A husband sold and installed blinds on commission and his wife managed the office; part of their pay was reported as self-employment income. Do they owe gross receipts tax on it, and does the state's late assessment excuse the penalty and interest?

Subject

Bill and Sherri McConnell (D&O 98-57)

(The Decision and Order spells the taxpayers' surname "McConnell"; the state's web address and this page's file name use the single-l "McConnel." The two-l spelling used throughout the decision is used here.)

Plain-English summary

Bill and Sherri McConnell both worked for Blinds Direct Factory Showroom in Albuquerque in 1994. Bill sold and installed window blinds; Sherri managed the office. Their accountant reported most of their pay as self-employment (business) income on federal Schedule C, and they paid self-employment tax. When the Department later matched their federal return, it assessed gross receipts tax, penalty, and interest (about $3,899.23) on that business income. The McConnells protested, arguing they were really employees whose pay is exempt from gross receipts tax under Section 7-9-17. Hearing Officer Margaret B. Alcock denied the protest, analyzing each spouse separately.

Bill was an independent contractor. Using the common-law right-to-control test (Burruss; Harger v. Structural Services, adopting Restatement (Second) of Agency § 220; Benavidez v. Sierra Blanca Motors), the Hearing Officer found Blinds Direct controlled only the result, not the means: Bill covered the showroom just two days a week and could send a substitute, set his own appointments the rest of the week, followed no script, installed blinds unsupervised using his own car (23,000 business miles), was paid by the job with no taxes withheld, understood from hiring that he was a contractor, and reported the income on Schedule C while paying self-employment tax. On the totality of the circumstances his commission and installation pay was taxable gross receipts, not exempt wages.

Sherri was partly an employee — but she was stuck with how she reported the rest. Blinds Direct withheld income, Social Security, and Medicare taxes from $6,968 of her pay, which was properly reported as wages and is exempt. But another $4,875 had been reported as business income on Schedule C-EZ, and there were unexplained discrepancies (why 40% of her pay had no withholding; a gap between her testified hours and the income reported). The Department offered a practical out: it would abate the gross receipts tax on that $4,875 if the McConnells filed amended 1994 federal and state returns treating it as wages. After several extensions, the McConnells declined to amend. Because New Mexico law requires a taxpayer to treat a transaction consistently for federal and state purposes (Co-Con, Stohr, Sutin, Thayer & Browne), they were bound by their original federal reporting as business income and could not now claim the wage exemption for that $4,875.

Penalty and interest stood. The assessment (issued November 1997 for 1994) was within the Department's three-year assessment window (Section 7-1-18), so the McConnells' "unfair delay" objection failed. Interest is mandatory under Section 7-1-67 — it compensates the state for the time value of unpaid tax, and the reason for late payment is irrelevant. The negligence penalty under Section 7-1-69 applied because, in New Mexico's self-reporting system, taxpayers must ascertain their own tax consequences; the McConnells were negligent in not checking their gross receipts tax obligations or questioning how their accountant reported their income. (Notably, the penalty maxes out at 10% after five months, so the Department's delay didn't increase it.) Protest DENIED.

What this means for you

• Selling and installing on commission, with no withholding, usually makes you an independent contractor. If you set your own schedule, work unsupervised, can send a substitute, use your own vehicle and tools, and get paid by the job with no taxes taken out, you likely owe gross receipts tax on that income — it isn't exempt employee pay.
• How you (and your accountant) report income federally can lock in the state result. If pay is reported as Schedule C business income and you pay self-employment tax on it, New Mexico will treat it as taxable gross receipts. You generally can't call it wages for state purposes while calling it business income federally.
• The fix for a misclassification is to amend both returns — and the state may even meet you halfway. Here the Department offered to drop the tax on the disputed $4,875 if the McConnells amended their federal and state returns. Declining that offer left them bound by their original filing. If your paperwork is genuinely wrong, amend it.
• Review your return before signing, and question your preparer. Signing a return you don't understand — and not asking why part of your pay is "wages" and part is "business income" — can be treated as negligence supporting a penalty.
• A slow assessment is not a defense. The Department has three years after the end of the year the tax was due to assess. Within that window, delay doesn't excuse the tax, and interest and penalty are figured from the original due date regardless.
• Interest is compensation, not punishment, and it's mandatory. It runs from the day the tax was due until paid, no matter why the payment was late. Penalty for negligence is separate and caps at 10%.

