Can New Mexico deny an income-tax refund and tax your wages when you report zero federal adjusted gross income, without waiting for the IRS to act?

Plain-English summary

Kerry D. and Kathy L. Shahan, New Mexico residents, filed a 1995 state personal income tax return reporting zero federal adjusted gross income and asked for a refund of the $1,516.19 in New Mexico tax that had been withheld from Kerry Shahan's pay. When the Department asked for the supporting W-2 forms, the couple provided them — and the W-2s showed Mr. Shahan had earned $6,164.53 from Queen Oil & Gas and $33,793.96 from Andarko Petroleum, nearly $40,000 in wages. The Department denied the refund, and the Shahans protested using a series of legal arguments rather than any facts.

The Hearing Officer denied the protest and rejected each argument:

• The Department can determine your federal AGI itself. The Shahans argued the Department was bound by their "zero" figure unless and until the IRS said otherwise. Not so: Section 7-1-4 authorizes the Department to investigate and independently determine any person's tax liability. New Mexico's tax starts from federal adjusted gross income (§ 7-2-2(B)), but the Department doesn't have to wait for the IRS to decide what that number is — and § 7-1-26 lets it deny a refund when there's doubt about the correct liability.
• Wages are income. Internal Revenue Code § 61 defines gross income as "all income from whatever source derived," including compensation for services. Mr. Shahan's wages plainly counted, so the "zero income" claim was wrong.
• The "non-resident alien / federal-employees-only / territorial jurisdiction" theory fails. The income tax applies to "individuals" (26 U.S.C. § 1) in the ordinary sense of that word, not just federal employees, and New Mexico has been within the territorial jurisdiction of the United States since the 1848 Treaty of Guadalupe Hidalgo (through the 1850 Organic Act and 1912 statehood).
• Whether the IRS "legally exists" is irrelevant. The couple submitted a magazine "open letter" questioning the IRS's authority. New Mexico's Income Tax Act simply borrows the Code's definitions to calculate state tax on every resident's net income (§ 7-2-3); it doesn't depend on the IRS's existence or the validity of the federal income tax.
• These are "tired arguments." Quoting Coleman v. Commissioner (7th Cir.), the Hearing Officer noted that courts have repeatedly upheld the taxation of wages against exactly these theories.

The couple bore the burden of proving they were owed a refund and instead showed they had substantially underreported their income. The Hearing Officer noted they could still file an accurate amended return to claim any refund they might genuinely be due.

What this means for you

"Zero income" and other tax-protester refund claims don't work

Reporting zero income when you were paid wages will not produce a refund — it invites a denial and a correction. Wages are income under § 61, New Mexico taxes the net income of every resident, and the recycled theories (you're a "non-resident alien," the IRS isn't real, wages aren't taxable) have been rejected for decades. Filing a return built on them can also expose you to penalties in other cases.

New Mexico doesn't have to wait for the IRS

A key, practical point: because New Mexico's income tax is calculated from your federal adjusted gross income, people sometimes assume only the IRS can decide that number. The Department has its own authority (§ 7-1-4) to investigate and determine your federal AGI and New Mexico liability, and to deny a refund when your reported figures look wrong (§ 7-1-26). An unresolved federal return won't shield a plainly incorrect state filing.

If you're actually owed a refund, file an accurate return

The decision left the door open: the Shahans might be due some refund based on a correct calculation of their New Mexico base income, but only if they file an accurate amended return. A refund claimant carries the burden of proof, so the way to recover an overpayment is with correct numbers and supporting documents — not legal theories.

Accountants and tax professionals

Two durable points: (1) the Department's § 7-1-4 investigatory power lets it independently determine a taxpayer's federal AGI and deny a refund under § 7-1-26 without an IRS determination — piggybacking on federal AGI (§ 7-2-2(B)) does not make the state a passive follower of the IRS; and (2) New Mexico's income tax rests on § 7-2-3 (net income of every resident) and the Code's definitions, so challenges aimed at the IRS's authority or the federal tax's constitutionality are simply not material to state liability.

