NOTICE: IC § 6-8.1-3-3.5 and IC § 4-22-7-7 require the publication of this document in the Indiana Register. This document provides the general public with information about the Department's official position concerning a specific set of facts and issues. This document is effective as of its date of publication and remains in effect until the date it is superseded or deleted by the publication of another document in the Indiana Register. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Letter of Findings.

Individuals did not establish that the Department's calculations of individual income tax were incorrect. Therefore, the Department's proposed assessments for individual income tax are correct.

I. Income Tax–Individual Income.

Authority: IC § 6-3-2-1; IC § 6-8.1-5-1; Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007); 45 IAC 3.1-1-3.

Taxpayers protest proposed assessments for additional income tax.

II. Tax Administration–Penalties and Interest.

Authority: IC § 6-8.1-10-1; IC § 6-8.1-10-2.1; 45 IAC 15-11-2.

Taxpayers protest the imposition of penalties and interest.

Taxpayers are married individuals ("Husband" and "Wife") who live in Indiana and file a federal married joint income tax return. Taxpayers are sole shareholders and principally involved in day-to-day operations of an automotive company. As the result of a tax audit, the Indiana Department of Revenue ("Department") determined that for the tax years 2012 and 2013, payments were being made on behalf of the shareholders as compensation in lieu of wages and the Business's checking account had several payments listed for transactions which did not appear to be business-related. During the audit, it was determined that bills were paid from the Business's checking account for personal expenses at the home of the shareholders, such as, septic services, plumbing and toilet repair, lawn care, pool filter repair, window cleaning, satellite television, home phone service, water service, electrical services, trash service, gas service, washer/dryer repairs, payments on furniture, wall coverings, ornamental trees, cleaning expenses, and personal cell phones for the shareholders' children. The business account also paid for expenses at restaurants, nail salons, dry cleaners, athletic club membership dues, for ballet tickets, professional football tickets, boat repairs, shareholders' home insurance policy, personal auto insurance policy, health insurance policy, and life insurance policy. Income tax payments were also made to the federal and state governments on behalf of the shareholders from the corporation's business checking account.

The Department therefore adjusted the amounts of business expenses listed. This adjustment resulted in a reduction of business expenses available for Business, which resulted in higher amounts of taxable income for Business for the tax years. The increased taxable income for Business flowed through to Taxpayers. The Department consequently decided that Taxpayers' income was higher than originally reported for the tax years 2012 and 2013. The Department issued proposed assessments for individual income tax, penalty, and interest for those years. Taxpayers protested that some of the Department's adjustments were incorrect and that they did not owe as much individual income tax as determined in the audit. An administrative hearing was held and this Letter of Findings results. Further facts will be supplied as required.

Taxpayers protest the Department's determination of additional income tax due for the tax years 2012 and 2013. Specifically, Taxpayers protest that the Department incorrectly determined that certain purchases by Business were not qualified business expenses. The Department based its determinations on the grounds that Business had claimed certain amounts of qualified business expenses on its federal income tax returns. The Department reviewed Business's records and found several purchases listed which the Department deemed to be of a personal nature and not qualified business expenses. The Department's audit states that during the audit Taxpayers did provide some requested documentation such as, but not limited to, detailed receipts of purchases, and explanations of purchases. After review, the Department determined that the documentation was not credible. In one instance the Taxpayer provided a computer generated bill of sale showing that the acquisition of a motorcycle by the business was after the date of sale. Additionally, the bill of sale was only signed by the shareholder and it was not possible to determine the disposition of the motorcycle. Additionally, cash withdrawals were also being made from the business check accounting account at ATM-machines by the shareholders with no records identifying whether the cash was used on ordinary and necessary business expenses. Without such documentation, the Department was unable to verify that Business's claimed qualified business expenses were actually qualified business expenses and so added those unverified amounts back to Business's federal taxable income. The increased amount of taxable income flowed through to Taxpayers and resulted in proposed assessments for additional Indiana individual income tax.

Taxpayers protest that the documentation was available but was not accepted by the Department. Nevertheless, the documentation provided was not sufficient to substantiate the corporation's claim that the charges were ordinary and necessary business expenses.

As a threshold issue, it is the Taxpayers' responsibility to establish that the existing tax assessment is incorrect. As stated in IC § 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the department's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made." Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007). Consequently, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Further, "[W]hen [courts] examine a statute that an agency is 'charged with enforcing. . . [courts] defer to the agency's reasonable interpretation of [the] statute even over an equally reasonable interpretation by another party.'" Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014). Thus, all interpretations of Indiana tax law contained within this decision, as well as the preceding audit, shall be entitled to deference.

IC § 6-3-2-1(a) provides for the imposition of individual income tax. Also of relevance is 45 IAC 3.1-1-3, which provides:

Therefore, Indiana does allow certain business expenses to be deducted from a taxpayer's income, if those expenses are allowed to be deducted as provided by the Internal Revenue Code ("IRC"), as explained by 45 IAC 3.1-1-3.

In the course of the protest and hearing process, Taxpayer provided documentation in support of its position that some of the amounts added back by the Department were qualified business expenses and should not have been added back. The documents provided were the same documents provided during the Audit and previously deemed not to substantiate the claim of business expenses. After a second review in the protest process, the Department remains unconvinced of the documents' credibility. Taxpayers have not met the burden imposed by IC § 6-8.1-5-1(c).

In conclusion, Taxpayers argue that the Department's adjustments to their gross income were incorrect. However, Taxpayers have not provided sufficient documentation supporting their position and have not established that the payments made from Business's checking account were qualified business expenses which were eligible to be included. Since they have not established that the adjustments to Business's returns were incorrect, Taxpayers have not met the burden imposed by IC § 6-8.1-5-1(c) of proving the proposed assessments for individual income tax wrong.

Taxpayers' protest is denied.

II. Tax Administration– Penalties and Interest.

Taxpayers protest the imposition of penalties and interest. The Department notes that it is not permitted to waive interest, as provided by IC § 6-8.1-10-1(e). Taxpayers protest the imposition of penalties pursuant to IC § 6-8.1-10-2.1. Penalty waiver is permitted if the taxpayers show that the failure to pay the full amount of the tax was due to reasonable cause and not due to willful neglect. 45 IAC 15-11-2(b) clarifies the standard for the imposition of the negligence penalty as follows:

The standard for waiving the negligence penalty is given at 45 IAC 15-11-2(c) as follows:

In this case, due to Taxpayers' negligence in reporting all income, the penalty remains.

Taxpayers' protest to the imposition of penalties and interest is denied.

Taxpayers' Issue I protest regarding the imposition of individual income tax is denied. Taxpayers' Issue II protest regarding the imposition of penalties is denied.