Key questions answered

Why was Bill an independent contractor when he worked for a single company?
Because the right-to-control test looks at whether the company controlled the means of his work, not just the result. Blinds Direct didn't: Bill set his own appointments, could send a substitute, worked unsupervised with his own car, had no withholding, and reported the income as a business on Schedule C. That pattern of independence made his pay taxable gross receipts.

Sherri was an office manager — how is any of her pay taxable?
The wages Blinds Direct actually withheld taxes on ($6,968) were exempt employee wages. The problem was a separate $4,875 the McConnells had reported as business income. The Department offered to abate tax on it if they amended their returns to call it wages, but they declined — so they were held to their original business-income reporting.

Could they have avoided the tax on the $4,875?
Yes — by filing amended federal and state returns reclassifying it as employee wages, exactly as the Department offered. Their choice not to amend meant the consistency rule bound them to the taxable characterization.

Does the Department's delay in assessing cancel the penalty or interest?
No. The assessment came within the three-year statutory window (Section 7-1-18). Interest is mandatory and runs from the due date (Section 7-1-67), and the negligence penalty caps at 10% after five months — so the delay changed neither.

Why were they "negligent" if they relied on an accountant?
New Mexico's self-reporting system charges every taxpayer with a duty to determine their own tax consequences. The McConnells signed a return without asking why part of Sherri's pay was reported as business income and never asked their accountant about state gross receipts tax. That inattention was negligence under Section 7-1-69.

Verbatim citations

The exemption the McConnells claimed (Section 7-9-17):

Exempted from the gross receipts tax are the receipts of employees from wages, salaries, commissions or from any other form of remuneration for personal services.

The control test (quoting Restatement (Second) of Agency § 220, via Harger):

The important distinction is between service in which the actor's physical activities and his time are surrendered to the control of the master, and service under an agreement to accomplish results or to use care and skill in accomplishing results. Those rendering service but retaining control over the manner of doing it are not servants.

The consistency requirement (quoting Co-Con, Inc. v. Bureau of Revenue):

Taxpayers must treat transactions uniformly for all purposes within the tax scheme and not attempt to show, first, a lease for federal purposes and second, a non-taxable event for state tax purposes.

Interest is mandatory (Section 7-1-67(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....

The holding on Bill's status:

The totality of the circumstances surrounding Mr. McConnell's sales and installation activities establishes that Blinds Direct did not exercise the control of an employer over his time and physical activities, nor did it control his means of accomplishing his work.... Mr. McConnell engaged in these activities as an independent contractor.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Bill and Sherri McConnel
• Decision PDF: D&O 98-57

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
BILL AND SHERRI McCONNELL 98-57
ID. NO. 02-288997-00 3
ASSESSMENT NO. 2189371

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on September 30, 1998, before

Margaret B. Alcock, Hearing Officer. Bill and Sherri McConnell appeared on their own behalf. The

Taxation and Revenue Department ("the Department") was represented by Monica M. Ontiveros,

Special Assistant Attorney General. At the end of the hearing, the record was kept open to allow the

parties time to provide additional information to the Department. The matter was submitted for

decision on November 17, 1998. Based on the evidence and the arguments presented, IT IS

DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. During 1994, both the McConnells worked for Blinds Direct Factory Showroom in

Albuquerque, New Mexico.

2. Sherri McConnell worked as office manager for Blinds Direct performing secretarial

and bookkeeping services.

3. Blinds Direct withheld federal and state income taxes, social security taxes, and

Medicare taxes from a portion of its payments to Mrs. McConnell.

4. Bill McConnell worked as a salesperson for Blinds Direct.
5. Mr. McConnell was required to cover the showroom two days a week. If he was

unable to work on an assigned day, he could arrange for someone else to take his place.

6. Mr. McConnell was not paid for the time he spent in the showroom, but any customers

who called or came in were treated as Mr. McConnell's customers and he was paid a commission on

any sales contracts he subsequently entered into with those customers.

