SC Administrative Law Court Decisions

STATEMENT OF THE CASE

This matter is before the Administrative Law Court (“ALC”) for a final order and decision following a contested case hearing pursuant to S.C. Code Ann. § 12-60-460 (Supp. 2006) and S.C. Code Ann. § 1-23-600(B) (Supp. 2006). Petitioner Gary Chapman (“Chapman”) challenges Respondent South Carolina Department of Revenue’s (“Department’s”) proposed income tax assessments for the 1999 and 2002 tax years.

After timely notice to the parties, the court held a hearing on this matter on September 26, 2007, at the ALC in Columbia, South Carolina. Both parties attended the hearing. Evidence was introduced and testimony presented. After carefully weighing all of the evidence, the court finds that monies received by Chapman in 1999 and 2002 are subject to state income taxes without any further deductions.

PROCEDURAL HISTORY

Chapman failed to file South Carolina income tax returns for 1999 and 2002. As a result, the Department issued Chapman proposed assessments for these years based on information it received from the Internal Revenue Service (“IRS”). Chapman timely contested both proposed assessments. On May 7 and 8, 2007, the Department issued Final Agency Determinations in which it affirmed the proposed assessments. On June 4, 2007, Chapman timely requested a contested case hearing before the ALC.

ISSUES

The issues raised in this matter are (1) whether Chapman has tax liability for the tax years in question; (2) whether the Department’s proposed assessments are invalid because they are based upon inadmissible hearsay; (3) whether Chapman is entitled to any further deductions or expenses; and (4) whether Chapman’s penalties should be waived.

FINDINGS OF FACT

Having observed the witnesses and exhibits presented at the hearing and closely passed upon their credibility, and taking into consideration the burden of persuasion by the parties, the court makes the following Findings of Fact by a preponderance of the evidence.

Chapman is a resident of South Carolina who failed to file South Carolina income tax returns for 1999 and 2002. The Department received information from the IRS indicating that Chapman received the following taxable income in South Carolina for 1999 and 2002:

Based upon this information, the Department calculated Chapman’s state tax liability by applying a standard deduction and one exemption to the reported wage income and issued a proposed income tax assessment for 1999 on July 22, 2005. The Department contended that, for the 1999 tax year, the income tax owed by Chapman was:

S.C. Tax Due (less withholding) $ 1,548

Penalty $ 774

Interest (as of May 7, 2007) $ 606.93

TOTAL Amount Due $ 2,928.93

However, based on a letter written by Chapman dated August 19, 2005 claiming additional deductions for his wife and children, and also based on the fact that Chapman’s wife did not file a separate tax return in 1999, the Department gave Chapman additional deductions for the 1999 tax year. The amended assessment, dated January 5, 2006, reflected the 1999 income tax owed by Chapman as:

S.C. Tax Due (less withholding) $ 960

Penalty $ 480

Interest (as of May 7, 2007) $ 542.77

TOTAL Amount Due $ 1,982.77

The interest identified in the proposed assessment has continued to accrue since the issuance of the proposed assessment, and will accrue until the proposed assessment is paid. By letter dated January 17, 2006, Chapman protested the proposed amended assessment for tax year 1999 to the Department.

Also based upon the above information, the Department calculated Chapman’s state tax liability for 2002 by applying a standard deduction and one exemption to the reported wage income and issued a proposed income tax assessment for 2002 on October 24, 2006. The Department contends that for the 2002 tax year, the income tax owed by Chapman is:

S.C. Tax Due (less withholding) $ 848

Penalty $ 398.56

Interest (as of October 5, 2006) $ 194.38

TOTAL Amount Due $ 1,440.94

Although Chapman claimed additional deductions and expenses for 2002 for his wife and children, the Department did not adjust the assessment for 2002 as it had done for 1999 based on the fact that Chapman’s wife filed a separate tax return in 2002 and claimed the children as dependents. The interest identified in the proposed assessment has continued to accrue since the issuance of the proposed assessment, and will accrue until the proposed assessment is paid. By letter dated November 20, 2006, Chapman protested the proposed assessment for tax year 2002 to the Department.

While pursuing his protests with the Department, Chapman raised an objection to the taxation of any money or services he received in exchange for services based on an unpublished decision of the United States Court of Appeals for the Fourth Circuit. In addition, Chapman denied the income figures provided by the IRS and claimed that an illegal immigrant had stolen his social security number. Finally, Chapman claimed that the gain from the pre-paid tuition plan from Bob Jones University could not be considered taxable income because he did not work for Bob Jones University.

