If you fill out a New Mexico income tax return wrong by not following the instructions, do you owe penalty and interest even though it was an honest mistake caught years later?

Plain-English summary

Jim Tilghman, an electrical engineer, earned wages in both Arizona and New Mexico in 1994 and moved to New Mexico during that year. On his New Mexico return, instead of starting from federal adjusted gross income as the form directs (Line 7), he entered only his New Mexico wages — reasoning that New Mexico can't tax his Arizona income. He also skipped the PIT-B form, which is how New Mexico correctly handles income earned partly in and partly out of state: it uses total income to set the tax rate, then allocates the tax in proportion to New Mexico wages. Although he had the instruction packet, he didn't consult it.

The Department's IRS "tape match" flagged the mismatch. With a Department employee's help, Mr. Tilghman filed an amended 1994 return with a PIT-B on July 21, 1997, showing $1,094 more tax due, and paid it that day. The Department then assessed $109.40 penalty and $382.90 interest (Assessment No. 719596). The Tilghmans protested.

The Hearing Officer denied the protest:

• The Department couldn't just cut them a break. Its authority to compromise a liability (which by § 7-1-3(U) includes penalty and interest) is limited by § 7-1-20(A) and Regulation 3 NMAC 1.6.14.1 to cases of good-faith doubt about the liability — not inability to pay, small dollar amounts, or expedience. There was no doubt here, so no compromise was available.
• Interest is mandatory and runs from the due date. Section 7-1-67 requires interest on any tax not paid when due (here, from April 1, 1995), with no exceptions. It compensates the state for the time value of money, so the two-year gap before the Department noticed, and Mr. Tilghman's willingness to pay immediately once told, made no difference.
• Not following clear instructions is negligence. The § 7-1-69(A) penalty applies to negligence, defined in Regulation 3 NMAC 1.11.10. The Hearing Officer found the return and instructions clear and unambiguous, and the error came from not reading them, not from genuine complexity. In a self-reporting system, the duty to get it right is the taxpayer's (Tiffany Construction); the Department's failure to catch the mistake doesn't shift that duty, and "human error" is exactly what the negligence standard covers.

Mr. Tilghman's plea — that the state should chase real tax cheats and give honest people a break, and that even the Department admits "we are only human" — didn't change the legal result.

What this means for you

People with income in more than one state

If you earn income both inside and outside New Mexico (or move mid-year), you generally must start from federal adjusted gross income and use the PIT-B form to allocate — not simply plug in your New Mexico wages. New Mexico uses your total income only to set the rate, then taxes the New Mexico share. Doing it your own way, however logical it seems, is what got these taxpayers a negligence penalty. Follow the form instructions exactly, or have a preparer handle the allocation.

Anyone who made an honest return error

An honest mistake is still negligence if it came from not reading and following the instructions. The state won't waive penalty or interest because the amount is small, because you paid promptly once notified, or because it took years to catch the error — the responsibility to file correctly is yours from the start. Interest in particular keeps running until you pay, so fixing an error quickly limits the interest but never erases it.

Accountants and tax professionals

Two points are worth flagging for clients. First, the Department's settlement power is narrow: § 7-1-20(A) and Regulation 3 NMAC 1.6.14.1 permit compromise only on good-faith doubt of liability — not hardship or nuisance value — so "it's a small amount, just waive it" is not an option the Department can grant. Second, "tax" for these purposes includes penalty and interest (§ 7-1-3(U)), and the negligence standard expressly reaches ordinary human error. For multistate clients, confirm the PIT-B allocation is done rather than a manual wage entry on Line 7.

Common questions

Q: New Mexico can't tax my out-of-state income — so wasn't I right to leave it off?
A: New Mexico doesn't tax the out-of-state income directly, but the correct method is to start from federal adjusted gross income and use the PIT-B form, which sets the rate from total income and then taxes only the New Mexico share. Substituting your New Mexico wages on Line 7 skips that mechanism and understates the tax.

