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 Indiana Department of Revenue'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 This document is effective as of its date of publication and remains in effect until the date it is superseded by the publication of another document in the Indiana Register.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.

Indiana Medical Center and Pharmacy were not able to document various expenses claimed on their federal corporate income tax returns and failed to file Indiana state corporate income tax returns, and therefore did not show that adjustments made by the Department of Revenue were incorrect.

I. Corporate Income Tax - Imposition.

Authority: I.R.C. § 63; Treas. Reg. § 1.261-1; IC § 6-3-1-3.5; IC § 6-3-1-20; IC § 6-3-1-21; IC § 6-3-2-1; IC § 6-3-2-2; IC § 6-8.1-5-1; IC § 6-8.1-5-4; IC § 6-8.1-10-1; Indiana Dep't. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007); Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138 (Ind. Tax Ct. 2010); Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480 (Ind. Tax Ct. 2012); Indiana Dep't of State Rev. v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); 45 IAC 3.1-1-66.

Taxpayers protest the Department's adjustments made to corporate income tax returns.

Taxpayers, a Medical Center and a Pharmacy with common ownership, are part of an integrative medical practice in Indiana. The practice is a blend of primarily holistic medicine with some traditional medicine and nutrition. The Medical Center is an S Corporation that operates as a medical clinic and therapy treatment center. The Pharmacy is a limited liability company ("LLC") that serves the patients of the Medical Center. The Medical Center's sole shareholder, an individual, is also the sole member of the Pharmacy ("Shareholder"). The building in which Taxpayers are located is wholly owned by Shareholder. The Medical Center and the Pharmacy are not in separate suites of the building, but they are separate legal entities. The Medical Center and Pharmacy are collectively referred to in this Letter of Findings as "Taxpayers."

The Indiana Department of Revenue ("Department") conducted a sales and use tax audit of Taxpayers' businesses. During the course of the audit, the Department discovered that corporate state income tax returns had not been filed for the Medical Center for tax years 2007 through 2013, and for the Pharmacy for tax years 2010 through 2013 (the "Tax Years at Issue"). The Department assessed Taxpayers penalties for failure to timely file returns for each Tax Year at Issue; Taxpayers do not protest the assessment of these penalties. The Department conducted a limited scope investigation of Taxpayers' income for the Tax Years at Issue. During the investigation, the Department discovered expenses that were personal in nature, undisclosed distributions made in excess of the shareholder's basis, of assets acquired for which no supporting documentation was provided, and of the use of accounting methods which are not in line with Generally Accepted Accounting Principles ("GAAP") or any other observed method. The Department utilized information from Taxpayers' adjusted federal income tax returns and Taxpayers' records to prepare corporate state income tax returns for the Tax Years at Issue. Taxpayers' income flowed through to Shareholder. As a result, the Department issued proposed income tax assessments to Taxpayers' Shareholder.

Taxpayers and Shareholder filed the instant protest in response to the proposed assessments, arguing that the audit improperly disallowed certain expenses and depreciation deductions. An administrative phone hearing was held, and this Letter of Findings results for the Medical Center and Pharmacy Taxpayers. Letter of Finding 01-20160570 will be issued separately addressing the Shareholder's protest. Additional facts will be addressed herein as necessary.

I. Corporate Income Tax - Imposition.

As a threshold issue, all tax assessments are prima facie evidence that the Department's claim for the unpaid tax is valid; the taxpayer bears the burden of proving that any assessment is incorrect. IC § 6-8.1-5-1(c); Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007); Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012). Thus, the taxpayer is required to provide documentation explaining and supporting its challenge that the Department's assessment is wrong. Poorly developed and non-cogent arguments are subject to waiver. Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138, 1145 (Ind. Tax Ct. 2010); see also Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480, 486 n.9 (Ind. Tax Ct. 2012). When an agency is charged with enforcing a statute, the jurisprudence defers the agency's reasonable interpretation of that statute "over an equally reasonable interpretation by another party." Indiana Dep't of State Rev. v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014).

