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STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION

OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION

IN THE MATTER OF INDIVIDUAL INCOME TAX REFUND CLAIM DENIAL

ACCT. NO.: LETTER ID: DOCKET NOS.: 20-449 (2018) (AMOUNT DENIED)

TODD EVANS, ADMINISTRATIVE LAW JUDGE APPEARANCES

This case is before the Office of Hearings and Appeals upon a written

protest received December 16, 2019, signed by , Attorney at Law,

on behalf of , the Taxpayers. The Taxpayers protested a

refund claim denial issued by the Department of Finance and Administration

(“Department”).

The hearing was held in Bentonville, Arkansas, on February 28, 2020, at

1:00 p.m. The Department was represented by Amanda Land1, Attorney at Law,

Office of Revenue Legal Counsel (“Department’s Representative”). Present for

the Department was Kevin Melson (“Auditor”). and ,

Attorneys at Law, Taxpayer’s Representatives, appeared at the hearing and

represented the Taxpayers. Present for the Taxpayers was CPA.

The record remained after the administrative hearing for post-hearing

submissions. On March 30, 2020, Mr. Theis and the Taxpayer’s Representatives

filed their initial post hearing submission. The parties filed their response brief

1 The Answers to Information Request were filed by John Theis, Attorney at Law, Office of Revenue Legal Counsel.

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on April 14, 2020. The record was closed and the matter was submitted for a

decision on April 15, 2020.

ISSUE

Whether the refund claim denial issued against the Taxpayer should be

sustained after the adjustment to the other state tax credit agreed to by the

Department? Yes.

FACTUAL AND LEGAL CONTENTIONS OF THE PARTIES

Prehearing Filings

Within his Answers to Information Request, the Mr. Theis provided a

rendition of facts, stating the following2:

(“Taxpayers”) are residents of , Arkansas. Taxpayers filed an Arkansas individual income tax return with the Arkansas Department of Finance and Administration (“DFA”) for tax year 2018. That return reported income from Arkansas sources including wages, interest, and dividends. The return also reported income from sources in The source income consisted of gambling winnings in the amount of . The

source income consisted of capital gain income and raises no issue involved in this case. Taxpayers claimed a credit on their 2018 Arkansas income tax return for taxes paid to both as allowed by Ark. Code Ann. § 26-51-504. The total amount of other state tax credit claimed by the Taxpayers was which consisted of for taxes paid to

and for taxes paid to DFA reviewed Taxpayers’ 2018 return and determined that Taxpayers properly claimed the credit for taxes paid to however, DFA denied a portion of the tax credit claimed for taxes paid to DFA determined that the credit allowed for taxes paid to should be limited to . DFA denied all but of the credit claimed for taxes paid to because the credit claimed by Taxpayers exceeded the amount allowed by Arkansas law. Arkansas law and rules providing that

2 All exhibits support the statements for which they are cited.

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the credit for taxes paid to another state may not exceed the Arkansas income tax paid by the Taxpayer on that portion of their income subject to tax in both states. The source income reported on Taxpayers 2018 Arkansas income tax return was reported on line 22 of Form AR1000F under the heading of “other income”. The Taxpayer completed a form AR-01 indicating that, except for , their other income was derived from

gambling winnings of . In accordance with Ark. Code Ann. § 26-51-424, Taxpayers claimed a miscellaneous itemized deduction for gambling losses of . A gambling loss deduction is allowed only to the extent of a taxpayer’s gambling winnings. Taxpayer’s gambling loss deduction offset 100% of their gambling winnings subject to tax in Arkansas. Accordingly, Taxpayers only paid in Arkansas income tax by virtue of reporting the source income on their 2018 Arkansas return and the credit for taxes paid to is limited to that amount. The additional tax due of arose because a difference in the apportionment of the itemized deductions resulted in being placed in a different tax bracket. The following exhibits are attached for reference with regard to DFA’s actions for the 2018 tax year:

• Exhibit No. 1 - 2018 Arkansas return filed by the Taxpayers reflecting other income on line 22 of for and

for itemized deductions on Line 27 of for and for tax due of on Line 29, and tax credit of on line 36;

• Exhibit No. 2 - 2018 Arkansas form AR-OI reflecting the source of Other Income reported on line 22 of the Taxpayer's 2018 Arkansas return. This form AR-OI reveals that all but of “Other Income” earned resulted from gambling winnings.