Q: It was an honest mistake and I paid the moment I was told — why the penalty and interest?
A: The negligence penalty covers honest mistakes that come from not following clear instructions, and interest is mandatory on any late payment regardless of the reason. Paying promptly once notified limits the interest but doesn't eliminate the penalty or the interest already accrued.

Q: Can't the Department just waive a small amount like this?
A: No. Its authority to compromise a liability — which includes penalty and interest — is limited by statute to cases of good-faith doubt about whether the tax is actually owed. It cannot waive a valid liability because the amount is small or to save the cost of a hearing.

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 multistate allocation rules and its penalty/interest standards, but your facts may differ.

Citations and references

Statutes and regulations:

• § 7-1-67(A) NMSA 1978 — interest on tax not paid when due is mandatory ("shall"), from the due date until paid
• § 7-1-69(A) NMSA 1978 — 2% per month penalty (max 10%) for failure to pay due to negligence
• § 7-1-20(A) NMSA 1978 — the Department may compromise a liability only when there is a good-faith doubt as to the liability
• § 7-1-3(U) NMSA 1978 — "tax" includes any penalty or interest relating to taxes
• Regulation 3 NMAC 1.6.14.1 — closing-agreement/compromise rule (no compromise for inability to pay or mere expedience); Regulation 3 NMAC 1.11.10 — definition of negligence

Case law cited:

• State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977) — "shall" makes the interest assessment mandatory
• Tiffany Construction Co. v. Bureau of Revenue, 90 N.M. 16, 558 P.2d 1155 (Ct. App. 1976), cert. denied, 90 N.M. 255, 561 P.2d 1348 (1977) — every person has a duty to ascertain the tax consequences of their actions; failure to do so is negligence

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Jim and Margaret Tilghman
• Decision PDF: D&O 98-15

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
JIM AND MARGARET TILGHMAN NO. 98-15
PROTEST TO ASSESSMENT NO. 719596

DECISION AND ORDER

This matter came on for formal hearing on March 24, 1998, before Gerald B. Richardson,

Hearing Officer. Mr. and Mrs. Jim Tilghman, hereinafter, “Taxpayers” or “the Tilghmans” were

represented by Mr. Jim Tilghman. The Taxation and Revenue Department, hereinafter,

“Department”, was represented by Monica M. Ontiveros, Special Assistant Attorney General.

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

FOLLOWS:

FINDINGS OF FACT

1. Mr. Tilghman is an electrical engineer who, during tax year 1994, had income from

wages earned in both Arizona and New Mexico. During most of the year, the Tilghmans resided

in New Mexico, but before the end of 1994, they moved their residence to New Mexico.

2. Line 7 of the 1994 New Mexico personal income tax return form is the starting point

for reporting and calculating taxpayer’s 1994 New Mexico personal income taxes. It calls for

taxpayers to fill in their federal adjusted gross income from line 31 of federal form 1040, line 10

from federal form 1040A or line 3 from federal form 1040EZ, depending upon which federal

form a taxpayer used.

3. In filling out the Tilghman’s 1994 New Mexico personal income tax return, Mr.

Tilghman filled in Line 7 with the amount of his New Mexico wages as reported on his federal

W-2 form instead of filling in the amount of his federal adjusted gross income. Mr. Tilghman

did this because knowing that New Mexico does not have the power to impose its income tax

upon his Arizona income, he did not think it was correct to start the return with federal adjusted

gross income which included his wages earned in Arizona.

4. The New Mexico personal income tax filer’s kit contains both tax return forms and

instructions as to how to fill out those forms. Mr. Tilghman admitted to having those

instructions available when he filled out his 1994 New Mexico personal income tax return.

Those instructions inform first year residents who have moved to New Mexico during the tax

year and were nonresidents in the prior year that they are required to file their New Mexico

personal income taxes using forms PIT-1 and PIT-B to allocate and apportion income from

within and outside of New Mexico.