On May 7 and 8, 2007, the Department issued Final Agency Determinations for the 1999 and 2002 tax years, respectively, in which it affirmed the proposed assessments. Chapman timely filed a request for a contested case before this court to challenge the Department’s Final Agency Determination.

In the proceedings before this court, Chapman primarily focused his objections to the state taxation of his 1999 and 2002 monies on three arguments: first, that the Department’s calculations failed to take into account additional deductions and expenses Chapman incurred during those tax years, and that Chapman should be permitted to deduct a percentage of his business expenses; second, that Chapman has no tax liability because he either did not receive or does not know whether he received income from all the income sources listed by the IRS, and his social security number was stolen by an illegal immigrant; and third, that the Department’s proposed assessments are invalid because they are based upon “hearsay” information obtained by the Department.^[1]

LAW

Based on the foregoing Findings of Fact, the court concludes the following as a matter of law.

1. Jurisdiction and Review

Jurisdiction over this case is vested with the South Carolina Administrative Law Court pursuant to S.C. Code Ann. §§ 1-23-310 et seq. (2000 & Supp. 2006), § 1-23-600(B) (Supp. 2006), and § 12-60-410 et seq. (Supp. 2006).

The weight and credibility assigned to evidence presented at the hearing of a matter is within the province of the trier of fact. See S.C. Cable Television Ass’n v. S. Bell Tel. & Tel. Co., 308 S.C. 216, 222, 417 S.E.2d 586, 589 (1992). Furthermore, a trial judge who observes a witness is in the best position to judge the witness’s demeanor and veracity and to evaluate the credibility of his testimony. See, e.g., Woodall v. Woodall, 322 S.C. 7, 10, 471 S.E.2d 154, 157 (1996); Wallace v. Milliken & Co., 300 S.C. 553, 556, 389 S.E.2d 448, 450 (Ct. App. 1990). In presiding over this contested case, the court serves as the finder of fact and makes a de novo determination regarding the matters at issue. Reliance Ins. Co. v. Smith, 327 S.C. 528, 534, 489 S.E.2d 674, 677 (Ct. App. 1997); see also S.C. Code Ann. § 1-23-600(B) (Supp. 2006).

2. State Income Tax Assessments

a. Procedures

A taxpayer may appeal a proposed assessment issued by the Department by requesting a contested case hearing before the ALC. S.C. Code Ann. § 12-60-450 (Supp. 2006). The standard of proof in these proceedings is a preponderance of the evidence. See Anonymous v. State Bd. of Med. Exam’rs, 329 S.C. 371, 496 S.E.2d 17 (1998). The petitioner bears the burden of proof in this situation. See Leventis v. S.C. Dep’t of Health & Envtl. Control, 340 S.C. 118, 530 S.E.2d 643 (Ct. App. 2000); Stephen P. Bates, The Contested Case Before the ALJD, in South Carolina Administrative Practice & Procedure 161, 200-01 (Randolph R. Lowell & Stephen P. Bates eds., 2004). Furthermore, exemption statutes must be strictly construed against the taxpayer such that the taxpayer must demonstrate that it falls within the parameters of the exemption. Owen Indus. Products, Inc. v. Sharpe, 274 S.C. 193, 262 S.E.2d 33 (1980).

b. Income Tax Act

The State Income Tax Act (“Act”) imposes a tax upon the income of individuals residing in or having certain connections with the State of South Carolina. See S.C. Code Ann. § 12-6-510(A) (2000). The Act directly and plainly states that “[f]or taxable years beginning after 1994, a tax is imposed on the South Carolina taxable income of individuals, estates, and trusts and any other entity except those taxed or exempted from taxation under Sections 12-6-530 through 12-6-550 . . . .” Id. (emphasis added). To compute a resident individual’s taxable South Carolina income, as well as the gross income and adjusted gross income used to arrive at that taxable income figure, the Act adopts, with certain modifications, the mechanisms for making such calculations set forth in the federal Internal Revenue Code. See S.C. Code Ann. § 12-6-560 (2000) (“A resident individual’s South Carolina gross income, adjusted gross income, and taxable income is computed as determined under the Internal Revenue Code with the modifications provided in Article 9 of this chapter and subject to allocation and apportionment as provided in Article 17 of this chapter.”); S.C. Code Ann. § 12-6-1110 (Supp. 2006) (containing similar language). Under the Internal Revenue Code, an individual’s “gross income” includes “all income from whatever source derived.” I.R.C. § 61(a). A taxpayer’s “taxable income” is simply the amount remaining after certain specified deductions have been subtracted from that gross income. I.R.C. § 63(a), (b).