• Exhibit No. 3 - 2018 Schedule of Tax Credits reflecting other state tax credit of and reflecting the portion attributable to tax paid to and the portion attributable to tax paid to

• Exhibit No. 4 - 2018 Itemized deduction schedule reflecting a

miscellaneous deduction of on Line 28; • Exhibit No. 5 - 2018 Statements attached to the Arkansas return

reflecting gambling losses taken as a miscellaneous deduction of on Statement 4;

• Exhibit No. 6 - 2018 Nonresident return reflecting source income of on Line 1 of form

.

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• Exhibit No. - 2018 Schedule Attached to Nonresident return reflecting that Taxpayers source income of

resulted from gambling winnings in that state.

Also attached as Exhibit No. 7 is a document prepared by the DFA auditor reflecting that fact that Taxpayer owed in Arkansas income tax for 2018 by virtue of including their source income on their Arkansas income tax return. DFA originally allowed credit for tax paid to

of . A recalculation of the allowable credit to apportion the Taxpayers’ gambling income in a manner more favorable to the Taxpayers increases the allowable credit amount from to . An additional adjustment was made by DFA which is not at issue. That adjustment was to allow Taxpayers an itemized deduction on their Arkansas return for the amount of income taxes paid by the Taxpayers on excess of the credit allowed.

Within the Answers to Information Request, the Department provided

that the tax credit allowed under Ark. Code Ann. § 26-51-504 (Supp. 2019) is

limited to the amount of additional income tax that would be due under Arkansas

income if that out-of-state income is added to the Arkansas income and that

liability was calculated under Arkansas law. In this case, he noted that the

allowable credit for the income tax should be limited to .

The Taxpayer’s Representative provided the following information within

the protest, stating:

In 2018, the Taxpayers were Arkansas residents who earned income in Arkansas, and The Taxpayers’ income was gambling winnings. As residents of , Arkansas, during 2018, the nearest casinos to the Taxpayers were in For this reason, the Taxpayers gambled almost exclusively in

Since they earned source income, the Taxpayers, through their CPA, filed a nonresident income tax return ( , attached as Exhibit 3) and paid

state income tax. The amount of income tax paid in 2018 was calculated in accordance with law as follows:

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1. The Taxpayers determined their source income . . . . . . . . .

2. The Taxpayers determined their adjusted gross income

. . . . .

3. The Taxpayers subtracted their itemized deductions and exemptions from their AGI to determine their Taxable Income . . . .

4. The Taxpayers calculated their income tax from on the . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . .

5. The Taxpayers determined their tax percentage based on a fraction the numerator of which was their source

income and the denominator of which was their Federal AGI . . . . . . . . . . . . . . .

6. The Taxpayers multiplied their income tax by the tax percentage to determine the amount of income tax due

. . . . . . . . . . . . . Thus, all of the Taxpayers’ income from all sources is included in the calculation of the Taxpayers' income tax. However, the actual

income tax due is based on the portion of their federal adjusted gross income represented by their source (gross) income. See

. See also Instructions for .

Since they earned source income, the Taxpayers,

through filed a nonresident income tax return (Form , attached as Exhibit 4), and paid state income tax. First, the Taxpayers determined their Nonresidents Taxable Percentage using Schedule PN: 1. The Taxpayers determined their total income . . . .

. . . . . 2. The Taxpayers determined their total income subject to tax

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3. The Taxpayers netted their Adjustments (additions and

deductions to determine their total income modified by . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . .

