SC Administrative Law Court Decisions

STATEMENT OF THE CASE

This matter is before the Court upon a request for a contested case hearing filed by Petitioner (Taxpayer) pursuant to S.C. Code Ann. § 12-60-460 (Supp. 2004). There are two issues presented in this matter. The first issue is whether certain monies received by Taxpayer in 1999 are subject to state income taxes. The second issue is whether Taxpayer should be compelled to pay a monetary penalty to Respondent South Carolina Department of Revenue (Department) pursuant to S.C. Code Ann. § 12-54-43(J) (2000) because his objections to his 1999 income tax liability are frivolous. After timely notice to the parties, a hearing of this case was held at the South Carolina Administrative Law Court in Columbia, South Carolina, on May 17, 2005. Based upon the evidence presented and arguments made at that hearing, and upon the applicable law, I find that certain monies received by Taxpayer in 1999 are income subject to state income taxes and that Taxpayer must pay a monetary penalty to the Department because he has taken a frivolous position in this matter.

FINDINGS OF FACT

Having carefully considered all testimony, exhibits, and arguments presented at the hearing of this case, and taking into account the credibility and accuracy of the evidence, I make the following Findings of Fact by a preponderance of the evidence:

1. Taxpayer filed a timely 1999 South Carolina income tax return. The return indicated that Taxpayer had zero federal taxable income, zero South Carolina taxable income, zero South Carolina withholdings, and zero South Carolina tax liability.[1]

2. After Taxpayer filed his South Carolina return, the Department received a Revenue Agent Report (RAR) from the federal Internal Revenue Service (IRS). That report stated that Taxpayer received the following monies from the following sources during the 1999 tax year:

Rollings Leasing Corporation $ 3,617

Ruan Leasing Company $ 4,985

Fruehauf Trailer Service $ 6,671

UPS Truck Leasing $ 3,007

Thomas & Howard Company $ 1,374

Gambling Winnings $ 8,000

Total: $27,654

3. The Department issued a proposed income tax assessment to Taxpayer for the 1999 tax year based on the amounts reported in the RAR. The amount of the proposed assessment was as follows:

Tax $1,009.00

Interest $ 284.40

Total: $1,293.40

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.

4. Taxpayer timely protested the proposed assessment. While pursuing his protest with the Department, Taxpayer did not deny that he received the amounts specified in the RAR. Rather, he raised a number of objections to the taxation of any amounts of money he received during 1999. The gravamen of these objections is that the federal government lacks the constitutional and statutory authority to impose a tax upon his income.

5. On September 8, 2004, the Department issued a Final Agency Determination in which it affirmed the proposed assessment and additionally assessed a $500 penalty upon Taxpayer on the ground that his “zero return” was a frivolous filing. Taxpayer timely filed a request for a contested case before this Court to challenge the Department’s Final Agency Determination.

6. On December 21, 2004, the Department propounded Requests for Admissions to Taxpayer pursuant to ALC Rule 21 and Rule 36, SCRCP. These requests asked Taxpayer to admit or deny that he received the monetary amounts identified in the IRS Revenue Agent Report. The requests did not deem the amounts received as taxable income, but rather simply asked whether Taxpayer had received the specific dollar amounts from the various identified entities. However, as Taxpayer’s response to the requests failed to admit or deny whether he received such amounts, but instead challenged the taxability of his income, this Court deemed the Department’s Requests for Admissions to be admitted pursuant to Rule 36(a), SCRCP, by an Order dated April 6, 2005. See Resp’t Ex. #1, #2.

7. In the proceedings before this Court, Taxpayer primarily focused his objections to the state taxation of his 1999 income on three arguments: first, that the federal government does not have the authority to impose a direct, non-apportioned income tax upon individuals; second, that the term “income” as used in the Internal Revenue Code does not apply the monies he received during 1999; and third, that the Department’s proposed assessment is invalid because it was based upon information fraudulently provided by an IRS agent. See Pet’r Preliminary Tax Statement (filed Dec. 21, 2004); Pet’r First Exchange of Evidence and Foundation for Documents (filed Jan. 18, 2005).

