ORDERS:
FINAL ORDER AND DECISION
STATEMENT OF THE CASE
This matter comes before me pursuant to S.C. Code Ann. § 12-60-460 (Supp. 1998) upon
Petitioners' request for a contested case hearing. Petitioners ("Taxpayers") contest the Final Agency
Determination of Respondent South Carolina Department of Revenue ("DOR") finding that
Taxpayers are not entitled to income tax deductions for investment interest expense and
miscellaneous business expense, for tax years 1989 through 1991, pursuant to S.C. Code Ann. § 12-7-450 (Supp. 1994).
Taxpayers exhausted their pre-hearing remedies pursuant to S.C. Code Ann. § 12-60-450
(Supp. 1998). After notice to the parties, a hearing was conducted on October 29, 1998. Based upon
the evidence presented, I find and conclude that the Taxpayers are not entitled to the disputed income
tax deductions for tax years 1989 through 1991. Pursuant to the agreement of both parties, this
tribunal's ruling shall apply to subsequent tax years for the Taxpayers. Any motions or issues raised
in the proceedings, but not addressed in this Order are deemed denied pursuant to ALJD Rule 29(C).
STIPULATIONS OF FACT
The parties have stipulated that the following facts be taken as true for purposes of this
contested case proceeding:
1. The Taxpayers ("Husband" and "Wife") are residents of New York.
- The Taxpayers are required to file nonresident South Carolina income tax returns
because Wife owns 50% of the stock of a South Carolina subchapter S corporation
("Corporation X").
- The Corporation X stock is the only investment which the Taxpayers have in South
Carolina.
- The Taxpayers have not borrowed any funds to finance their stock.
- Corporation X was profitable during all the years in question.
- There are no loans from shareholders to Corporation X for the tax periods in
question.
- The Taxpayers deducted the following amounts of investment interest expense and
miscellaneous business expenses on their federal and South Carolina income tax
returns:
Investment Interest Miscellaneous Business
Year Expense Expense
1989 $2,355,816 $ 393,882
1990 $2,724,412 $ 339,877
1991 $1,244,425 $1,072,317
- The Taxpayers own interests in over 150 partnerships and are shareholders in over
125 S corporations. The only one of these entities that does business in South
Carolina is Corporation X.
- The Taxpayers do not actively or materially participate in Corporation X.
- The following miscellaneous business expenses were passed through to the taxpayers
directly from partnerships and S corporations:
1989 $313,611
1990 $ 44,614
1991 $525,218
No miscellaneous business expenses were passed through from Corporation X to the
taxpayers.
- The total assessment by the Department issued on June 22, 1995, was as follows:
Tax $388,191.69
Interest 155,032.45
Penalty 97,047.42
Total 640,271.56(1)
Interest and penalties continue to accrue after June 22, 1995, although penalties have reached
a maximum amount as of the hearing date.
FINDINGS OF FACT
I make the following Findings of Fact in addition to the stipulated facts, taking into
consideration the burden on the parties to establish their respective cases by a preponderance of the
evidence, and taking into account the credibility of the witnesses:
1. On June 15, 1998, DOR issued its Final Agency Determination, stating that the
Taxpayer was not entitled to tax deductions for investment interest expense and miscellaneous
business expense for the tax years 1989 through 1991.
2. Both parties have agreed that the ruling in this case should apply to subsequent tax
years for the Taxpayers.
DISCUSSION
The issue presented in this case is whether the Taxpayers are entitled to deduct investment
interest expense and miscellaneous business expense from their income taxable in South Carolina
for tax years 1989 through 1991. The statute that applies to the tax years in question is S.C. Code
Ann. § 12-7-450 (Supp. 1994), which reads, in pertinent part, as follows:
The South Carolina taxable income of a nonresident
individual . . . is the same as if he were a resident individual . . .