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4. The Taxpayers Adjustments to determine their total income

subject to tax modified by . . . . . . . . . . . . . .

5. The Taxpayers determined their Nonresidents Taxable Percentage

using a fraction, the numerator of which was their total income subject to tax modified by adjustments ( ) and the denominator of which was their total income modified by adjustments ( ) . . . . .

Next, the Taxpayers determined using as follows:

1. The Taxpayers determined their Federal AGI . . . . . . . . . . . . . . . . . . . .

2. The Taxpayers netted their additions to Federal AGI and

deductions Federal AGI and subtracted their standard Deduction (Line 11). . .

3. The Taxpayers applied their Nonresidents Taxable Percentage from

Schedule PN to the result of no. 7, above, to determine their Taxable Income (Line 14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4. The Taxpayers calculated their Income Tax based on the

Taxable Income (Line 15). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

As Arkansas residents in 2018, the Taxpayers also filed an Arkansas

income tax return for a full year resident (Form 1000F, attached as Exhibit 5) and paid Arkansas state income tax. The Taxpayers filed as “Married Filing Separately on the Same Return. The amount of Arkansas income tax paid in 2018 was calculated as follows: 1. The Taxpayer determined their total income (Line 23) . . . . . . .

and . . . .

2. The Taxpayer determined their AGI (Line 25) . . . . . . . . . . . . . . and . . . .

3. The Taxpayers subtracted their itemized deductions from their AGI to

determine their Arkansas Net Taxable Income ("ANTI")(Line 28) . . . . .

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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4. The Taxpayers calculated their Arkansas income tax based on the

Arkansas tax table . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . and . . . . .

NOTE: The remaining calculation is a combined calculation. 5. The Taxpayers calculated their combined tax owed to Arkansas before

credits (Line 30) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6. The Taxpayers calculated their Other State Tax Credit using Form

AR1000TC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7. The Taxpayers subtracted their Other State Tax Credit and other tax

credits to determine their Arkansas net tax .....................................

In the tax return preparation process, followed the

applicable instructions for preparing all of the above returns and schedules. This includes the instructions for Form AR1000TC. In the first ETA dated September 26, 2019 (“ETA 1), Mr. Melson denies the Taxpayers’ Other State Tax Credit for taxes paid to and states that their credit for the taxes paid is limited to per Arkansas Tax Code §1.26-51-504(a). In the second ETA dated November 14, 2019 (ETA 2), Mr. Melson denies the Taxpayers’ Other State Tax Credit for taxes paid to and instead allows an itemized deduction for the taxes paid.

Within the protest, the Taxpayer’s Representatives provided their

objections to the refund claim denial. Initially, asserted that the

properly followed all provided instructions and asserted that the

purpose of Ark. Code Ann. § 26-51-504 (Supp. 2019) is to prevent double

payment of income taxes and is not concerned with deductions, citing Morley v.

Pitts, 217 Ark. 755, 233 S.W.2d 539 (1950). Consequently, he reasoned that the

limitation under Ark. Code Ann. § 26-51-504 (Supp. 2019) should be calculated

by simply applying Arkansas Tax Rates to the Taxpayers’ out-of-state income

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without consideration of any deductions that may be applicable to that income

within the State of Arkansas. He additionally asserted that, by not allowing the

full amount of income tax paid to the State of on the

derived income, the Department is creating double taxation of the same income.

Hearing Testimony

A. Auditor’s Testimony

The Auditor testified that he performed the review of the Taxpayers’

refund claim. He described and certified the exhibits attached to the

Department’s Answers to Information Request. The Taxpayers claimed

for the other state tax credit. Within Arkansas, the Taxpayers were

allowed an itemized deduction for gambling losses. The Taxpayers deduction for

gambling losses fully offset the Taxpayers’ gambling income. The

Taxpayers reported gambling income of on their

nonresident income tax return. Except for the calculation of the other state tax

credit, he did not notice any other errors in the filed Arkansas income tax return.