CONCLUSIONS OF LAW

Based upon the foregoing Findings of Fact, I conclude the following as a matter of law:

Taxability of Taxpayer’s Income

As noted above, Taxpayer essentially raises three arguments to support his contention that the Department is prohibited from assessing an income tax upon the monies he received in 1999. These arguments center around the authority of the federal government to impose an income tax upon individuals. However, as discussed below, these arguments are without merit, and Taxpayer’s 1999 income is subject to taxation in South Carolina.

The South Carolina Income Tax Act (Act), S.C. Code Ann. §§ 12-6-10 et seq. (2000 & Supp. 2004), 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). In order 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 (2000) (same). Under the Internal Revenue Code, an individual’s “gross income” includes “all income from whatever source derived,” I.R.C. § 61(a) (2000), and his or her “taxable income” is simply the amount remaining after certain specified deductions have been subtracted from that gross income, I.R.C. § 63(a) (2000).

In the case at hand, the compensation for services and gambling winnings received by Taxpayer in 1999 fall within the definition of gross income provided in the Internal Revenue Code. See I.R.C. § 61(a)(1) (defining “gross income” as including “[c]ompensation for services, including fees, commissions, fringe benefits, and similar items”); McClanahan v. United States, 292 F.2d 630, 631 (5th Cir. 1961) (“This Court has long since held that gambling winnings of the type here involved are includable in gross income and that gambling losses, to the extent permitted by statute, are deductions.”) (citation omitted); Lutz v. Comm’r, 83 T.C.M. (CCH) 1446, ____ (2002) (“Gross income includes all income from whatever source derived, including gambling.”). And, as these amounts are not, on their face, subject to deduction from that gross income, these monies constitute taxable income under the Internal Revenue Code. I.R.C. § 63(a). Accordingly, these funds also constitute Taxpayer’s 1999 taxable income for the purpose of South Carolina’s income taxes. S.C. Code Ann. §§ 12-6-560, 12-6-1110. Therefore, based upon the definitions of gross and taxable income provided in the Internal Revenue Code and incorporated into the South Carolina Income Tax Act, the funds received by Taxpayer in tax year 1999, as itemized in Finding of Fact # 2, are taxable South Carolina income upon which Taxpayer must pay the appropriate income tax. The Department has calculated that tax to be $1,009.00, plus interest.

In his objections to these taxes, Taxpayer does not contest the accuracy of the Department’s calculations, but rather, he challenges the Department’s authority to assess income taxes upon him in the first instance. These objections are, however, essentially groundless. First, a number of Taxpayer’s objections relate to the power of the federal government under the Sixteenth Amendment to impose a direct, non-apportioned income tax upon individuals. These arguments are not only baseless, but are also irrelevant to the case at hand, in which the taxation power of the State of South Carolina, not the federal government, is at issue. Regardless of whether the federal government has the authority to impose an income tax upon the income received by Taxpayer in 1999, the state clearly has such power, which it has validly exercised through the South Carolina Income Tax Act. See, e.g., State v. Charron, 351 S.C. 319, 323, 569 S.E.2d 388, 390 (Ct. App. 2002) (holding that “the General Assembly may enact any law not expressly or by clear implication, prohibited by the State or Federal Constitution” and that “there is no state or federal constitutional provision prohibiting the South Carolina General Assembly from levying an income tax”). That is, while the state has adopted portions of the Internal Revenue Code for definitional and computational purposes, the state’s power to impose an income tax is not dependent upon the authority of the federal government to impose such a tax and the taxes imposed by the state are not derivative of the taxes imposed by the federal government.

Second, Taxpayer contends that the monies he received in 1999 are not “income” under the Internal Revenue Code, because that term can only be properly construed as applying to corporate income. As discussed above, the income received by Taxpayer in 1999 falls squarely within the definitions of “gross income” and “taxable income” set forth in the Internal Revenue Code and adopted as the mechanism for computing South Carolina taxable income. Moreover, a number of courts have flatly rejected as frivolous the argument that term “income” as used in the Internal Revenue Code does not include the income of individuals. See, e.g., Lonsdale v. United States, 919 F.2d 1440, 1448 (10th Cir. 1990) (characterizing such arguments as “completely lacking in legal merit and patently frivolous”); Biermann v. Comm’r, 769 F.2d 707, 708 (11th Cir. 1985) (stating that arguments like that made by Taxpayer “are patently frivolous, have been rejected by courts at all levels of the judiciary, and, therefore, warrant no further discussion”).

