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Dealing with large bureaucratic organizations can be confusing and frustrating. It sometimes transpires, for example, that the left hand of an entity says yes when the right hand says no. We are told that we can do something by one person and that we can’t by another. Most of us have had at least one experience like this at some point in our lives – and have the high blood pressure and nervous tics to prove it.

When faced with such a situation, a salon owner in New Mexico fought the bureaucratic machine – and won. Her tactic was ingenious: She cited a New Mexico gross receipts tax regulation to fight a New Mexico gross receipts tax assessment (plus penalties and interest).

Back story

The New Mexico Taxation and Revenue Department (Department) assessed the salon owner a total of $2,263.28 for underpayment of gross receipts tax during three separate reporting periods, plus penalty and interest. As the owner and sole proprietor of a salon, she not only receives payment for salon services provided and remits tax on the gross receipts, she also receives tips. This had never been a problem until, in 2010, a new bookkeeper “included Taxpayer’s tips with Taxpayer’s total gross receipts” and the salon owner ended up paying gross receipt tax on the tips. After realizing the error, she filed an amended return “to separately state tips from her gross receipts tax.” And her business caught the eye of the auditor.

The hearing

[she took them to court . . etc]

The Department didn’t think she deserved a refund. In fact, they thought she should have been paying tax on tips all along. The Department’s stance is that “all receipts of a person engaged in business are presumed subject to gross receipts tax and there is no specific statutory deduction or exemption for the receipt of tips.” Therefore, argued the department’s attorney, “Taxpayer’s receipts from tips are subject to gross receipts tax.”

The law

So the salon owner went straight to the law. To defend her position, Taxpayer pointed to Regulation 3.2.1.18 (R) NMAC:

  1. Service charges; tips.

                    (1)     Except for tips, receipts of hotels, motels, guest lodges, restaurants and other similar establishments from amounts determined by and added to the customer’s bill by the establishment for employee services, whether or not such amounts are separately stated on the customer’s bill, are gross receipts of the establishment.

                    (2)     A tip is a gratuity offered to service personnel to acknowledge service given.  An amount added to a bill by the customer as a tip is a tip.  Because the tip is a gratuity, it is not gross receipts. [Emphasis mine.]

                    (3)     Amounts denominated as a “tip” but determined by and added to the customer’s bill by the establishment may or may not be gross receipts.  If the customer is required to pay the added amount and the establishment retains the amount for general business purposes, clearly it is not a gratuity.  Amounts retained by the establishment are gross receipts, even if labeled as “tips”.  If the customer is not required to pay the added amount and any such amounts are distributed entirely to the service personnel, the amounts are tips and not gross receipts of the establishment.

According to Taxpayer, section 2 substantiates her claim that her tips are not subject to the gross receipts tax.

According to the Department, it does not.

The verdict

At the hearing, the Taxation Department found in favor of the taxpayer: “The threshold problem with the Department’s argument is the Department’s own regulation stating that tips are not gross receipts.” It was determined that “since the Department has issued Regulation 3.2.1.18 (R)(2) NMAC … the Department’s argument is not legally persuasive in this protest.” Reason prevails.

To read the full decision, please refer to Tax Decision and Order 15-17.

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