c. Exchange of Taxpayer Information Between the IRS and the Department

I.R.C. § 6103(d)(1) and S.C. Code Ann. § 12-54-220 (2000) permit the IRS and the Department to exchange information concerning taxpayers. Additionally, S.C. Code Ann. § 12-60-430 permits the Department to base its proposed assessments from information received from the IRS. That section provides:

If a taxpayer fails or refuses to make a report or to file a return required by the provisions of this title or required to be filed with the department, the department may make an estimate of the tax liability from the best information available and issue a proposed assessment for the taxes, including penalties and interest.

S.C. Code Ann. § 12-60-430 (Supp. 2006) (emphasis added).

3. Conclusions

Chapman’s uncertainty as to whether he actually received the monies reported on the IRS documents does not excuse his tax liability. The Department based its proposed tax assessments for 1999 and 2002 on information obtained from the IRS, which S.C. Code Ann. § 12-60-430 (Supp. 2006) permits it to do. Although Chapman argues that the Department should be held to the same standard of proof as Chapman, the burden of proof is on the taxpayer to prove that the Department’s assessment is incorrect and to prove the amount that he contends he actually owes. See Stephen P. Bates, The Contested Case Before the ALJD, in South Carolina Administrative Practice & Procedure 161, 200-01 (Randolph R. Lowell & Stephen P. Bates eds., 2004) (burden “rests with the non-agency petitioner to prove . . . that the agency action is incorrect . . . .”); Reliance Ins. Co. v. Smith, 327 S.C. 528, 534, 489 S.E.2d 674, 677 (Ct. App. 1997) (property assessment case wherein challenging party was required to prove correctness of valuation he was seeking); cf. Cloyd v. Mabry, 295 S.C. 86, 367 S.E.2d 171 (1988) (“A taxpayer contesting an assessment has the burden of showing the valuation of the taxing authority is incorrect. [citations omitted]”). Chapman cannot prove by a preponderance of the evidence that the IRS and Department records are faulty if Chapman neither maintained records nor produced any evidence to the contrary.

Chapman argues that he has no tax liability because the exchange of labor for services is not taxable. Chapman bases this argument on an unpublished Fourth Circuit case, United States v. Clarkson, No. 78-5213 (4th Cir. June 24, 1982) (part of a table of decisions without reported opinion), even though citing to unpublished decisions is “disfavored” by the Fourth Circuit. 4th Cir. R. 32.1. Regardless, reference to cases from other jurisdictions is unnecessary where, as here, the South Carolina Code clearly delineates the method for determining taxable income. S.C. Code Ann. § 12-6-560(A) imposes a tax on the taxable income of individuals who are South Carolina residents, and that income is computed “as determined under the Internal Revenue Code . . . .” S.C. Code Ann. § 12-6-560 (2000). Under the Code, taxable income is gross income, minus any deductions or exclusions. I.R.C. § 63. Gross income includes “compensation for services, including fees, commissions, fringe benefits, and similar items . . . .” I.R.C. § 61(a)(1). Clearly, Chapman’s compensation for the services he provided falls under this definition.

Chapman also asserts that he should be allowed to deduct a certain percentage of his business expenses – although he has no records to substantiate this claim – based on the case of Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). In Cohan, the United States Court of Appeals for the Second Circuit held that a taxpayer should be allowed deductions for business expenses even where the taxpayer did not maintain exact records. See Cohan, 39 F.2d at 543-44. Chapman’s reliance on Cohan is misplaced. For Cohan to even arguably apply, the taxpayer must first prove that an expenditure occurred, and only that the exact amount of that expenditure remains to be determined. See Knauss v. Comm’r, 2005 WL 90985, *7 (Tax Ct. 2005) (“First, to qualify for the Cohan rule, a taxpayer must show that some expenditure in fact occurred and only its precise amount lacks direct proof.”). Furthermore, Cohan is a decision by a federal court, based on federal law, whereas Chapman’s situation is clearly a matter of state law, and is governed by South Carolina’s laws and cases.