Finally, Taxpayer contends that the Department’s proposed assessment of an income tax upon his 1999 income was improper because it was based upon information from an IRS Revenue Agent Report, which he contends was a fraud perpetrated by an IRS Agent. This argument is misplaced. Regardless of how the Department learned of the income Taxpayer received in 1999, the fact remains that Taxpayer has South Carolina income tax liability for that income and the Department is entitled to issue a proposed assessment for that liability. See S.C. Code Ann. § 12-60-410 et seq. (Supp. 2004). In short, while there is no evidence to suggest that the Revenue Agent Report was fraudulent, even if that report were improperly issued, Taxpayer would not escape liability for income tax upon the income he actually received in 1999. As noted above, the state’s authority to impose and collect income taxes is not dependent upon the taxation authority or collection actions of the federal government.

In sum, I find that the income received by Taxpayer as payment for services rendered and as gambling winnings during the 1999 tax year is subject to income taxation by the State of South Carolina for that year.[2]

Frivolous Filing Penalty

Because Taxpayer’s position in these proceedings is wholly without merit, I further find that a frivolous filing penalty should be assessed against Taxpayer pursuant to S.C. Code Ann. § 12-54-43(J) (2000). That section provides that

[w]henever it appears to an administrative law judge that proceedings before him have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer’s position is frivolous or groundless, damages in an amount not to exceed five thousand dollars must be awarded to the State in the administrative law judge’s decision. These damages must be assessed at the same time as the deficiency, paid upon notice and demand from the department, and collected as a part of the tax.

Id. A “frivolous” argument is one that entirely lacks a legal basis or legal merit. See Black’s Law Dictionary 677-78 (7th ed. 1999) (defining “frivolous,” “frivolous appeal,” and “frivolous suit”); cf. Kahn v. United States, 753 F.2d 1208, 1214 (3d Cir. 1985) (holding that a claim that no federal income tax is owed is frivolous if “there is no argument on either the law or the facts to support it”).

In the instant case, Taxpayer’s position that his 1999 income is not subject to taxation by the State of South Carolina is wholly without legal merit and, thus, frivolous. Taxpayer’s arguments are primarily based upon citations to and quotations from a number of federal court decisions. However, most of the cited cases are outdated and irrelevant to the issues in the instant matter and most of the quotations used by Taxpayer are taken out of context and misconstrue the holdings of those cases. Further, on cross examination, Taxpayer admitted that he had not, in fact, read any of the cases he cited in support of his position. Moreover, other courts that have addressed arguments similar to those made by Taxpayer have noted that those arguments “are patently frivolous, have been rejected by courts at all levels of the judiciary, and, therefore, warrant no further discussion.” Biermann, 769 F.2d at 708. However, despite the frivolous and groundless nature of Taxpayer’s position in this matter, this Court declines to award the Department the entirety of its costs and expenses in this case, a total of some $2,118.07. Rather, this tribunal recognizes that Taxpayer may not have the legal sophistication to appreciate the full extent of the complexities of this tax matter,[3] and therefore limits the monetary penalty imposed upon Taxpayer to the Department’s customary $500 penalty for frivolous filings.

ORDER

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

IT IS HEREBY ORDERED that the Department’s proposed assessment of an income tax upon Taxpayer for the income he received in the 1999 tax year is SUSTAINED. Taxpayer is therefore liable to the Department for income taxes of $1,009.00, plus applicable interest, for tax year 1999.

IT IS FURTHER ORDERED that, as Taxpayer’s position in this contested case matter is frivolous, Taxpayer is additionally liable to the Department for a $500 monetary penalty pursuant to S.C. Code Ann. § 12-54-43(J) (2000).

AND IT IS SO ORDERED.

______________________________

JOHN D. GEATHERS

Administrative Law Judge

Post Office Box 11667

Columbia, South Carolina 29211-1667

June 22, 2005

Columbia, South Carolina