Common questions

Q: I reported zero income and want my withholding back. Why was the refund denied?
A: Because you had income. Wages are income under Internal Revenue Code § 61, and here the W-2s showed nearly $40,000. A refund claim contradicted by your own wage forms will be denied, and you carry the burden of proving you're actually owed a refund.

Q: Doesn't New Mexico have to accept my federal AGI until the IRS changes it?
A: No. The Department has independent authority under § 7-1-4 to determine your federal adjusted gross income and New Mexico liability, and can deny a refund under § 7-1-26 when the reported figures are doubtful. It need not wait for the IRS.

Q: If the IRS's authority (or the federal income tax) is challenged, does that affect my New Mexico tax?
A: No. New Mexico's Income Tax Act borrows the Code's definitions to tax every resident's net income (§ 7-2-3). It doesn't depend on the IRS's existence or the validity of the federal income tax.

Q: Could I still get a refund?
A: Possibly — but only by filing an accurate amended return with correct income figures. The Hearing Officer specifically noted the taxpayers could do that if a genuine overpayment exists.

Q: Does this decision apply to my situation?
A: Not directly. A Decision and Order resolves one taxpayer's protest on its specific facts and the law in effect at the time. It illustrates New Mexico's authority over income-tax refund claims and the treatment of wages, but your facts may differ. (Note: this is a separate Decision and Order from D&O 97-34, a New Mexico compensating-tax matter involving the same family.)

Citations and references

New Mexico statutes:

• § 7-2-2(B) NMSA 1978 — New Mexico "base income" begins with the taxpayer's federal adjusted gross income
• § 7-2-3 NMSA 1978 — imposes income tax on the net income of every resident individual deriving income from property or employment in the state
• § 7-2-12 NMSA 1978 — individuals required to file must file their returns with the Department
• § 7-1-4 NMSA 1978 — authorizes the Secretary to examine records and determine the extent of any person's tax liability
• § 7-1-26 NMSA 1978 — authority to deny a claim for refund; § 7-1-24 NMSA 1978 — timely written protest
• §§ 9-11-1 to 9-11-13 NMSA 1978 — Taxation and Revenue Department Act, establishing a single unified department to administer the tax laws

Federal law:

• 26 U.S.C. § 61 — gross income means all income from whatever source derived, including compensation for services
• 26 U.S.C. § 62 — adjusted gross income is gross income less certain listed deductions
• 26 U.S.C. § 1 — imposes the individual income tax on "individuals"

Cases cited:

• Coleman v. Commissioner of Internal Revenue, 791 F.2d 68 (7th Cir. 1986) — wages are income and the tax on wages is constitutional; catalogs the standard tax-resister arguments and the cases rejecting them
• Brushaber v. Union Pacific R.R., 240 U.S. 1 (1916) — upholding the federal income tax
• Bettini v. City of Las Cruces, 82 N.M. 633, 485 P.2d 967 (1971) — words in statutes are presumed used in their ordinary sense

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Kerry D. & Kathy L. Shahan
• Decision PDF: D&O 97-41

Original ruling text

BEFORE THE HEARING OFFICER
THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
KERRY D. AND KATHY L. SHAHAN NO. 97-41
PROTEST TO DENIAL OF CLAIM FOR REFUND

DECISION AND ORDER

This matter came on for formal hearing on October 28, 1997, before Gerald B.

Richardson, Hearing Officer. Kerry and Kathy Shahan, hereinafter, “Taxpayers”, represented

themselves at the hearing. The Taxation and Revenue Department, hereinafter, “Department”,

was represented by Frank D. Katz, Chief Counsel. Based upon the evidence and the arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

1. On April 8, 1996, the Taxpayers filed a New Mexico personal income tax return

with the Department. On line 7 of the return, the Taxpayers reported that they had zero Federal

adjusted gross income, as reported on line 31 of federal form 1040 or line 16 of federal from

1040A. The Taxpayers also reported that $1516.19 of New Mexico income tax had been

withheld from them and they requested a refund in that amount.