To determine the allowable other state tax credit, he calculated the

Taxpayers’ Arkansas income tax liability with and without the income.

The difference between those amounts was allowed as the credit. Originally, he

only allowed ; however, that amount was increased to 3 after an

error was corrected within his original calculation while preparing an exhibit for

the Department’s Answers to Information Request. This adjustment has not been

applied to the Taxpayer’s return but will be applied after completion of the

3 This increase represents the adjustment to the other state tax credit agreed to by the Department.

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administrative hearing process. The Auditor relied on the applicable statute when

he performed the calculation, which limits the other state tax credit to the

amount of additional Arkansas income tax due as a result of the out of state

income. The limiting of the other state tax credit increased the Taxpayers’

Arkansas income tax liability by . He allowed an itemized deduction

for taxes paid to other states in excess of the allowed credit as well. Originally, he

was unaware of this deduction but later allowed it and issued a second

explanation to the Taxpayers when informed of this issue by Rob Allen, another

auditor. A second adjustment letter was provided to the Taxpayers to explain his

later adjustment to the Taxpayers’ refund claim.

He has audited roughly fifteen (15) income tax returns involving gambling

winnings. He was not specifically directed to look for issues related to other state

tax credit when reviewing income tax returns. Regulations help taxpayers

interpret statutes. The Taxpayers claimed full credit for any taxes paid to other

states. does utilize all of the Taxpayers’ income as a part of the

calculation of income tax owed to but does not fully tax that income.

The Taxpayers owed to for income taxes. He reviewed and

allowed full credit was allowed for income taxes paid to

When computing the allowable other state tax credit, you start by

considering all of a taxpayer’s income. Addressing Comprehensive Individual Tax

Regulations § 1.26-51-504(a), the Auditor acknowledged that the rule generally

allowed an other state tax credit for income tax actually owed by residents to

other jurisdictions. That credit, however, cannot exceed what the tax would be on

all of the Arkansas resident’s income calculated using Arkansas tax rates. He

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agreed that the Taxpayers’ total Arkansas income tax liability that was calculated

using the Taxpayer’s total income from wherever derived exceeded the amount of

other state tax credit being claimed by the Taxpayers, satisfying this limitation.

The Auditor highlighted that the Taxpayers would still have to prove that they

would be subject to double taxation on a portion of their income. He conceded

that shifting the Taxpayers’ gambling activity to resulted in an overall

increase in the Taxpayers’ total tax liability across all states. He averred that the

Taxpayers are not being double taxed on the income since Arkansas

allowed an offset of the resulting additional tax after allowing the itemized

deduction for the gambling losses. Both states do begin their calculation utilizing

the Taxpayers’ entire income, but ultimately only taxes the gambling

income through the use of a percentage. If taxed other income, a credit

would likely be allowed for any taxes associated with that income. He relied on

the relevant code section and rule in reaching his determination and asserted that

both items largely mirror each other but utilize different wording.

Addressing the instructions4 for an Arkansas income tax return, the

Auditor emphasized that the return instructions provide that the allowable credit

cannot exceed the Arkansas income tax on the same income and cannot exceed

the total Arkansas tax liability. He again conceded that the income tax

liability did not exceed the total income tax owed to Arkansas. He asserted that

the claimed other state tax credit for did exceed Arkansas income

4 These instructions were entered as Taxpayers’ Exhibit 6.

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taxes on the same income.5 He instructed that the out of state income is added to

the Arkansas income, resulting in the highest tax benefit for taxpayers.

The Department is charged to interpret Arkansas tax laws. The governing

code section does require a calculation of the additional Arkansas income taxes

due upon the out of state income. His methodology follows the Department’s

treatment of this issue with other taxpayers.

B. CPA’s Testimony

The CPA testified that he is a CPA in Arkansas. He has been

employed as a CPA and prepared income tax returns since . He prepared the

Taxpayers’ income tax returns for 2018 for Arkansas, and

He completed those returns utilizing from .