5. The PIT-B form provides the mechanism for imposing income tax in a method by

which only New Mexico wages are considered when determining the amount of income tax to be

imposed upon individuals with income from wages earned both within and without New Mexico.

Rather than directly allocating income between in state and out of state, the total wages are taken

into consideration in determining the tax rate to be applied and to arrive at a calculation of tax.

Then the tax is allocated in proportion to the ratio between New Mexico and non-New Mexico

wages to arrive at the amount of income tax to be imposed.

6. Line 25 of the 1994 New Mexico personal income tax return, form PIT-1, calls for

taxpayers who file a PIT-B form to enter on that line the amount of tax imposed as a result of the

calculations on the PIT-B form.

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7. Line 26 of the 1994 New Mexico personal income tax return, form PIT-1, calls for

taxpayers who filled in Line 25 with the tax calculation from their PIT-B form to enter the

amount from Line 25 on Line 26.

8. Mr. Tilghman did not consult the instruction packet when filling out his 1994 PIT-1

return and did not file or fill out a PIT-B form when originally filing his 1994 New Mexico

personal income taxes.

9. Mr. Tilghman skipped over Lines 25 and 26 when filling out his 1994 New Mexico

PIT-1 return, leaving them blank.

10. The Department has an information sharing agreement with the Internal Revenue

Service (“IRS”) whereby the IRS provides federal income tax return information to the

Department with respect to New Mexico residents.

11. The Department has a “tape-match” program where it compares the information

provided to the IRS and that provided to the Department, with respect to persons filing New

Mexico personal income tax returns.

12. As a result of its tape match program, the Department noticed the discrepancy

between the Tilghman’s federal adjusted gross income as reported to the IRS and to the

Department and requested an explanation. As a result of the discussions which ensued between

Mr. Tilghman and the Department, on July 21, 1997 Mr. Tilghman, with assistance from a

Department employee, filed an amended 1994 New Mexico personal income tax return,

including a PIT-B form. The amended return reported that the Tilghman’s owed the Department

an additional $1,094 in personal income taxes for the 1994 tax year.

13. On that same date, July 21, 1997, Mr. Tilghman paid the Department the additional

$1,094 in taxes.

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14. On August 13, 1997, the Department issued Assessment No. 719596 to the

Tilghmans, assessing $109.40 in penalty and $382.90 in interest with respect to the Tilghman’s

underpayment of their 1994 income taxes as originally filed.

15. On September 5, 1997, the Tilghman’s filed a timely, written protest to Assessment

No. 719596.

DISCUSSION

The issues to be determined herein are whether the Taxpayers are liable for the

assessment of interest and penalty for failing to pay the full and correct amount of personal

income tax for tax year 1994 in a timely manner. Mr. Tilghman has raised several arguments

against the imposition of interest and penalty. With respect to interest, Mr. Tilghman argued

that the amount of interest assessed was excessive because approximately two years elapsed from

the time he filed his 1994 personal income tax return and when the Department notified him of

the discrepancy in reporting tax. Mr. Tilghman paid the tax promptly as soon as he was notified

of the problem, and had he been notified sooner, he would have paid sooner to avoid the

imposition of interest as occurred in this case. Additionally, Mr. Tilghman feels that it is unfair to

assess either penalty and interest before a taxpayer is notified of its error and given an

opportunity to promptly correct the problem.

With respect to penalty, Mr. Tilghman argued that he never intended to underpay tax and

that the underpayment was the result of unintentional error. He argued that the calculation of tax

was complex for taxpayer’s with income from both within and without the state and that he feels

that persons of ordinary intelligence should be able to read and interpret the state tax forms and

instructions. Mr. Tilghman also cited Deputy Secretary Gail Reese’s comment to reporters for

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the Albuquerque Journal when asked about an error in the Department’s 1997 personal income

tax returns. Ms. Reese had admitted the Department’s error and had responded that “We are only

human.” Mr. Tilghman feels that taxpayers, as well as the Department should be given some

allowance for human error with respect to the requirements for filing and reporting taxes.