with the following modifications:
(a) South Carolina taxable income as determined in §§ 12-7-410,
12-7-420 or 12-7-425 only includes income from the
following sources:
Income, gains, losses, or deductions attributable to:
(1) The ownership of any interest in real or tangible personal property located in South Carolina;
(2) A business, trade, profession, or occupation
carried on in South Carolina or compensation for
services performed in South Carolina;
(3) A business, trade, profession, or occupation
carried on or compensation for services performed
partly within and partly without South Carolina to the
extent allocable and apportionable to South Carolina
as determined under Article 9 of this chapter;
(4) The distributive share of the South Carolina part
of partnership income, gains, losses, or deductions;
(5) The distributive share of the South Carolina part
of estate or trust income, gains, losses, or deductions;
(6) Income from intangible personal property,
including annuities, dividends, interest, and gains
from the disposition of intangible personal property to
the extent that such income is from property employed
in a trade, business, profession, or occupation carried
on in South Carolina. . . . .
(7) The distributive share of the South Carolina
taxable income or loss of a corporation defined in
Subchapter S of the Internal Revenue Code.
(b) The South Carolina taxable income of a nonresident
individual . . . must be adjusted as follows:
. . .
(2) If a nonresident individual itemizes
deductions, the itemized deductions must be
reduced to an amount which is the same
proportion as South Carolina adjusted gross
income is of federal adjusted gross income.
. . .
(5) For purposes of the computations required
in subitems (1) through (4) of this item, the
term South Carolina adjusted gross income
means the adjusted gross income of the
taxpayer, computed based solely on the
income taxable in South Carolina as
provided in item (a) of this section and in
accordance with the provisions of the
Internal Revenue Code, with the
adjustments provided in § 12-7-230, where
applicable. Adjustments to gross income
authorized by Internal Revenue Code § 62
must be apportioned based on the ratio of
South Carolina gross income to federal
gross income unless the adjustment is
directly connected with an item of gross
income and in such event the adjustment is
allowed in computing South Carolina
adjusted gross income only to the extent the
item of income is taxable in South Carolina.
(emphasis added).(2)
Additionally, S.C. Code Ann. § 12-7-410 (Supp. 1994) provides that the South Carolina gross
income, adjusted gross income, and taxable income of an individual is the individual's gross income,
adjusted gross income, and taxable income as determined under the Internal Revenue Code with the
modifications specified in §§ 12-7-430 and 12-7-435.
S.C. Code Ann. § 12-7-430 (Supp. 1994), entitled "Adjustments to federal gross, adjusted
gross, and taxable income" reads, in pertinent part, as follows:
The South Carolina taxable income of individuals . . . is modified as
provided in this section.
. . .
(e) If the income of a taxpayer is subject to allocation or
apportionment, or both, pursuant to Article 9 of this chapter[,] then
South Carolina taxable income is modified as provided in that article.
Article 9 of Chapter 7 (Title 12 of the S.C. Code) includes S.C. Code Ann. § 12-7-1120,
which provides for the allocation of certain items of income, such as interest, dividends, rents, and
royalties, less all related expenses, to the domicile of the individual taxpayer, or, in the case of rents
and royalties, to the state in which the property was located at the time the income was derived.
(emphasis added). Under this statute, gains or losses from the sale of real property are to be
allocated to the state in which the real property is located Id. Regulation 117-73 defines the term
"related expenses" as any cost incurred, directly or indirectly, in connection with investments for the
production of income or future income which is or will be specifically and directly allocable under
Section 12-7-1120 or costs incurred in the acquisition, sale or exchange of property. 27 S.C. Code
Ann. Regs. 117-73 (1976).
STATUTORY CONSTRUCTION
"The primary rule of statutory construction is to ascertain and give effect to the legislature's
intention or purpose as expressed in the statute." Scholtec v. Estate of Reeves, 327 S.C. 551, 490
S.E.2d 603, 606 (Ct. App. 1997). The language used should be given its plain and ordinary meaning
without resort to subtle or forced construction to expand or limit the scope of a statute. See
Berkebile v. Outen, 311 S.C. 50, 426 S.E.2d 760 (1993). Courts, however, will reject an
interpretation leading to a result so plainly absurd that it could not possibly have been intended, or
would defeat the plain legislative intention; if possible, courts will construe the statute so as to
escape absurdity and carry the intention into effect. Historic Charleston Foundation v. Krawcheck,
313 S.C. 500, 443 S.E.2d 401 (Ct. App. 1994).
A tribunal should not focus on any single section or provision but should consider the
language of the statute as a whole. Mid-State Auto Auction of Lexington, Inc. v. Altman, 324 S.C.