2. On August 9, 1996, the Department wrote the Taxpayers and proposed to make

adjustments to the Taxpayers’ return. Among the proposed adjustments was that no New

Mexico income tax had been withheld from the Taxpayers because the Taxpayers’ original return

did not provide copies of the Taxpayers’ W-2 forms to support their claim that income tax had

been withheld.

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3. On August 26, 1996 the Taxpayers responded to the Department’s letter. They

provided copies of two W-2 forms and reiterated their demand for a refund in the amount of

income tax withheld, $1516.19.

4. The W-2 forms provided confirmed that the Taxpayers had had $1516.19 of New

Mexico income tax withheld. The W-2 forms also indicated that in 1995, Kerry Shahan had

received wages, tips or other compensation from Queen Oil & Gas Company in the amount of

$6164.53 and he had also received wages, tips or other compensation from Andarko Petroleum

Corporation in the amount of $33,793.96

5. Based upon its review of the Taxpayers’ W-2 forms and returns, on November 8,

1996 the Department wrote to the Taxpayers and informed them that it had denied their claim for

refund.

6. On December 30, 1996 the Taxpayers filed a written protest to the Department’s

denial of their claim for refund.

7. The Taxpayers are residents of New Mexico.

DISCUSSION

The sole issue to be determined herein is whether the Department erroneously denied the

Taxpayers a refund of the income taxes withheld from Mr. Shahan’s wages from employment in

New Mexico.

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The Taxpayers declined to present any factual evidence in support of their claim of

entitlement to the refund claimed. Instead, the Taxpayers chose to rely upon various legal

arguments in support of their claim.

New Mexico imposes its income tax upon the net income of "every resident individual".

New Mexico is among the majority of states which "piggy-back" or use the federal income tax

system as the basis for calculating state income taxes. The calculation of personal income taxes in

New Mexico begins with a determination of "base income" which is defined to be the taxpayer's

"adjusted gross income" as defined in Section 62 of the Internal Revenue Code, plus certain net

operating loss deductions which can be deducted for federal purposes in arriving at federal adjusted

gross income but which New Mexico does not allow to be deducted in the same manner. See,

NMSA 1978, § 7-2-2(B). New Mexico then allows certain deductions, such as the federal standard

or itemized deductions and deductions for income from federal obligations, to arrive at "net

income" upon which income tax is imposed. See, NMSA 1978, 7-2-2(N) and 7-2-3.

The primary issue raised by the Taxpayers is the Department’s authority to make an

independent determination that the zero amount that the Taxpayers reported on line 7 of their New

Mexico return did not accurately reflect their federal adjusted gross income. The Taxpayers argue

that until the Internal Revenue Service makes a determination that their federal adjusted gross

income is other than zero, that the Department is bound by their declaration of zero federal adjusted

gross income. Although the Taxpayers presented no evidence that they also reported zero federal

adjusted gross income to the Internal Revenue Service for the tax year at issue, it will be assumed

for purposes of this discussion that they did so.

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The Taxation and Revenue Department is established under the Taxation and Revenue

Department Act, Sections 9-11-1 to 9-11-13 NMSA 1978. As stated at Section 9-11-3, “[T]he

purpose of the Taxation and Revenue department act is to establish a single, unified department to

administer all laws and exercise all functions relating to taxation, revenue and vehicles charged to

the department.” Section 9-11-6 NMSA 1978 sets forth the authority of the Secretary of the

Taxation and Revenue Department. Specifically, Subsection A provides that it is the Secretary’s

duty to, “manage all operations of the department and to administer and enforce the laws with

which the secretary or the department is charged.” The Income Tax Act, Sections 7-2-1 to 7-2-31

