NOTICE: IC § 6-8.1-3-3.5 and IC § 4-22-7-7 requires 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 This document is effective on its date of publication and remains in effect until the date it is superseded or deleted by the publication of another document in the Indiana Register.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.

Married couple protested the determination that a payment pursuant to a promissory note constituted taxable income. After review of the documentation and analysis provided in the protest process, the Department confirmed that the payment was taxable income.

I. Individual Income Tax–Promissory Note.

Authority: IC § 6-3-1-3.5; IC § 6-3-2-1; IC § 6-8.1-5-1; Indiana Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014); 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, 897 N.E.2d 289, 292 (Ind. Tax Ct. 2007); 45 IAC 3.1-1-1; Blacks Law Dictionary (10th ed. 2014).

Taxpayers protest the imposition of Indiana income tax on a payment made to them pursuant to a promissory note.

Taxpayers ("Husband" and "Wife") are a married couple living in Indiana. In 2015, Taxpayers received a payment made under the terms of a promissory note. The Indiana Department of Revenue ("Department") determined that the payment constituted taxable income and issued a proposed assessment for Indiana adjusted gross income tax ("AGIT"), penalty, and interest. Taxpayers filed a protest, arguing that the payment was not taxable income in Indiana. An administrative hearing was held and this Letter of Findings results. Further facts will be supplied as required.

I. Individual Income Tax–Promissory Note.

Taxpayers protest the imposition of Indiana AGIT. Husband had been employed by a company that went out of business. As a result of the business closure, the business converted Husband's capital interest in the business into a series of promissory notes. Several years later, Husband was allowed by the Internal Revenue Service ("IRS") via an agreement ("Agreement") following an IRS examination, to claim as a loss the amount of partnership interest he held in the business. The Agreement also provided that if Husband subsequently received payment for any amount claimed as a loss, such a payment would be considered taxable income in the year it was received. In 2015, the business made a payment representing part of the amount claimed as a loss under the Agreement. The Department considered that payment to be income subject to Indiana AGIT. Taxpayers disagree with the Department's determination.

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 [D]epartment'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, 897 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) states:

IC § 6-3-1-3.5 provides:

Taxpayers protest that the Department misunderstands the nature of the payment they received. Taxpayers state that the payment was, in substance as well as legal form, a payment of a promissory note. Also, Taxpayers state that the only reason the payment was taxable for federal reasons was that the Agreement made it so. In effect, Taxpayers argue, they were repaying the IRS for a tax benefit taken under the terms of the Agreement. Additionally, Taxpayers state that they were not residents of Indiana in the year they took the federal tax benefit under the Agreement, therefore no corresponding Indiana tax benefit was ever taken.

Taxpayers also point to the Department's instructions for filing the IT-40 Indiana income tax return. Those instructions state that a taxpayer who recovers an itemized deduction which that taxpayer claimed in an earlier year should list such a recovery in the following manner:

Taxpayers believe that the "616" code description in the IT-40 instructions is analogous to the payment they received. Taxpayers argue that a federal benefit taken in an earlier year is being repaid, but that no Indiana benefit was ever taken and therefore does not need to be repaid.

The Department does not agree with Taxpayers' conclusion. Specifically, IC § 6-3-1-3.5(a)(6) and the instructions for filing the IT-40 provide that a taxpayer should subtract any amounts included in federal adjusted gross income under Section 111 of the Internal Revenue Code as a recovery of items previously deducted as an itemized deduction from adjusted gross income. In the instant case, Taxpayers did not take the loss as an itemized deduction in the earlier year. Taxpayers have not referred to any statute, regulation, or court case which supports their position that non-itemized deductions may be subtracted from Indiana AGIT calculations.

Taxpayers also state that they were residents of another state in the year that the business went out of business and also in the year that they signed the Agreement with the IRS. This, Taxpayers believe, means that the benefit of taking the loss was never related to Indiana and so Indiana is now precluded from imposing AGIT on the payment. Taxpayers have not referred to any statute, regulation, or court case in support of their position that the fact that they did not live in Indiana during the year when they took the loss under the Agreement means that the payment was not subject to Indiana AGIT.

Next, Taxpayers argue that it is inherently inequitable to require them to treat the payment differently from its legal form of a promissory note payment. "Promissory Note" defined in Blacks Law Dictionary (10th ed. 2014) as:

Taxpayers believe that the fact that the payment flowed from a promissory note means that the payment was not income subject to Indiana AGIT. Taxpayers have not provided any additional analysis to explain why a payment resulting from a promissory note is not income subject to Indiana AGIT. As provided in the definition of "promissory note" above, it is in and of itself merely a promise from one party to pay money to another party. A payment made pursuant to a promissory note is not inherently a recovery of any nature, let alone a recovery of a previously claimed itemized deduction as required by IC § 6-3-1-3.5(a)(6). Taxpayers have not referred to any statute, regulation, or court case in support of their position that equity is a relevant factor in determining Indiana AGIT.

In conclusion, the Department is not convinced by Taxpayers' argument. The Agreement between Taxpayers and the IRS provides that any payment related to the promissory notes for which Taxpayers were allowed to claim losses would be considered taxable income in the year is was received. Under IC § 6-3-1-3.5(a), such an amount would be included in calculating Indiana AGIT. Taxpayers were residents of Indiana when they received the payment in 2015, therefore they received income which was properly included in their 2015 Indiana AGIT. The payment was not a recovery of an itemized deduction, as required by IC § 6-3-1-3.5(a)(6). Taxpayers have not referred to any statutes, regulations, or court cases which would support their position regarding equity.

Taxpayer's protest is denied.

October 29, 2018.