7. Mr. McConnell was not told how to deal with customers and was not given a set script

to follow.

8. Mr. McConnell also performed installation services for Blinds Direct. He installed

blinds for his own customers as well as the customers of other salespeople who did not want to do

installation work.

9. Blinds Direct gave Mr. McConnell a list of the orders that came in and he contacted the

customer to arrange a convenient time to deliver and install the blinds.

10. No one went with Mr. McConnell to supervise his work.

11. Customers were charged $5.00 per bracket for installation: Blinds Direct kept 25 cents

per installed bracket and paid Mr. McConnell the balance of $4.75.

12. Blinds Direct issued one monthly check to Mr. McConnell that included both sales

commissions and payment for installation work.

13. When Mr. McConnell was hired by Blinds Direct, he understood he would be working

as an independent contractor rather than as an employee.

14. Blinds Direct did not withhold income taxes or social security taxes from the payments

it made to Mr. McConnell.

15. Mr. and Mrs. McConnell did not receive federal Forms W-2 or 1099 from Blinds Direct

at the end of 1994, although they called several times requesting these documents.

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16. Robert Millner, who had acted as Blinds Direct's accountant in the past, declined to

perform any further work for the company. The company made no other arrangements to issue

required tax forms to its employees and independent contractors.

17. Because Mr. Millner had access to the payroll records of Blinds Direct, the McConnells

engaged him to prepare their 1994 income tax returns.

18. Using Blinds Direct's payroll register, Mr. Millner prepared a federal Form 4852,

Substitute for Form W-2, Wage and Tax Statement, for Sherri McConnell listing wages of $6,968.00

and showing $406.01 federal income tax withheld, $432.02 social security tax withheld, $101.04

medicare tax withhold, and $97.20 New Mexico income tax withheld.

19. Mr. Millner reported $6,968.00 in wages on Line 7 of the McConnells' federal Form

1040, Wages, salaries, tips, etc. He reported the $4,875.00 balance of Mrs. McConnell's income from

Blinds Direct on Schedule C-EZ, Net Profit from Business.

20. Mr. Millner reported Bill McConnell's $39,662.00 of income from sales commissions

and installation work on a separate Schedule C, Profit or Loss from Business, and deducted $6,670.00

for car expenses.

21. Mr. Millner also prepared Schedules SE, Self-Employment Tax, for both Sherri and Bill

McConnell.

22. The McConnells reviewed and signed the 1994 federal Form 1040 prepared by Mr.

Millner. They did not question the method Mr. Millner used to report their income or ask why a

portion of Mrs. McConnell's income was shown as wages while another portion was shown as business

income.

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23. The McConnells did not ask their accountant whether they had any liability for New

Mexico gross receipts tax on their business income and he did not offer them any advice on this subject.

24. On November 9, 1997, the Department mailed the McConnells a notice of

assessment of $3,899.23 in gross receipts tax, penalty and interest due on the business income

reported on their 1994 federal income tax return.

25. On December 1, 1997, the McConnells filed a protest to the assessment based on their

position that they worked for Blinds Direct as employees rather than as independent contractors.

26. At the hearing held September 30, 1998, the Department stated that it would abate the

gross receipts tax, penalty and interest assessed on the $4,875.00 listed as business income on Sherri

McConnell's Schedule C-EZ, provided the McConnells filed amended 1994 state and federal income

tax returns to reflect their position that this income was actually employee wages and should have been

reported as such on their 1994 returns.

27. The hearing officer set the following schedule for the parties to supplement the record:

(1) On or before November 2, 1998, the Department's counsel was to inform the hearing officer, in

writing, whether the McConnells had filed amended 1994 income tax returns acceptable to the

Department; (2) on or before November 12, 1998, the McConnells were to file any response they

wished to make to the information submitted by the Department.

28. On November 2, 1998, Monica M. Ontiveros, counsel for the Department, filed a letter

stating that she had not received any amended returns from the McConnells. The letter further stated

that Ms. Ontiveros called Mr. McConnell that day and was told the McConnells were still working on

the amended returns.