He does review tax returns prior to filing. collects an income tax from

nonresidents earning income within that state. uses a taxpayer’s total

federal income and then performs state adjustments. The state taxable income is

ultimately reduced utilizing a percentage that is then used to calculate a

taxpayer’s tax liability. The Taxpayers owed in state income taxes to

for the relevant tax year. He noted that Arkansas taxes income from all

sources for state residents. The CPA claimed an other state tax credit of

, the total taxes paid to and He relied on

the relevant regulation and statute when calculating the available credit.

He reviewed the Department’s adjustments. He believes that the

Taxpayers are subject to double taxation on their income. He testified that

ends up mashing all of a taxpayer’s income into a pot and using a

5 During questioning of the Auditor, emphasized that the other state tax credit should be allowed on any portion of income subject to double taxation.

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percentage. He noted that the other state tax credit cannot exceed the Arkansas

tax liability calculated at Arkansas tax rates, which is not implicated in this

matter. He explained that shifting a portion of the Taxpayers’ income to

increased the Taxpayers’ overall tax liability. He prepared the income

tax return under Arkansas law and highlighted that the governing law and

instructions speak of income, not deductions. He does not believe that the

deductions should even be considered in the calculation of the limitation of the

other state tax credit.

C. Assertions of

declared that the Taxpayers are entitled to a full credit if any

portion of their income is subjected to double taxation. He asserted that the

Arkansas rule does not require a tracing of income.

Post-Hearing Filing

A. Department’s Initial Post-Hearing Filing

Within his initial post-hearing filing, Mr. Theis noted that the income tax

credit for taxes paid on out-of-state income is generally limited to the tax

imposed on such income by the state granting the credit, citing State Taxation

Vol. II (3rd ed. 2003). He stated that the Taxpayers are seeking credit for taxes

paid to in excess of the Arkansas income tax paid on the

income. He emphasized that Ark. Code Ann. § 26-51-504(a)(1) (Repl. 2012)

provides: “However, credit shall not exceed what the tax would be on the outside

income, if added to the Arkansas income, and calculated at Arkansas income tax

rates.” He noted that the Taxpayers’ income is largely offset within

Arkansas by the Arkansas itemized deduction for gambling losses under Ark.

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Code Ann. § 26-51-424 (Supp. 2019). In this matter, he claimed that the other

state tax credit claimed by the Taxpayers exceeded Arkansas income tax owed on

the income. He declared that the purpose of the other tax credit is

limited to preventing double taxation within Arkansas, not to allow

income tax to be fully offset by reducing a resident’s Arkansas income tax

liability.

To properly calculate the other state tax credit, Mr. Theis instructed that a

taxpayer should add the other state income to their Arkansas income and

calculate the Arkansas income tax that is actually owed on that income at

Arkansas income tax rates. That credit, however, is then limited by calculating a

taxpayer’s income tax liability if all of the other state’s income is excluded from

taxation in Arkansas. He asserted that the difference between these two amounts

is the amount of other state tax credit allowed for a particular state’s taxes due to

the limitation. He averred that allowing the full income tax paid on the

out of state income would result in a windfall by causing Arkansas income tax on

Arkansas sourced income to offset income tax owed to another state on different

income.

Considering income tax system, Mr. Theis noted that the

Court of Appeals specifically concluded that, while non-

income may be used in the calculation of income tax for nonresident, the

income is not taxed as a result of this calculation, citing Walters v.

State of , (1996).6 He

6 A review of this citation and the case of the Supreme Court of the United States cited within that decision demonstrates that both the Department and the Court of Appeals correctly summarized the holdings from these matters.

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noted that case also cited

, which concluded that the inclusion of the entire estate of a

decedent to calculate a proportion for determining inheritance tax on property

within a single state does not equate to an attempt by that state to tax foreign

property. Since the Taxpayers’ Arkansas income is not taxed within he

reasoned that, so long as Arkansas allows credit for the additional Arkansas tax

liability that results from inclusion of the income, no double taxation

will occur.