Finally, Mr. Tilghman argued that given the relatively small amount at issue herein, the fact he

made an honest mistake with no intention to cheat the state of its taxes and that it is commonly

known that there are many who are illegally refusing to report and pay taxes, that the Department

should focus its resources on the really “bad guys” and give a break to honest taxpayers.

While I have no doubt whatsoever about the honesty and integrity of Mr. Tilghman and

that his mistake was, indeed, an honest mistake, the Department is governed by the statutory

directives of the legislature with respect to its administration of taxes. It is required to administer

the tax statutes and to collect taxes when the statutes establish a taxpayer’s liability for tax. The

Department’s authority to compromise or cut deals with respect to liabilities is quite constrained.

Section 7-1-20(A) NMSA 1978 limits the Department secretary’s authority to compromise the

assessment of tax1 to situations where there is a “good faith doubt” as to a taxpayer’s liability for

tax. This limits the Department’s authority to compromise taxes to situations where there is a

legal doubt about liability. As regulation 3 NMAC 1.6.14.1 provides:

The secretary may compromise the assessed liability of a taxpayer
by entering into a written closing agreement only if and when there
is a good faith doubt as to the liability. The written agreement
must adequately protect the interests of the state and be approved
by the attorney general. The secretary may not compromise a
taxpayer’s liability because of the taxpayer’s inability to pay. The
secretary may not compromise a taxpayer’s liability solely because
of the threat of litigation or as an expedient means of disposing of

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“tax” is defined at Section 7-1-3(U) NMSA 1978 to include any penalty or interest relating to taxes for which a
taxpayer is liable

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a controversy unless the secretary has a good faith doubt as to the
liability. (emphasis added).

Thus, although it may not be cost efficient to take a case of this magnitude to formal hearing and

decision, the Department does not have the authority to settle the case for reasons of expediency

in order to focus its resources on cases involving taxpayer dishonesty or where larger amounts of

liability may be in issue.

Section 7-1-67(A) NMSA 1978 governs the imposition of interest on tax

deficiencies and provides as follows:

A. 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. (emphasis added).

It is a well settled rule of statutory construction that the use of the word "shall" in a statute indicates

that the provisions are intended to be mandatory rather than discretionary, unless a contrary

legislative intent is clearly demonstrated. State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977).

Applying this rule to Section 7-1-67, the statute requires that interest be paid to the state on any

unpaid taxes and no exceptions to the imposition of interest are countenanced by the statute. Thus,

it doesn't matter why taxes were not paid in a timely manner. Interest is imposed any time that

taxes are not paid when they are due, and for the period of time that they are unpaid.

There is an aspect of Mr. Tilghman’s argument which conceives of interest as a penalty

imposed to punish a taxpayer for the late payment of taxes. This argument misapprehends the

nature of the assessment of interest. Interest is imposed to compensate the state for the lost value of

having tax revenues at the time they are required to be paid. Those tax revenues could have been

invested by the state and interest earned upon those revenues, until the state needed to use the

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money to meet its obligations. While one may disagree with the rate of interest set by the

legislature, as being excessive in comparison with market rates of interest, that is a matter within

the sound discretion of the legislature, and the Department is without authority to substitute its own

judgment for that of the legislature in setting the rate of interest to be imposed.

In addition to lacking the authority to change the rate at which interest is imposed, the
Department also lacks the authority to depart from the mandates of Section 7-1-67 with respect to
the period for which interest must be imposed. The statute requires that interest be imposed from
the due date for the taxes (in this case, April 1, 1995), until the tax is paid. Thus, the Mr. Tilghman
must take his concerns about imposing interest before taxpayers are notified of a liability to the
legislature which writes the tax statutes.
The imposition of penalty is governed by the provisions of NMSA 1978, Section 7-
1-69(A)(1995 Repl. Pamp.), which imposes a penalty of two percent per month, up to a maximum
of ten percent:
In the case of failure, due to negligence or disregard of rules and regulations, but
without intent to defraud, to pay when due any amount of tax required to be paid or
to file by the date required a return regardless of whether any tax is due,....

