances;

2) inaction by taxpayers where action is required;

3) inadvertence, indifference, thoughtlessness, careless, erroneous belief or
inattention.

The Taxpayers were negligent. Every person is charged with the reasonable duty to ascertain the

possible tax consequences of his actions. Tiffany Construction Company v. Bureau of Revenue
90 N.M. 16 (App. 1976); cert. denied 90 N.M. 255 (1977). Nothing in the 1990 New Mexico

Personal Income Tax instructions addressed or authorized the Taxpayers to exempt their federal
retirement income nor did they present any evidence that they sought clarification of this matter

from a tax advisor or the Department. The Taxpayers were erroneous in their belief that their
retirement income was not taxable and were inattentive in not seeking clarification of this issue

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before failing to report this income. Although there was litigation over this issue, the issue was

resolved by the time the Taxpayers 1990 PIT return was due. The penalty was properly

assessed. Additionally, the interest was properly assessed as the tax was due on April 15, 1991

and has not been paid. Section 7-1-67 NMSA 1978 (1995 Repl.).

The Taxpayers argued that the taxes they incorrectly paid, by not taking a deduction for

federal retirement benefits in 1987 and 1988, should be refunded and applied to their 1990

liability. The Taxpayers requested a refund of their 1987 and 1988 taxes around April or May of

1993. Section 7-1-26(B) NMSA 1978 (1995 Repl.) informs taxpayers how to claim a refund

and requires that any claim for refund must be made within three years from the end of the

calendar year in which the overpayment was made. The overpayment of 1987 taxes was made

on or before April 15, 1988. The claim for refund needed to be made by December 31, 1991.

The overpayment of 1988 taxes was made on or before April 15, 1989. Any claim for refund for

1988 PIT had to be requested by December 31, 1992. The Taxpayers attempted to perfect their

claim for a refund by amending and refiling their 1987 and 1988 PIT returns. The filing of an

amended returns acted as a claim for a refund but still needed to be filed within time set forth in

Section 7-1-26(B). The Taxpayers are not entitled to refunds since their claims were not timely

filed.

The Taxpayers have not met their burden of showing that Assessment No. 564818 was

incorrect. In fact, at the hearing it was clear that the Taxpayers do not really dispute that they

owed the taxes assessed for the 1990 tax year but they strongly objected to the manner in which

the assessment and their claims for refund were handled by the Department. The Taxpayers are

justified in their frustrations with the Department. This case provides an example of how the

Department has created work for itself and wasted its own resources, the resources of the hearing

officer, and the time and resources of the Taxpayers because of its careless and inattentive

handling of the Taxpayers' original refund claims. If the Department had promptly and

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courteously responded to the Taxpayers' refund claim and explained that it must be denied on the

basis of untimeliness rather than on the basis of the merits of their claim, chances are the

Taxpayers would have accepted the basis for their refund denial. It would also have been an

excellent opportunity for the Department to explain how the tax treatment of federal retirement

benefits evolved as a result of both litigation and the legislature's response. This would have

given the Taxpayers the opportunity to understand that they had improperly filed for 1990

without the necessity of the assessment at issue herein. They would have had the opportunity to

file an amended return and to avoid the imposition of additional interest. Instead, the Taxpayers

were treated with indifference and carelessness. While I am sympathetic to the Taxpayers'

frustrations with the Department's handling of their refund claim, nonetheless, the Department

must follow the mandates of the Legislature with respect to when such claims must be filed.

The claims were filed beyond the statute of limitations and cannot be granted to offset the

Taxpayers' liability for the 1990 tax year.

With respect to the assessment at issue, it is simply not a defense that other matters were

mishandled by the Department. Obviously, it would have been best if the Department had

quickly and adequately responded to the Taxpayers' original requests for a refund. This does

not, however, overcome the fact that the Taxpayers improperly claimed an exemption for their

federal retirement income for the 1990 tax year. Assessment No. 564818 correctly assessed

tax, penalty and interest based upon the Taxpayers' erroneous 1990 tax filing and the Taxpayers'

protest must be denied.

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CONCLUSIONS OF LAW

1. The Taxpayers timely filed a written protest, pursuant to Section 7-1-24 NMSA

1978 (1995 Repl.), to Assessment No. 5564818 and, therefore, jurisdiction lies over the parties

and the subject matter of this protest.

2. The Taxpayers erroneously failed to include their 1990 federal military retirement

benefits in their income reported to the Department for the 1990 tax year.

3. The Taxpayers were negligent in not including federal military retirement benefits

received in 1990 when determining their 1990 tax liability.

4. The Taxpayers' claim for refund for overpayment of 1987 and 1988 taxes was not

filed within the time limitations of Section 7-1-26(B) NMSA 1978 and, consequently, the

Taxpayers are not entitled to a refund of such taxes.

5. The Department's gross mishandling of the Taxpayers' claim for a refund for the

1987 and 1988 tax years does not excuse the Taxpayers from liability for the taxes owed for the

1990 tax year.

For these reasons, the Taxpayers' protest is hereby denied.

Done this 24th day of April, 1996.

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