Mr. Theis proceeded to analyze the effect of Arkansas Comprehensive

Individual Income Tax Regulations § 1.26.51.504(a) on this proceeding. He noted

that rules methodology was followed by the Department in calculating the

Taxpayers’ other state tax credit. He acknowledged that the income taxes paid to

other states did not exceed the Arkansas tax liability reflected on the Taxpayers’

2018 Arkansas income tax return but noted that a second limitation exists within

the rule to ensure that the credit is not allowed unless a resident can show double

taxation of a portion of their income. He asserted that the Department’s

allowance of an other state tax credit of (representing the additional tax

liability resulting from the inclusion of the sourced income) prevents

double taxation. He declared that the allowance of any additional amount would

violate the second limitation. Reviewing the example within the rule, he observed

that the example similarly limited the other state tax credit to the amount of

additional Arkansas income tax that resulted from inclusion of the out of state

income. He concluded noting that Arkansas’s approach appears to be similar to

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the methodology followed within New Jersey and arguing that the Taxpayers’

interpretation of the governing law is contrary to legislative intent.

B. Taxpayers’ Initial Post-Hearing Filing

initially noted that the Auditor stated during the

administrative hearing that the only issue preventing the application of the other

state credit claimed by the Taxpayer was proof of double taxation. He argued that

the Department’s methodology was not authorized by the rule or statute. He

stated that the Arkansas General Assembly did not intend that Taxpayers source

each dollar of tax to a particular income source. He highlighted that the

governing regulation does not discuss the application of deductions and only

requires a showing of double taxation on a portion of the Taxpayer’s income. He

argued that the consideration of deductions in the application of the credit is

inappropriate under Morley v. Pitts, 217 Ark. 755, 233 S.W.2d 539 (1950).

asserted that a portion of the Taxpayer’s income is still subject

to double taxation under the Department’s methodology since both Arkansas’s

and tax calculation require the consideration of a taxpayer’s entire

income. He argued that those approaches result in the taxation of the Taxpayers’

entire income. He instructed that simply transferring all of the income

to Arkansas and removing the Taxpayers’ tax liability results in a

reduced total tax liability for the Taxpayer. He declared that this fact means that

double taxation is proven. He further noted that appears to

agree with the Taxpayers’ interpretation.

Addressing the example within the rule, he declared that it does not

address applicable deductions at all and does not delineate the steps used by the

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Department in calculating the other state tax credit. He asserted that the example

supports the Taxpayer’s position that a full credit for out of state taxes should be

allowed since the Arkansas tax liability on the out of state income would be

higher than the tax liability charged by other states without consideration of

applicable deductions. He averred that the first guidance of the Department’s

proposed methodology was issued within Opinion .

He also argued that the Department’s approach unfairly benefits Taxpayer’s

claiming the standard deduction because that nonitemized deduction cannot be

linked to particular income sources. He provided an example where all itemized

deductions were related to out of state income and, thus, allowed no deductions

with respect to the calculation of the Arkansas income tax without the out of state

income. As a result, he noted that the other state tax credit was fully offset due to

the itemization of deductions, harming the itemizing taxpayer.7 He also asserted

that this method would be unworkable for Taxpayers earning interstate business

income with associated expenses.8 He concluded reasserting that the application

of the Department’s proposed methodology results in double taxation.

C. Department’s Post-Hearing Reply

Within his post-hearing reply filing, Mr. Theis reasserted that, under the

Walthers case, it was evident that only the Taxpayers’ gambling

income was subject to income tax. He further contended that the

relevant Arkansas statute only intends to provide the credit for income taxable

7 It is entirely uncertain how this factual scenario (where all available itemized deductions are only related to the out of state income) could occur. This example is simply not persuasive to prove that the Department’s methodology results in higher taxation of an itemizing taxpayer. 8 This argument is also not persuasive as this scenario appears to implicate the Uniform Division of Income for Tax Purposes Act under Ark. Code Ann. § 26-51-701 et seq. (Repl. 2012, Supp. 2019).