Under state law, Chapman is required to maintain records to claim deductions for his business expenses. See S.C. Code Ann. § 12-54-210(A) (Supp. 2006) (“A person liable for a tax . . . administered by the department or for the filing of a return with the department . . . shall keep . . . records, render statements, make returns, and comply with regulations as the department prescribes.”) (emphasis added). Because Chapman produced no evidence to substantiate his claim that he should receive additional deductions for business expenses, the Department’s use of the standard deduction should be upheld, and Chapman should receive no further deductions.

Even if this court were to find Cohan persuasive, Chapman presented no evidence whatsoever to support his claim that he is entitled to business deductions. Chapman did not produce a single document to substantiate his alleged business expenses. Nor did he even provide any specific, particularized testimony as to any of his alleged business expenses; rather, he simply vaguely estimated that his total business expenses constituted approximately fifty percent of his income. Indeed, accepting Chapman’s speculative estimates on the basis of Cohan would be “to condone the use of that doctrine as a substitute for burden of proof. This the court will not do.” Coloman v. Comm’r, 540 F.2d 427, 431-32 (9th Cir. 1976).

Chapman also claims that the tuition break he received from Bob Jones University as part of a pre-paid tuition plan is not “wages,” “income,” or “profit,” and therefore not a taxable item. Nevertheless, the benefit Chapman received as a result of this tuition break also falls under the above Code definitions. Although certain pre-paid tuition plans became exempt from taxation under I.R.C. § 529(c)(3)(B)(iii), this particular plan is not included in the exemption. Chapman provides no proof for his claim that the gain he received should not be taxable.

Because there is no evidence showing that any of the reported monies are subject to deductions, they constitute taxable income under the Internal Revenue Code. I.R.C. § 63(a); see Lovell v. United States, 579 F. Supp. 1047 (W.D. Wis. 1984) (“Compensation for labor or service is taxable income . . . .”), aff’d, 755 F.2d 517 (7th Cir. 1984). Therefore, these funds also constitute Chapman’s 1999 and 2002 taxable income for the purpose of South Carolina’s income taxes upon which Chapman must pay the appropriate income tax. See S.C. Code Ann. § 12-6-560 (2000); S.C. Code Ann. § 12-6-1110 (Supp. 2006).

Chapman also argues that the Department’s decision is based upon hearsay. This argument is misplaced for several reasons. First, when a taxpayer fails to file a return, S.C. Code Ann. § 12-60-430 allows the Department to issue a proposed assessment based on the best information available. S.C. Code Ann. § 12-60-430 (Supp. 2006). In this case Chapman did not file a return, and the Department established that this was the best information available to the Department concerning Chapman’s 1999 and 2002 income. Accordingly, the proposed assessments were in accordance with S.C. Code Ann. § 12-60-430. Second, Chapman’s argument misses the mark because whether the Department bases its decision upon hearsay is irrelevant. See Rule 801(c), SCRE (defining hearsay as a “statement, other than one made by the declarant while testifying at the trial or hearing, offered in evidence to prove the truth of the matter asserted”). Finally, to the extent that Chapman’s complaint is that the Department’s records introduced at the hearing contain hearsay, the court notes that the Department’s records, which are based upon the information obtained from the IRS database, were admissible. See, e.g., Rule 803(6), SCRE; Danny R. Collins, South Carolina Evidence 608 (2d ed., S.C. Bar 2000) (stating that the broad definition of “business” contained in Rule 803(6) includes state and federal agencies) (citing Kershaw County Dep’t of Soc. Servs. v. McCaskill, 276 S.C. 360, 278 S.E.2d 771 (1981) and State v. Duncan, 274 S.C. 379, 264 S.E.2d 421 (1980)).

Chapman further claims that his social security number was stolen by an illegal immigrant, and the IRS records reflect some income earned by that individual, rather than Chapman himself. However, he presented no evidence to substantiate this claim.^[2]

Finally, Chapman was charged a penalty for failure to file and for failure to pay, and requested that those penalties be waived. The Department uses South Carolina Revenue Procedural Bulletin #02-5,^[3] which identifies the circumstances under which penalties should be waived. Chapman’s situation does not fall into any of the circumstances laid out in the Bulletin. Moreover, in light of the fact that Chapman has not filed any state tax returns since 1999, a waiver does not appear to be appropriate.

ORDER

Based upon the Findings of Fact and Conclusions of Law stated above, it is hereby

ORDERED that the Department’s proposed income tax assessments for the 1999 and 2002 tax years are upheld.

IT IS SO ORDERED.

______________________________

PAIGE J. GOSSETT

Administrative Law Judge

October 26, 2007

Columbia, South Carolina