65, 476 S.E.2d 690, 692 (1996); see also City of Columbia v. Niagara Fire Insurance Company, 249
S.C. 388, 154 S.E.2d 674 (1967) (The plain meaning of a statute is best determined by reading the
statute as a whole so that phraseology of an isolated section is not controlling.). "A statutory
provision should be given a reasonable and practical construction consistent with the purpose and
policy expressed in the statute." Town of Mount Pleasant v. Shaw, 315 S.C. 111, 432 S.E.2d 450,
451 (1993) quoting Hay v. South Carolina Tax Commission, 273 S.C. 269, 255 S.E.2d 837, 840
(1979). Additionally, sections which are part of the same general statutory law must be construed
together and each one given effect, if it can be done by any reasonable construction. Ray Bell
Construction Company, Inc. v. School District of Greenville County, 331 S.C. 19, 501 S.E.2d 725
(1998).
APPLICATION OF SECTION 12-7-450 TO THE TAXPAYERS
To adequately determine legislative intent, S.C. Code Ann. § 12-7-450 must be read as a
whole and must be construed together with other sections which are part of the same general
statutory law. Ray Bell Construction , 501 S.E.2d at 730 (1998); Mid-State Auto, 476 S.E.2d at 692
(1996). When read together, Sections 12-7-410, -430, -450, and -1120, require that expenses
associated with the production of income be allocated to the state in which that income is generated.
If such expenses are included in an individual's federal itemized deductions and they are allocable
to a state other than South Carolina, they must be excluded before applying the ratio set forth in
section 12-7-450(b)(2). To include such expenses in the computation of allowable itemized
deductions for South Carolina would render meaningless the allocation requirement in subsection
(a) and in Section 12-7-1120. Therefore, the inclusion of such expenses in the computation of
allowable itemized deductions could not have been intended by the legislature. Historic Charleston
Foundation v. Krawcheck, 443 S.E.2d at 405-406 (Ct. App. 1994); see also Purvis v. State Farm
Mut. Auto. Ins. Co., 304 S.C. 283, 403 S.E.2d 662 (Ct. App. 1991) (appellant's argument rejected
where it rendered a statutory definition meaningless).
Section 12-7-450(b) cannot be read in isolation to mean that the only restriction on South
Carolina itemized deductions is a mere percentage of federal itemized deductions. Such a reading
would give nonresidents an advantage over South Carolina residents by allowing them deductions
that otherwise would have to be allocated to another state under related statutes. Such a reading
would also be inconsistent with the introductory language of Section 12-7-450: "The South Carolina
taxable income of a nonresident individual . . . is the same as if he were a resident individual . . . with
the following modifications. . . ." Subsection (b) then requires the nonresident's taxable income to
be adjusted as specified in that section. Nothing in subsection (b), however, states that the
adjustments listed in that subsection are the only adjustments which must be made. The adjustments
required of all individuals, whether resident or nonresident, in Section 12-7-1120 must also be made.
In fact, paragraph (5) of Section 12-7-450(b) reiterates legislative intent that a taxpayer should not
be allowed to deduct expenses attributable to income not taxed in South Carolina.
The foregoing statutory construction is consistent with the matching principle recognized as
law in South Carolina. See Dalton v. South Carolina Tax Commission, 295 S.C. 174, 367 S.E.2d
459 (Ct. App. 1988). In Dalton, the South Carolina Court of Appeals stated that "[t]he principle of
matching income not taxable in South Carolina[,] since it was generated wholly outside South
Carolina[,] with the expenses that generated that non-taxable income is firmly established as the law
in South Carolina." The matching principle requires that expenses associated with the production
of income be allocated to the state in which that income is generated.