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within both states. He argued that allowing the credit to be applied in the way

recommended by the Taxpayers would result in a windfall by allowing the

Taxpayers to offset their income tax liability by reducing their

Arkansas income tax solely applicable to income from Arkansas sources. He

further opined that that Taxpayers’ interpretation ignores the language limiting

the other state tax credit to the amount of Arkansas income tax paid on the

income.

Mr. Theis proceeded to argue that deference to administrative

interpretations means that the Department’s interpretation should not be

overturned unless it is clearly wrong and governing rules of construction provide

that the other state tax credit must be narrowly construed. He declared that the

Department’s method for applying the governing statute’s limitation to the other

state tax credit is a reasonable one that limits the other state tax credit to the

additional Arkansas income tax resulting from the inclusion of out of state

income upon the Arkansas return. While the Taxpayers have shown that their

total tax liability is increased by earning their gambling income within

he surmised that the Taxpayers’ real objection was the unfavorable tax treatment

provided to their income under tax laws. He explained that

the Department’s approach complied with the holding of the Morley case by

allowing applicable deductions and advised that this Office ignore the standard

deduction argument raised by as irrelevant since the Taxpayers

itemized their deductions.

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D. Taxpayers’ Post-Hearing Reply

Within this document, reasserted that the Department’s

calculation methodology is not present within the governing statute. He further

reasserted that the full amount of tax owed to the other state upon the same

income must be allowed to avoid double taxation. He summarized that the

Taxpayers’ approach is simpler, avoids the pitfalls created by the Department’s

methodology, best complies with the approach utilized within Arkansas

Comprehensive Individual Income Tax Regulation § 1.26.51-504, and best

complies with the legislative intent of the Arkansas General Assembly.

Specifically, proposed that the disputed limitation only means

that the other state tax credit should not exceed the total amount of tax produced

by multiplying the total income by the applicable Arkansas tax rate without

considering applicable Arkansas deductions. He also asserted that all out of state

income must be excluded under the Department’s methodology and claimed that

the Department was selectively applying its approach only to the

income and not the income.

restated that the Department’s approach results in different

treatment of itemizing taxpayers relative to taxpayers claiming the standard

deduction. He contended that the Department’s approach makes the first

limitation (that the other state tax credit cannot become refundable by exceeding

the total Arkansas income tax due) superfluous since the second limitation (as

interpreted by the Department) renders the first limitation superfluous.9

9 This argument is not persuasive in that the second limitation appears to simply represent a further narrowing of the credit after consideration of the first limitation.

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proceeded to declare that the limitation against double

taxation within the regulation does not require proof of double taxation of any

specific portion of a taxpayer’s income, asserting that double taxation is

demonstrated by showing that the Taxpayers’ total tax liability is increased by

simply sourcing their gambling income out of state and the inclusion of all

income of a nonresident within the income tax calculation

methodology. He distinguished Department’s earlier citations to other states’

applications of their other states tax credits and treatises as irrelevant to the

matter at hand.

concluded by arguing in the alternative that the Department

improperly applied its own methodology by not excluding both and

sourced income in the calculation of the other state tax credit

applicable to 10

After a general discussion of the burdens of proof in tax proceedings, a

legal analysis with associated conclusions shall follow.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

Standard of Proof

Ark. Code Ann. § 26-18-313(c) (Supp. 2019) provides, in pertinent part, as

follows:

10 This argument is not persuasive since the Department’s method is only trying to determine the difference in the Arkansas tax liability that results from the inclusion of the income when calculating the other state tax credit limitation applicable to the credit for the income taxes. During the hearing, the Auditor explained that the full other state tax credit was allowed when he reviewed the allowable credit applicable to that state’s income tax. That testimony implies application of the same methodology utilized for and not that the Department selectively applied their calculation of the credit limitation. Consequently, the selective application argument is also not persuasive.