NMSA 1978 is one of those laws relating to taxation which the Department administers. Although

there is no specific provision which explicitly states that the Department administers the Income

Tax Act, there are numerous references to the Department and the Secretary of Taxation and

Revenue within the act to support this conclusion. For instance, Section 7-2-12 requires that

individuals required to file income tax returns to file them with the Department. Additionally, the

Income Tax Act is administered pursuant to the provisions of the Tax Administration Act. See,

Sections 7-2-22 and 7-1-2(A)(1) NMSA 1978. Section 7-1-4 of the Tax Administration Act

provides the authority for the Secretary of the Department to investigate and determine tax

liabilities. Specifically, Subsection A provides:

For the purpose of establishing or determining the extent of the
liability of any person for any tax, for the purpose of collecting any
tax or for the purpose of enforcing any statute administered under the
provisions of the Tax Administration Act, the secretary or the
secretary’s delegate is authorized to examine equipment and to
examine and require the production of any pertinent records, books,
information or evidence, to require the presence of any person and to
require that person to testify under oath concerning the subject
matter of the inquiry and to make a permanent record of the
proceedings.

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This provision gives the Secretary or his delegates the authority to investigate and determine the

extent of liability of any person for any tax. This language is sufficiently broad to authorize the

Department to make its own determinations with respect to any taxpayer’s income tax liability.

Although the calculation of an individual’s New Mexico’s income tax liability starts with a

taxpayer’s adjusted federal gross income, there is no reason to think that only the Internal Revenue

Service can make the determination of what that is. Tax preparers and professionals, as well as

millions of individuals make their own determination of what their client’s or their own federal

adjusted gross income is every time they complete and file a federal income tax return. They make

this calculation by applying the provisions of the Internal Revenue Code to their own individual

circumstances. Section 7-1-4 authorizes the Department to make its own investigation of the facts

and make its own determination of the proper amount of tax owing whenever the Department has

cause to disagree with the information contained in a taxpayer’s return. Thus, the Taxpayer’s

argument that only the Internal Revenue Service can determine a taxpayer’s federal adjusted gross

income is simply erroneous. 1

The Internal Revenue Code, hereinafter, "Code", defines adjusted gross income to

be gross income, less certain deductions which are listed in Section 62 of the Code. Gross income

is defined in Section 61 of the Code as follows:

Except as otherwise provided in this subtitle, gross income means all
income from whatever source derived, including (but not limited to)
the following items:

(1) Compensation for services, including fees, commissions, fringe
benefits and similar items;

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A more difficult issue would be posed if the Internal Revenue Service and the Department made separate
determinations of the amount of a given taxpayer’s federal adjusted gross income which disagreed. As the
Taxpayers presented no evidence to suggest that the IRS had accepted their declaration of their adjusted gross
income nor that it had made its own determination, that issue is not presented by this case.
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(2) Gross income derived from business;

(3) Gains derived from dealings in property;

(4) Interest;

(5) Rents;

(6) Royalties;

(7) Dividends;

(8) Alimony and separate maintenance payments;

(9) Annuities;

(10) Income from life insurance and endowments contracts;

(11) Pensions;

(12) Income from discharge of indebtedness;

(13) Distributive share of partnership gross income;

(14) Income in respect of a decedent; and

(15) Income from an interest in an estate or trust.

26 U.S.C. § 61 (1997). This definition is quite broad and inclusive, and is certainly broad enough

to include under the first listed category of compensation for services the wages or salary paid by

Andarko Petroleum Corporation and Queen Oil Company to Mr. Shahan. Thus, the evidence

establishes that the Taxpayer’s representation that they had zero federal adjusted gross income is

erroneous. We know that they had at least $39,978.49 in income from wages. We don’t know

whether they had additional income to be included in the calculation of federal adjusted gross

income based upon the record herein. Given this state of affairs, and given the Secretary’s

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authority, pursuant to Section 7-1-26 NMSA 1978 to deny any claim for refund of tax, there is

sufficient evidence to justify the Secretary in denying the Taxpayer’s claim for refund based upon a

doubt as to the Taxpayer’s correct income tax liability.