The Taxpayers argue that South Carolina case law on the matching principle is irrelevant
since the enactment of the federal Tax Reform Act of 1986. They reason that after passage of that
Act, investment interest expense and miscellaneous business expense are items not listed in federal
itemized deductions and therefore those expenses are not passed down to the state level anymore.
This argument, however, makes no sense in light of the Taxpayers' insistence that they be allowed
to take itemized deductions for these expenses by including them in the pro-rata calculation set forth
in Section 12-7-450(b)(2). In any event, the matching principle is still recognized as a fundamental
principle of South Carolina tax law.
The Taxpayers also argue that to construe the South Carolina income tax statutes as
disallowing their claimed deductions violates the Privileges and Immunities clause of the United
States Constitution. While the Privileges and Immunities clause prohibits a State from denying
nonresidents a general tax exemption provided to residents, States may limit nonresidents'
deductions of business expenses and nonbusiness deductions based on the relationship between those
expenses and in-state property or income. Lunding v. New York Tax Appeals Tribunal, 118 S.Ct.
766, 776 (1998).
The Taxpayers also argue that the South Carolina income tax statutes should be construed
in their favor. This rule of statutory construction, however, does not apply in the construction of a
statute authorizing deductions; rather, any ambiguity must be resolved against the taxpayer.
Southern Soya Corp. of Cameron v. Wasson, 252 S.C. 484, 167 S.E.2d 311 (1969). Taxpayers did
not present sufficient evidence to establish that any of the claimed expenses related to income
generated by Corporation X in South Carolina.(3) Therefore, S.C. Code Ann. §§ 12-7-450 and -1120
prohibit the deduction of those expenses from the Taxpayers' South Carolina income.
Finally, both parties have agreed to the desirability of applying the ruling in this case to
subsequent tax years for the Taxpayers. Therefore, the parties' agreement shall be incorporated into
this Order.
CONCLUSIONS OF LAW
Based on the foregoing Findings of Fact, I conclude, as a matter of law:
1. The Administrative Law Judge Division has jurisdiction of this matter pursuant to
S.C. Code Ann. § 12-60-460 (Supp. 1998).
2. The standard of proof in administrative proceedings is a preponderance of the
evidence. Anonymous v. State Board of Medical Examiners, 329 S.C. 371, 496 S.E.2d 17 (1998).
3. The trier of fact must weigh and pass upon the credibility of evidence presented. See
S.C. Cable Television Ass'n v. Southern Bell Tel. and Tel. Co., 308 S.C. 216, 417 S.E.2d 586
(1992). The trial judge who observes a witness is in the best position to judge the witness's
demeanor and veracity and evaluate his testimony. See, e.g., McAlister v. Patterson, 278 S.C. 481,
299 S.E.2d 322 (1982).
4. The statute applicable to tax years 1989 through 1991 is S.C. Code Ann. § 12-7-450
(Supp. 1994), which reads, in pertinent part, as follows:
The South Carolina taxable income of a nonresident
individual . . . is the same as if he were a resident individual . . . with
the following modifications:
(a) South Carolina taxable income as determined in §§
12-7-410, 12-7-420 or 12-7-425 only includes income
from the following sources:
Income, gains, losses, or deductions attributable to:
(1) The ownership of any interest in real or tangible personal property located in South Carolina;
(2) A business, trade, profession, or
occupation carried on in South Carolina or
compensation for services performed in South
Carolina;
(3) A business, trade, profession, or
occupation carried on or compensation for
services performed partly within and partly
without South Carolina to the extent allocable
and apportionable to South Carolina as
determined under Article 9 of this chapter;
(4) The distributive share of the South
Carolina part of partnership income, gains,
losses, or deductions;
(5) The distributive share of the South
Carolina part of estate or trust income, gains,
losses, or deductions;
(6) Income from intangible personal property,
including annuities, dividends, interest, and
gains from the disposition of intangible
personal property to the extent that such
income is from property employed in a trade,
business, profession, or occupation carried on
in South Carolina. . . . .
(7) The distributive share of the South
Carolina taxable income or loss of a
corporation defined in Subchapter S of the
Internal Revenue Code.
(b) The South Carolina taxable income of a nonresident
individual . . . must be adjusted as follows:
. . .