This statute imposes penalty based upon negligence (as opposed to a willful or fraudulent intent) for

failure to timely pay tax. As stated above, there is no contention that the failure to report and pay

taxes was based upon any conscious attempt by Mr. Tilghman to underreport taxes. What remains

to be determined is whether the Tilghman’s were negligent in failing to report their taxes properly.

Taxpayer "negligence" for purposes of assessing penalty is defined in Regulation 3 NMAC 1.11.10

(formerly TA 69:3) as:

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, carelessness, erroneous belief or
inattention.

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In this case the Taxpayers’ failure to report and pay taxes was based upon Mr. Tilghman’s

failure to follow the Department’s clear directives of its personal income tax return form and the

instructions which accompany it. Mr. Tilghman argued that the way in which New Mexico

calculates tax for those who have income from both within and without New Mexico is complex,

arguing that it was too complex for ordinary individuals to follow. I find the instructions on the

return which require taxpayers to begin with federal adjusted gross income to be quite clear. I also

found the instructions in the instruction packet to be clear and unambiguous. Frankly, Mr.

Tilghman’s failure to calculate his taxes correctly was due much more to his failure to consult, read

and follow the instructions contained in the return and instruction packet rather than the complexity

of New Mexico’s system. This qualifies as taxpayer negligence under pretty much any of the

characterizations of taxpayer negligence contained in regulation 3 NMAC 1.11.10.

Mr. Tilghman’s arguments that penalty and interest should not be imposed until the

Department notifies a taxpayer of the error in how it reported taxes misapprehends the nature of this

state’s tax system. New Mexico has a self-reporting tax system which requires that taxpayers

voluntarily report and pay their tax liabilities to the state. Because of this, the case law is well

settled that every person is charged with the reasonable duty to ascertain the possible tax

consequences of his actions, and the failure to do so has been held to amount to negligence for

purposes of the imposition of penalty pursuant to Section 7-1-69 NMSA 1978. Tiffany

Construction Co. v. Bureau of Revenue, 90 N.M. 16, 558 P.2d 1155 (Ct. App. 1976), cert. denied,

90 N.M. 255, 561 P.2d 1348 (1977).

Although the imposition of penalty is intended to penalize taxpayers who fail to report and

pay taxes in a timely manner, there are sound policy reasons behind the imposition of penalty. A

self-reporting tax system relies upon taxpayers accurately reporting their tax liabilities to the

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government. There are insufficient government resources to audit every taxpayer periodically to

otherwise assure tax compliance. The imposition of penalty provides taxpayers with an incentive to

understand the tax consequences of their actions, to ensure that they understand how taxes are

reported and calculated, and to accurately report their taxes. Thus, the statutes impose the primary

responsibility upon taxpayers to report and pay their taxes accurately and in a timely manner. The

Department’s failure to catch a taxpayer’s error does not act to shift this responsibility to the

Department nor does it provide a defense to the imposition of penalty for the failure to report and

pay the proper amount of taxes.

Finally, with respect to Mr. Tilghman’s argument that Taxpayer’s should be granted relief

from penalty for human error, the standards of negligence specifically encompass such things as

human error.

While it may seem unfair that taxpayers are held to higher standard of care than the tax

collector, this is a legislative policy which reflects the importance the legislature places upon its

requirement that taxpayers accurately report their taxes.

CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protests to Assessment No. 719596 and

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

2. Because the Taxpayers did not pay tax the full amount of tax for which they were

liable at the time it was due, interest was properly assessed pursuant to Section 7-1-67 NMSA 1978.

3. Mr. Tilghman was negligent in failing to follow the instructions with respect to how

to report and file his 1994 personal income taxes, resulting in the underpayment of tax and penalty

was properly assessed pursuant to Section 7-1-69 NMSA 1978.

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

DONE, this 27th day of March, 1998.

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