The second argument made by the Taxpayers is that they are non-resident aliens of the

United States and are therefore not subject to taxation under the Internal Revenue Code. By this

argument, I understand the Taxpayers to argue that the Internal Revenue Code applies only to

federal employees or to those residing within the territorial jurisdiction of the United States. There

is nothing in the Internal Revenue Code which limits its applicability to federal employees.

Individual income tax is imposed upon “individuals” pursuant to 26 U.S.C. 1. Although

“individual’ is not defined in the Code, words used in statutes are presumed to be used in their

ordinary and usual sense. Bettini v. City of Las Cruces, 82 N.M. 633, 485 P.2d 967 (1971). An

individual is commonly understood to mean a person and there is nothing in the ordinary

understanding of what an individual or a person is which would limit the term to only apply to

those persons employed by the federal government.

This decision maker has no quarrel with the concept that the Internal Revenue Code would

apply only to those residing within the territorial jurisdiction of the United States. The United

States first acquired territorial jurisdiction over this region from the Republic of Mexico under the

terms of the Treaty of Guadalupe Hidalgo in 1848. I would further direct the Taxpayers' attention

to the Organic Act Establishing the Territory of New Mexico, (Sept. 9, 1850, 9 Stat. 446, ch. 49),

which established the Territory of New Mexico; the joint resolution of Congress to admit the

Territory of New Mexico into the union as a state, (Aug. 21, 1911, No. 8, 37 Stat 39) and the

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presidential Proclamation Admitting New Mexico as a State Into the Union, (Jan. 6, 1912, 37 Stat

1723). New Mexico is clearly within the territorial jurisdiction of the United States.

The Taxpayers also submitted as an exhibit an “open letter to IRS Commissioner” which

was printed in the September, 1996 edition of Media Bypass Magazine, which claims to find no

authority within the Internal Revenue Code authority which created the Internal Revenue Service.

By submitting this article, I assume the Taxpayers argue that if the Internal Revenue Service does

not exist, that its authority to enforce the Internal Revenue Code also does not exist. While I have

not researched the issue of the authority of the Internal Revenue Service, it is really quite irrelevant

to the determination of this matter. New Mexico’s Income Tax Act does not rely upon the authority

of the Internal Revenue Service, but merely refers to definitions in the Code to determine how

taxpayers subject to New Mexico’s income tax must calculate their income taxes for New Mexico.

As noted above, the Department can make its own determination as to what a taxpayer’s federal

adjusted gross income is and apply the Income Tax Act to determine the income tax liability under

that act of those subject to income taxation in New Mexico. Since there is no dispute that the

Taxpayers are residents of New Mexico and since New Mexico’s Income Tax Act imposes a tax

on the net income of every resident individual deriving income from any property or employment

within the state, Section 7-2-3 NMSA 1978, it is simply irrelevant whether or not the Internal

Revenue Service is legally constituted.

As just noted, the legal authority of the Internal Revenue Service and even the legality or

constitutionality of the federal income tax are really irrelevant to the determination of the issue at

hand, which is whether New Mexico may impose its income taxes on those who reside within its

borders and earn income in New Mexico. The fact that New Mexico may use a well understood

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and widely accepted standard, federal adjusted gross income, to measure the calculation of its tax

does not depend upon the legality of the federal income tax itself. Nonetheless, since the

Taxpayer’s arguments really go to the legality of the federal income tax itself, I feel it incumbent to

direct them to the ample federal authority sustaining the federal income tax and upholding the

imposition of federal income tax on wages, specifically, in the face of many of the same arguments

the Taxpayers’ apparently hold dear. There is one case in particular, which addresses the standard

tax resister arguments and cites to numerous federal cases upholding federal income taxes in the

face of these arguments. In Coleman v. Commissioner of Internal Revenue, 791 F.2d 68, the