(2) If a nonresident individual itemizes
deductions, the itemized deductions must be
reduced to an amount which is the same
proportion as South Carolina adjusted gross
income is of federal adjusted gross income.
. . .
(5) For purposes of the computations required in
subitems (1) through (4) of this item, the term
South Carolina adjusted gross income means
the adjusted gross income of the taxpayer,
computed based solely on the income taxable
in South Carolina as provided in item (a) of
this section and in accordance with the
provisions of the Internal Revenue Code, with
the adjustments provided in § 12-7-230, where
applicable. Adjustments to gross income
authorized by Internal Revenue Code § 62
must be apportioned based on the ratio of
South Carolina gross income to federal gross
income unless the adjustment is directly
connected with an item of gross income and in
such event the adjustment is allowed in
computing South Carolina adjusted gross
income only to the extent the item of income
is taxable in South Carolina.
5. S.C. Code Ann. § 12-7-410 (Supp. 1994) provides that the South Carolina gross
income, adjusted gross income, and taxable income of an individual is the individual's gross income,
adjusted gross income, and taxable income as determined under the Internal Revenue Code with the
modifications specified in §§ 12-7-430 and 12-7-435.
6. S.C. Code Ann. § 12-7-430 (Supp. 1994), entitled "Adjustments to federal gross,
adjusted gross, and taxable income"reads, in pertinent part, as follows:
The South Carolina taxable income of individuals . . . is modified as
provided in this section.
. . .
(e) If the income of a taxpayer is subject to allocation or
apportionment, or both, pursuant to Article 9 of this chapter[,] then
South Carolina taxable income is modified as provided in that article.
7. Article 9 of Chapter 7 (Title 12 of the S.C. Code) includes S.C. Code Ann. § 12-7-1120, which provides for the allocation of certain items of income, such as interest, dividends, rents,
and royalties, less all related expenses, to the domicile of the individual taxpayer, or, in the case of
rents and royalties, to the state in which the property was located at the time the income was derived.
(emphasis added). Under this statute, gains or losses from the sale of real property are to be
allocated to the state in which the real property is located Id.
8. Regulation 117-73 defines the term "related expenses" as any cost incurred, directly
or indirectly, in connection with investments for the production of income or future income which
is or will be specifically and directly allocable under Section 12-7-1120 or costs incurred in the
acquisition, sale or exchange of property. 27 S.C. Code Ann. Regs. 117-73 (1976).
9. "The primary rule of statutory construction is to ascertain and give effect to the
legislature's intention or purpose as expressed in the statute." Scholtec v. Estate of Reeves, 327 S.C.
551, 490 S.E.2d 603, 606 (Ct. App. 1997). The language used should be given its plain and ordinary
meaning without resort to subtle or forced construction to expand or limit the scope of a statute. See
Berkebile v. Outen, 311 S.C. 50, 426 S.E.2d 760 (1993). Courts, however, will reject an
interpretation leading to a result so plainly absurd that it could not possibly have been intended, or
would defeat the plain legislative intention; if possible, courts will construe the statute so as to
escape absurdity and carry the intention into effect. Historic Charleston Foundation v. Krawcheck,
313 S.C. 500, 443 S.E.2d 401 (Ct. App. 1994).
10. A tribunal should not focus on any single section or provision but should consider the
language of the statute as a whole. Mid-State Auto Auction of Lexington, Inc. v. Altman, 324 S.C.
65, 476 S.E.2d 690, 692 (1996); see also City of Columbia v. Niagara Fire Insurance Company, 249
S.C. 388, 154 S.E.2d 674 (1967) (The plain meaning of a statute is best determined by reading the
statute as a whole so that phraseology of an isolated section is not controlling.). "A statutory
provision should be given a reasonable and practical construction consistent with the purpose and
policy expressed in the statute." Town of Mount Pleasant v. Shaw, 315 S.C. 111, 432 S.E.2d 450,
451 (1993) quoting Hay v. South Carolina Tax Commission, 273 S.C. 269, 255 S.E.2d 837, 840
(1979).