Indiana imposes a tax on every corporation's adjusted gross income derived from sources within Indiana. IC § 6-3-2-1(b). To compute the income subject to Indiana corporate income tax, Indiana adopts a multistep process to calculate a corporate taxpayer's taxable Indiana adjusted gross income. Caterpillar, Inc., 15 N.E.3d at 581. The federal law requires taxpayers to report and pay their federal income tax when their gross income exceeds a certain amount. The Indiana statute refers to the Internal Revenue Code to efficiently and effectively compute what is considered the taxpayers' Indiana income tax. That is, IC § 6-3-1-3.5(b) simply provides the starting point to determine a corporate taxpayer's taxable income, stating that the term "adjusted gross income" shall mean, "In the case of corporations the same as 'taxable income' (as defined in Section 63 of the Internal Revenue Code) adjusted as follows . . . ." In determining the taxpayer's Indiana adjusted gross income, Indiana first refers to I.R.C. § 63 as the starting point. From there, the taxpayer must follow various enumerated adjustments–additions and/or subtractions–under IC § 6-3-1-3.5(b). Then, the taxpayer makes additional adjustments based on provisions outside IC § 6-3-1-3.5(b). After making the above mentioned adjustments, the taxpayer determines how much of its income is apportioned (i.e., business income) or allocated (i.e. nonbusiness income) to Indiana, based on provisions outlined in IC § 6-3-2-2. Business income is "income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitutes integral parts of the taxpayer's regular trade or business operations." IC § 6-3-1-20 (as in effect for the Tax Years at Issue). Nonbusiness income is "all income other than business income." IC § 6-3-1-21.

Because both Taxpayers are pass-through entities, the income tax obligations flows through to the Shareholder. IC § 6-3-2-2(a) provides, in relevant part:

With respect to income tax obligations of S Corporations, 45 IAC 3.1-1-66 provides:

In the audit report, the Department disallowed several expenses claimed by Taxpayers. Taxpayers provided copies of their completed federal income tax returns for the Tax Years at Issue, as well as unsigned copies of Indiana corporate income tax returns, which the audit determined did not constitute valid returns under IC § 6-8.1-10-1(d). Taxpayers also provided general ledgers and bank statements for 2011, 2012, and 2013, but failed to provide other requested documents by the agreed upon deadline. Based upon the federal returns and documentation that were provided, the Department created state income tax returns on behalf of Taxpayers. However, the auditor concluded that certain expenses reported on Taxpayers' federal tax returns were not "ordinary and necessary" expenses of carrying on a trade or business under Treas. Reg. § 1.261-1, and therefore disallowed them. The audit report disallowed expense deductions related to assets, automobile expenses, cost of goods sold, depreciation, gross receipts, interest expense, janitorial services, meals and entertainment, repairs and maintenance, travel, office and miscellaneous expenses. Because these deductions were disallowed, these expenses were reclassified as income in the year they were claimed, resulting in additional income tax assessed to the shareholder/member.

The Department's audit made "general adjustments starting with the [Taxpayers'] originally filed federal adjusted gross income . . ." and found that "specific Indiana adjusted gross income calculation adjustments were needed." Taxpayers disagreed with seven of these adjustments as follows:

It must be emphasized that, "Every person subject to a listed tax must keep books and records so that the department can determine the amount, if any, of the person's liability for tax by reviewing those books and records." IC § 6-8.1-5-4(a). In addition, IC § 6-8.1-5-4(c) provides that, "A person must allow inspection of the books and records and returns by the department or its authorized agents at all reasonable times." When Taxpayer repeatedly failed to provide relevant documentation, the audit issued "proposed assessments" based upon the limited information available.

The Department's authority to determine an estimated amount of taxable income and assess additional income tax is based upon IC § 6-8.1-5-1(b) which states that, "If the department reasonably believes that a person has not reported the proper amount of tax due, the department shall make a proposed assessment of the amount of the unpaid tax on the basis of the best information available to the department."

Taxpayers have the burden of demonstrating that the proposed assessment of income tax for each entity was incorrect. IC § 6-8.1-5-1(c) in part states that, "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."

Taxpayers failed to provide adequate documentation to substantiate the various expenses claimed on their corporate income tax returns that were disallowed by the Department. Taxpayers were repeatedly asked for invoices, receipts, and loan documentation detailing the claimed expenses, but failed to provide the relevant documentation as requested. Documentation provided during the protest was the same as that provided during the audit, and therefore did not satisfy the burden of showing that the assessments issued as a result of the audit were wrong. The Department cannot substitute its findings with unsubstantiated estimates from Taxpayers. Therefore, Taxpayers have not shown that the Department's adjustments were incorrect.

Taxpayers' protest is respectfully denied.