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29. On November 10, 1998, the McConnells sent a draft of an amended 1994 federal

income tax return to Ms. Ontiveros. The return had not been filed with the Internal Revenue Service

and was not signed by Mr. McConnell. No amended state income tax return was submitted.

30. On November 16, 1998, Ms. Ontiveros notified the hearing officer that the Department

could not accept the McConnells' proposed amended return because the return subtracted $6,968.00 of

Sherri McConnell's income—the amount reported as wages on their original 1994 federal return—from

their adjusted gross income. In fact, the McConnells' adjusted gross income should have been

increased by $345.00, the amount of self-employment tax Sherri McConnell reported on the original

1994 return.

31. Ms. Ontiveros' letter stated that she had discussed the matter with Mrs. McConnell,

who said that she and her husband would consult with an accountant. The parties agreed that the

McConnells would have until November 17, 1998 to notify the hearing officer whether they would be

filing amended federal and state income tax returns for 1994.

32. On November 17, 1998, the McConnells notified the hearing officer that they had

decided not to file amended returns.

DISCUSSION

The issue presented is whether Sherri and Bill McConnell are liable for gross receipts tax on

the income they reported as business income on their 1994 federal income tax return. In the event

the McConnells are liable for gross receipts tax, a secondary issue is whether they are liable for the

full amount of interest and penalty assessed by the Department.

I BURDEN OF PROOF.

Section 7-1-17(C) NMSA 1978 provides that any assessment of tax by the Department is presumed

to be correct, and it is the taxpayer's burden to overcome this presumption. Archuleta v. O'Cheskey, 84

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N.M. 428, 431, 504 P.2d 638, 641 (Ct. App. 1972). Moreover, where an exemption from tax is

claimed, the exemption is strictly construed in favor of the taxing authority. Stohr v. New Mexico

Bureau of Revenue, 90 N.M. 43, 46, 559 P.2d 420, 423 (Ct. App. 1976), cert. denied, 90 N.M. 254, 561

P.2d 1347 (1977); Rock v. Commissioner, 83 N.M. 478, 479, 493 P.2d 963, 964 (Ct. App. 1972).

Section 7-1-3(U) NMSA 1978 defines tax to include not only the amount of tax principal imposed

but also, unless the context otherwise requires, the amount of any interest or civil penalty relating to

the assessment. Accordingly, it is the McConnells' burden to establish that the Department's

assessment of gross receipts tax, penalty and interest on their 1994 income is incorrect.

II EMPLOYEE V. INDEPENDENT CONTRACTOR. The McConnells maintain that they

worked for Blinds Direct as employees, rather than as independent contractors, and are therefore

entitled to the exemption from gross receipts found in Section 7-9-17 NMSA 1978, which states:

Exempted from the gross receipts tax are the receipts of employees
from wages, salaries, commissions or from any other form of
remuneration for personal services.

The Department takes the position that the McConnells were independent contractors whose self-

employment income did not qualify for the exemption provided in Section 7-9-17. The Department

further argues that the McConnells are required to treat their income in a consistent manner: they

cannot report their compensation from Blinds Direct as business income for income tax purposes

while reporting the same income as employee wages for gross receipts tax purposes.

In determining whether a person is an employee or an independent contractor, the principal

consideration is the right to control. The relationship of employer and employee usually results

where there is control over the manner and method of performance of the work to be performed.

Where there is only control over the results, and not the details of the performance, the worker is

usually considered to be an independent contractor. Burruss v. B.M.C. Logging Co., 38 N.M. 254,

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31 P.2d 263 (1934). A more recent pronouncement of this rule can be found in Harger v. Structural

Services, Inc., 121 N.M. 657, 663, 916 P.2d 1324, 1330 (1996). In that case, the New Mexico

Supreme Court adopted the approach set out in the Restatement (Second) of Agency § 220(1) to

determine a worker’s status as an employee or an independent contractor:

The important distinction is between service in which the actor’s
physical activities and his time are surrendered to the control of the
master, and service under an agreement to accomplish results or to
use care and skill in accomplishing results. Those rendering service
but retaining control over the manner of doing it are not servants.