11. Sections which are part of the same general statutory law must be construed together
and each one given effect, if it can be done by any reasonable construction. Ray Bell Construction
Company, Inc. v. School District of Greenville County, 331 S.C. 19, 501 S.E.2d 725 (1998).
12. When read together, Sections 12-7-410, -430, -450, and -1120, require that expenses
associated with the production of income be allocated to the state in which that income is generated.
If such expenses are included in an individual's federal itemized deductions, they must be excluded
before applying the ratio set forth in section 12-7-450(b)(2). To include such expenses in the
computation of allowable itemized deductions for South Carolina would render meaningless the
allocation requirement in subsection (a) and in Section 12-7-1120. Therefore, the inclusion of such
expenses in the computation of allowable itemized deductions could not have been intended by the
legislature. Historic Charleston Foundation v. Krawcheck, 443 S.E.2d at 405-406 (Ct. App. 1994);
Purvis v. State Farm Mut. Auto. Ins. Co., 304 S.C. 283, 403 S.E.2d 662 (Ct. App. 1991).
13. "The principle of matching income not taxable in South Carolina[,] since it was
generated wholly outside South Carolina[,] with the expenses that generated that non-taxable
income is firmly established as the law in South Carolina." Dalton v. South Carolina Tax
Commission, 295 S.C. 174, 367 S.E.2d 459 (Ct. App. 1988). The matching principle requires that
expenses associated with the production of income be allocated to the state in which that income is
generated.
14. While the Privileges and Immunities clause prohibits a State from denying
nonresidents a general tax exemption provided to residents, States may limit nonresidents'
deductions of business expenses and nonbusiness deductions based on the relationship between those
expenses and in-state property or income. Lunding v. New York Tax Appeals Tribunal, 118 S.Ct.
766, 776 (1998).
15. Any ambiguity in a statute authorizing deductions must be resolved against the
taxpayer. Southern Soya Corp. of Cameron v. Wasson, 252 S.C. 484, 167 S.E.2d 311 (1969).
16. Taxpayers did not present sufficient evidence to establish that any of their claimed
expenses for tax years 1989 through 1991 related to income generated by Corporation X in South
Carolina. Therefore, S.C. Code Ann. §§ 12-7-450 and -1120 prohibit the deduction of those
expenses from the Taxpayers' South Carolina income.
ORDER
Based upon the foregoing Findings of Fact and Conclusions of Law,
IT IS HEREBY ORDERED that the Taxpayers' claimed deductions for investment interest
expense and miscellaneous business expense for tax years 1989 through 1991 be denied.
IT IS FURTHER ORDERED that, pursuant to the agreement of both parties, the ruling in
this case shall apply to subsequent tax years for the Taxpayers.
AND IT IS SO ORDERED.
______________________________
ALISON RENEE LEE
Administrative Law Judge
Columbia, South Carolina
March 5, 1999
1. These amounts include audit adjustments which are not being contested by the
Taxpayers.
2. Internal Revenue Code § 62 provides for allowable deductions from federal gross
income.
3. Although the Taxpayers did not argue the unitary business doctrine before this tribunal, it appears
that the issue was raised before DOR prior to its Final Agency Determination. This doctrine allows
a taxpayer to offset income taxable in the taxing state with expenses deemed connected with a
multinational business generating income in that state. See Eastman Kodak v. South Carolina Tax
Commission, 308 S.C. 415, 418 S.E.2d 542 (1992). For the expenses to be deemed connected to the
business generating income in the taxing state, the taxpayer must show unity of ownership,
management and operation of the multinational activities of the business. Id. Whether an individual
nonresident taxpayer who is the shareholder of an S corporation with a South Carolina business situs
may offset that corporation's income with expenses attributable to the taxpayer's other holdings is
a question of first impression in this State. In fact, only one other jurisdiction has addressed this
question and it has disallowed the use of the doctrine to an individual taxpayer. See Preston v. Idaho
State Tax Commission, 960 P.2d 185 (Idaho 1998). In any event, even if the doctrine were
applicable to individuals in this State, the Taxpayers have not presented any evidence bearing on this
issue and their alleged entitlement to such treatment. |