Seventh Circuit Court of Appeals addressed the consolidated cases of Mr. Norman Coleman and

Mr. Gary Holder. Both of these individuals had argued that their wages were not subject to federal

income taxation. The court had this to say about those arguments:

Coleman says that wages may not be taxed because they come from
his person, a depreciating asset. The personal depreciation offsets
the wage, leaving no net income. Coleman thinks that only net
income may be taxed under the Sixteenth Amendment--net income
as Coleman defines it, not as Congress does. Holder, who styles
himself a "private citizen," insists that wages may not be taxed
because the Sixteenth Amendment authorizes only excise taxes, and
in Holder's world excises may be imposed only on "government
granted privileges." Because Holder believes that he is exercising no
special privileges, he thinks he may not be taxed. These are tired
arguments. The code imposes a tax on all income. See, 26 U.S.C.
§ 61. Wages are income, and the tax on wages is constitutional.
See, among hundreds of other cases, United States v. Thomas, 788
F.2d 1250, 1253 (7th Cir. 1986); Lovell v. United States, 755 F.2d
517 (7th Cir. 1984); Granzow v. CIR, 739 F.2d 265, 267 (7th Cir.
1984); United States v. Koliboski, 732 F.2d 1328, 1329 & n. 1 (7th
Cir. 1984). See also Brushaber v. Union Pacific R.R., 240 U.S. 1,
12, 24-15, 36 S.Ct. 236, 239, 244-45, 60 L.Ed. 2d 493 (1916).

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Id. at 70. As this case and the cases cited therein indicate, there is really no question that Mr.

Shahan’s income from wages paid is income for federal tax purposes, and as such, would be

included in federal adjusted gross income for federal purposes, and by statutory reference, would

also be included in “base income” for purposes of calculating New Mexico personal income taxes.

The Taxpayers may also have had other income which would also be considered to be included in

both federal adjusted gross income and New Mexico base income during the tax year at issue, but

the record is silent on this point. It is the Taxpayers who bear the burden of establishing their

entitlement to the refund which they claimed and the record, so far as it exists, is sufficient to

establish that they have substantially underreported their New Mexico base income upon which

taxes are calculated. It is possible that the Taxpayers are due some amount of refund based upon an

accurate rendition of their New Mexico base income and the Taxpayers may file an accurate

amended return to claim any such refund if they choose to do so. Unless and until they do so,

however, they have failed to meet their burden of proving their entitlement to the refund claimed in

this proceeding. For these reasons, the Taxpayers’ protest will be denied.

CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protest, pursuant to Sections 7-1-26 and 7-1-24

NMSA 1978 to the Department’s denial of their claim for refund and jurisdiction lies over the

parties and the subject matter of this protest.

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2. Mr. Shahan’s wages from employment in New Mexico are included in both gross

income and federal adjusted gross income as defined in the Internal Revenue Code.

3. Mr. Shahan’s wages from employment in New Mexico are included in both "base

income" and "net income" as those terms are defined in the Income Tax Act, Chapter 7, Article 2,

NMSA 1978.

4. The Department has the authority and responsibility to ensure that persons subject to

income tax in New Mexico properly report, calculate and pay their taxes to the Department and

pursuant to this authority, may determine, independently of the Internal Revenue Service, whether

taxpayers are properly reporting and calculating their income taxes owing to the Department.

5. The Taxpayers failed to accurately report their New Mexico base income on the

1995 personal income tax return they filed with the Department.

6. The Taxpayers failed to carry their burden of establishing their entitlement to a

refund of taxes withheld from Mr. Shahan’s wages for tax year 1995.

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

DONE, this 12th day of November, 1997.

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