Among the factors to be considered are: (1) direct evidence of control; (2) the right to terminate the

employment at will, by either party, without liability; (3) the right to delegate the work or to hire and

fire assistants; (4) the method of payment, whether by time or by the job; (5) whether the party

employed engages in a distinct occupation or business; (6) whether the work is part of the

employer’s regular business; (7) the skill required in the particular occupation; (8) whether the

employer supplies the instrumentalities, tools or the place of work; (9) the duration of a person’s

employment and whether that person works full-time or regular hours; and (10) whether the parties

believe they have created the relationship of employer and employee, insofar as this belief indicates

an assumption of control by one and submission to control by the other. Benavidez v. Sierra Blanca

Motors, 125 N.M. 235, 238, 959 P.2d 569, 572 (Ct. App. 1998). While all of the above factors may

be considered, it is the totality of the circumstances that should determine whether the employer has

the right to exercise essential control over a particular worker.

The Department has adopted Regulation 3 NMAC 2.17.7 (formerly GR 17:1) setting out the

following criteria to determine whether a worker qualifies as an employee:

7.1 In determining whether a person is an employee, the department
will consider the following indicia:

1. is the person paid a wage or salary;

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2. is the “employer” required to withhold income tax from the
   person’s wage or salary;

3. is F.I.C.A. tax required to be paid by the “employer”;

4. is the person covered by workmen’s compensation insurance;

5. is the “employer” required to make unemployment insurance
   contributions on behalf of the person;

6. does the person’s “employer” consider the person to be an
   employee;

7. does the person’s “employer” have a right to exercise control
   over the means of accomplishing a result or only over the
   result (control does not mean “mere suggestion’).

7.2 If all of the indicia mentioned in 3 NMAC 2.17.7.1 are present,
the department will presume that the person is an employee.
However, a person may be an employee even if one or more of the
indicia are not present.

A second regulation under Section 7-9-17 deals specifically with commissioned salespersons.

Regulation 3 NMAC 2.17.10 (formerly GR 17:5) states:

A salesperson who sells for a company on a commission basis is not
an employee of the company where the company exercises no direct
control over the details of performance of the salesperson’s duties
beyond general statements about the scope and nature of the
salesperson’s obligations under the contract between the salesperson
and the company. In addition, where commissions paid to a
salesperson are not subject to withholding taxes or social security
taxes, the salesperson is not considered an employee of the company.
Therefore, receipts from commissions paid to such salesperson for
selling property in New Mexico are subject to the gross receipts tax.

A. Application of Law to Bill McConnell. Applying the factors set out in the

Restatement (Second) of Agency and the Department’s regulations to the evidence presented at the

hearing leads to the conclusion that Mr. McConnell was not an employee entitled to claim the

exemption provided in Section 7-9-17 NMSA 1978. The relevant facts include:

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• Mr. McConnell was required to cover the Blinds Direct showroom only two days a
week; the other three days he set up his own appointments to meet with customers. If McConnell was
unable to work in the showroom on an assigned day, he could arrange for someone else to take his
place.

• Mr. McConnell was not paid for the time he spent in the showroom. Instead, Mr.
McConnell used the time to obtain leads and was paid a commission on any sales contracts he
subsequently entered into with the customers who called or came in while he was in the showroom.

• Mr. McConnell was not told how to deal with customers and was not given a set script
to follow.

• Salespeople for Blinds Direct were given the opportunity to perform installation
services, but were not required to do so. Mr. McConnell elected to install blinds for his own customers,
as well as the customers of other salespeople who did not want to do installation work.

• Blinds Direct gave Mr. McConnell a list of the orders that came in and he contacted the
customer directly to arrange a convenient time to deliver and install the blinds. No one went with Mr.
McConnell to supervise his work.

• Customers were charged $5.00 per bracket for installation: Blinds Direct kept only 25
cents per installed bracket and turned the balance of $4.75 over to Mr. McConnell.

• Mr. McConnell spent a substantial amount of time out of the office, using his own
automobile to carry out his sales and installation work. For 1994, Mr. McConnell claimed a $6,670.00
deduction for car expenses, stating that he drove 23,000 miles for business purposes during that year.

• Blinds Direct issued one monthly check to Mr. McConnell that included both sales
commissions and payment for installation work. Blinds Direct did not withhold income taxes or social
security taxes from the payments it made to Mr. McConnell.

• When Mr. McConnell was hired by Blinds Direct, he understood he would be working
as an independent contractor rather than as an employee. In 1994 he reported and paid self-
employment taxes to the federal government and reported his income and business deductions on
Schedule C of his federal Form 1040.1

The totality of the circumstances surrounding Mr. McConnell's sales and installation activities

establishes that Blinds Direct did not exercise the control of an employer over his time and physical

activities, nor did it control his means of accomplishing his work. Rather, Mr. McConnell was

1
As discussed in detail under Part II(B), this factor is of particular importance in determining whether a person is
acting as an employee for purposes of state tax reporting.

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engaged to obtain a particular result—the sale and installation of the company's products. Mr.

McConnell engaged in these activities as an independent contractor.

B. Application of Law to Sherri McConnell. Sherri McConnell was an employee of

Blinds Direct with regard to at least a portion of her income. She worked as office manager for Blinds

Direct, performing both secretarial and bookkeeping services. She testified that she was required to

work in the office Monday through Friday from 9:00 a.m. to 6:00 p.m. and was paid compensation of

$9.00 an hour. Blinds Direct withheld federal and state income taxes, social security taxes, and

medicare taxes from $6,968.00 of its $11,843.00 payments to Mrs. McConnell. Sherri McConnell was

an employee of Blinds Direct with regard to this portion of her income, which was reported as wages

on Line 7 of the McConnells' 1994 federal income tax return.

There remains some question concerning the $4,875.00 Mrs. McConnell reported as business

income. Although she was the office manager and performed bookkeeping duties for Blinds Direct,

Mrs. McConnell had no explanation for the company's failure to withhold taxes from approximately 40

percent of her compensation. The McConnells reviewed and signed their 1994 federal income tax

return, but did not ask their accountant (who was also the former accountant for Blinds Direct) why he

had reported this portion of her income as business income, rather than as employee wages. Nor is

there any indication they tried to contact Mr. Millner after this issue was raised in the context of the

Department's gross receipts tax assessment.

There is another discrepancy between Mrs. McConnell's testimony and the information con-

tained in her 1994 income tax return. Mrs. McConnell testified that she worked forty hours a week and

was paid $9.00 per hour. If she worked full time during 1994, this should have resulted in income of

approximately $18,720.00, rather than the $11,843.00 reported on the McConnells' federal return.

While it is certainly possible that Mrs. McConnell started work in the middle of the year, there was no

10
testimony to this effect. If Mrs. McConnell did not work a regular or full-time schedule throughout the

year, this could affect the determination of her status as an employee.

Given the unexplained discrepancies in the evidence, it would be my conclusion that the

McConnells have not met their burden of showing that the Department's assessment of gross receipts

tax on $4,875.00 of Sherri McConnell's income was incorrect. Nonetheless, the Department stipulated

that it would treat all of Mrs. McConnell's income as employee compensation not subject to gross

receipts tax if the McConnells amended their 1994 income tax returns to conform to this position.2

Because the McConnells declined to do so, the Department argues that the McConnells have effectively

waived their right to claim Sherri McConnell's income as employee compensation and are bound by the

manner in which they elected to treat their income on their 1994 income tax returns.

New Mexico law holds that a taxpayer must treat transactions uniformly for all purposes within

the tax laws. A taxpayer may not claim to be an independent contractor for purposes of filing federal

income tax returns and claim to be an employee exempt from filing state gross receipts tax returns for

the same period. The first case to address the requirement of consistency in state tax reporting was Co-

Con, Inc. v. Bureau of Revenue, 87 N.M. 118, 529 P.2d 1239 (Ct App., 1974), cert. denied, 87 N.M.

111, 529 P.2d 1232 (1974). Co-Con, Inc. was a wholly owned subsidiary of Universal Constructors,

Inc. During the audit period, pieces of construction equipment were used by both companies without

regard to which corporation held legal title to the equipment. Each corporation attributed a value to

the other corporation's use of the owner corporation's equipment and reflected that value as “gross

rentals” for federal income tax purposes. The Department treated the rental income reported on the

federal returns of Co-Con, Inc. and Universal Constructors, Inc. as gross receipts from leasing

property in New Mexico and assessed gross receipts tax on this amount. The corporations argued

11
that they did not have gross receipts from equipment rental. The Court of Appeals upheld the

assessments, finding that the corporations' treatment of the transactions as rentals for federal income

tax purposes was binding for state tax purposes. As the court stated:

Taxpayers must treat transactions uniformly for all purposes within
the tax scheme and not attempt to show, first, a lease for federal
purposes and second, a non-taxable event for state tax purposes. We
find ample evidence in the record to indicate that taxpayers engaged
in leasing, both by intent and within the scope of the statutory
definition.

Id., 87 N.M. at 121-122.

In Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d 420(Ct. App. 1976), cert.

denied, 90 N.M. 254, 561 P.2d 1347 (1977), the Court of Appeals upheld an assessment of gross

receipts tax against Mr. Stohr's compensation from performing carpentry work for various

individuals. Mr. Stohr argued that these amounts were wages exempt from gross receipts tax under

Section 72-16A-12.5 NMSA 1953, the predecessor to Section 7-9-17 NMSA 1978. The court noted

that during the audit period Mr. Stohr filed self-employment tax returns for social security purposes

and filed federal Schedule C's reporting his compensation as business income. In determining Mr.

Stohr liable for gross receipts tax, the court examined the indicia of employment found in the

Department’s regulation, which were the same as those found in current Regulation 3 NMAC 2.12.7.

The court then stated:

The controlling factor, however, is that the taxpayer must treat
transactions uniformly for all purposes within the tax laws. The
taxpayer must not attempt to show one scheme for federal tax
purposes and a nontaxable event for purposes of state gross receipts
taxes. (citations omitted, emphasis added).

2
In her November 16, 1998 letter to the hearing officer, Ms. Ontiveros estimated that this would reduce the
McConnells' gross receipts tax liability by approximately $500.00.

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Thus, the court found that the manner in which Mr. Stohr reported his compensation for federal

purposes controlled the determination of whether that compensation could be considered wages

exempt from gross receipts taxes.

The most recent case to address the need for consistency in filing state and federal returns is

Sutin, Thayer & Browne v. Revenue Division of the Taxation and Revenue Department, 104 N.M.

633, 725 P.2d 833 (Ct. App. 1985), cert. denied, 102 N.M. 293, 694 P.2d 1358 (1986). The issue in

that case was whether the Sutin firm could claim a wage deduction on its state corporate income tax

return that exceeded the wage deduction claimed on its federal return. The Tax Reduction and

Simplification Act of 1977, Pub. L. No. 95-30, enacted a new jobs tax credit to provide employers

with an incentive to create new jobs. Under that act, a corporation could either claim a federal tax

deduction for the wages paid to its employees or elect a jobs credit for wages paid to certain new

employees. The Sutin firm elected to claim the jobs credit on its federal return. Because New

Mexico did not have a similar jobs credit, the Sutin firm claimed a deduction for all of the wages

paid to new employees on its New Mexico return. The Department disallowed the deduction,

arguing that a taxpayer cannot claim the federal credit on its federal return and then add in the wage

deduction it forfeited on its federal return when calculating state taxable income. The court upheld

the Department's position, noting that, “[A] taxpayer who makes an election for federal purposes is

bound by that election in calculating the amount of its state taxes.” Id., 104 N.M. at 636.

The foregoing cases establish that a taxpayer may not treat a taxable transaction one way for

federal tax purposes and a different way for state tax purposes. In this case, the McConnells claim

that their 1994 federal and state income tax returns are incorrect and do not accurately reflect the

true character of Mrs. McConnell's compensation. Although they have been given the opportunity

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and, in fact, have an obligation3 to file amended federal and state income tax returns, they have

declined to do so. Under these circumstances, the McConnells are bound by their method of

reporting Mrs. McConnell's compensation to the federal government and are not entitled to claim the

exemption provided in Section 7-9-17 NMSA 1978.

III ASSESMENT OF PENALTY AND INTEREST

Having determined that the McConnells are liable for the Department's assessment of gross

receipts tax, it is necessary to address their protest to the assessment of penalty and interest. The

McConnells object to the Department's delay in notifying them of their gross receipts tax liability.

Under the Tax Administration Act, the Department has three years from the end of the calendar year

in which a payment of tax was due to issue an assessment. Section 7-1-18(A) NMSA 1978. The

Department’s November 9, 1997 assessment of gross receipts tax, penalty and interest for the period

January-December 1994 was within this three-year assessment period. The McConnells have not

cited any authority that would preclude the Department from enforcing a timely assessment on the

basis of unfair delay.

New Mexico has a self-reporting tax system that relies upon taxpayers, who have the most

accurate and direct knowledge of their activities, to determine their tax liabilities and accurately report

those liabilities to the state. There are insufficient government resources to audit every taxpayer

periodically to assure tax compliance. Every person is therefore charged with the reasonable duty to

ascertain the possible tax consequences of his action. 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). In this

3
Tax reporting, even when it does not distort income or result in tax savings, is not a matter of convenience or
selecting a method that simplifies reporting requirements. Tax returns are supposed to accurately reflect the
transactions being reported.

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case, it was the McConnells' responsibility to determine whether their business activities created a gross

receipts tax liability to the state.

A. Assessment of Interest. Section 7-1-67 NMSA 1978 governs the imposition of

interest on late payments of tax and provides, in pertinent part:

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).

The legislature’s use of the word “shall” indicates that the assessment of interest is mandatory rather

than discretionary. State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977). The legislature has directed the

Department to assess interest whenever taxes are not timely paid and has provided no exceptions to the

mandate of the statute. The assessment of interest is not designed to punish taxpayers, but to

compensate the state for the time value of unpaid revenues. The reason for a late payment of tax is

irrelevant to the imposition of interest. Even taxpayers who obtain a formal extension of time to pay

tax are liable for interest from the original due date of the tax to the date payment is made. Section

7-1-13(E) NMSA 1978. In this case, the McConnells failed to pay gross receipts taxes when due and

interest was properly assessed.

B. Assessment of Penalty. Section 7-1-69 NMSA 1978 (1995 Repl.Pamp.) governs the

imposition of penalty during the periods at issue in this protest. Subsection A 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...

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

(formerly GR 69:3) as:

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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.

The McConnells' failure to pay gross receipts tax was based on their inattention to the requirements of

New Mexico's tax laws. Although the McConnells did not intentionally fail to pay tax, they were

negligent in not taking the action required to correctly determine their tax liability to the state. In

particular, they were negligent in failing to question their accountant concerning the method he used to

report their 1994 income and the state tax consequences of such reporting.

Finally, it should be noted that the penalty imposed by Section 7-1-69(A) reaches a

maximum of 10 percent after five months from the original due date of the tax. The delay in issuing

the assessment did not affect the McConnells' liability for penalty, which was the same in November

1997 as it would have been in June 1995, five months after the liability was established.

CONCLUSIONS OF LAW

1. The McConnells filed a timely, written protest to Assessment No. 2189371 pursuant

to Section 7-1-24 NMSA 1978 and jurisdiction lies over both the parties and the subject matter of

this protest.

2. Bill McConnell was not an employee of Blinds Direct and is not entitled to claim the

exemption from gross receipts tax provided in Section 7-9-17 NMSA 1978.

3. Because the McConnells reported $4,875.00 of Sherri McConnell's income and all of

Bill McConnell's income as nonemployee compensation and as income from operating a business,

they are not entitled to claim this amount as wages, salary or commissions from employment for

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purposes of claiming an exemption from gross receipts tax pursuant to Section 7-9-17 NMSA 1978.

4. Pursuant to Section 7-1-67(A) NMSA 1978, interest was properly assessed against the

McConnells on the late payment of gross receipts tax on their 1994 business income.

5. Pursuant to Section 7-1-69(A) NMSA 1978, the McConnells were negligent in failing

to report gross receipts tax due for the period January-December 1994 and penalty was properly

imposed.

For the foregoing reasons, the Taxpayers’ protest IS DENIED.

Done this 9th day of December 1998.

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