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The burden of proof applied to matters of fact and evidence, whether placed on the taxpayer or the state in controversies regarding the application of a state tax law shall be by preponderance of the evidence. A preponderance of the evidence means the greater weight of the evidence.

Chandler v. Baker, 16 Ark. App. 253, 700 S.W.2d 378 (1985). In Edmisten v. Bull

Shoals Landing, 2014 Ark. 89, at 12-13, 432 S.W.3d 25, 33, the Arkansas

Supreme Court explained:

A preponderance of the evidence is “not necessarily established by the greater number of witnesses testifying to a fact but by evidence that has the most convincing force; superior evidentiary weight that, though not sufficient to free the mind wholly from all reasonable doubt, is still sufficient to incline a fair and impartial mind to one side of the issue rather than the other. The Department bears the burden of proving that the tax law applies to an

item or service sought to be taxed, and a taxpayer bears the burden of proving

entitlement to a tax exemption, deduction, or credit. Ark. Code Ann. § 26-18-

313(d) (Supp. 2019). Statutes imposing a tax or providing a tax exemption,

deduction, or credit must be reasonably and strictly construed in limitation of

their application, giving the words their plain and ordinary meaning. Ark. Code

Ann. § 26-18-313(a), (b), and (e) (Supp. 2019). If a well-founded doubt exists

with respect to the application of a statute imposing a tax or providing a tax

exemption, deduction, or credit, the doubt must be resolved against the

application of the tax, exemption, deduction, or credit. Ark. Code Ann. § 26-18-

313(f)(2) (Supp. 2019).

Tax Assessment

Ark. Code Ann. § 26-51-201 (Supp. 2019) imposes the Arkansas individual

income tax upon, and with respect to, the entire income of every resident,

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individual, trust, or estate. The tax is levied, collected, and paid annually upon

the entire net income of the individual. Gross income is broadly defined to

include: “Gains or profits and income derived from any source whatever . . ..”

Ark. Code Ann. § 26-51-404(a)(1)(E) (Supp. 2019). Ark. Code Ann. § 26-51-

102(2) (Repl. 2012) defines the term “taxpayer” to include any individual,

fiduciary, or corporation subject to the Arkansas income tax. Ark. Code Ann. §

26-51-102(3) (Repl. 2012) defines the term “individual” as a natural person. For

the purpose of tax imposition, the term “Resident” is defined at Ark. Code Ann. §

26-51-102 (Repl. 2012) as follows:

(14) “Resident” means natural persons and includes, for the purpose of determining liability for the tax imposed by this act upon or with reference to the income of any taxable year, any person domiciled in the State of Arkansas and any other person who maintains a permanent place of abode within this state and spends in the aggregate more than six (6) months of the taxable year within this state[.] [Emphasis added].

Here, it is uncontested that the Taxpayers are residents of the State of

Arkansas. The Department has demonstrated that the Taxpayers earned taxable

income during the relevant tax year. That income is generally taxable unless a

taxpayer can demonstrate that a tax credit, deduction, or exemption is applicable.

Consequently, the Department has borne its burden of proof in this matter.

A tax credit does exist for taxes paid on income that is also taxed within

Arkansas. Ark. Code Ann. § 26-51-504 (Supp. 2019) provides as follows, in

relevant part:

(a)(1) For the purpose of ascertaining the income tax due by an individual resident of Arkansas whose gross income includes income derived from property located outside the State of Arkansas, or from business transacted outside the State of Arkansas, the tax shall first be computed as

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if all of the income of the resident were derived from sources within the State of Arkansas, but a credit shall then be given on the tax as so computed, for the amount of income tax actually owed by the resident for the year to any other state or territory on account of income from property owned or business transacted in the other state or territory. However, credit shall not exceed what the tax would be on the outside income, if added to the Arkansas income, and calculated at Arkansas income tax rates. [Emphasis supplied.]

The Department is authorized to promulgate regulations for the enforcement of

this tax credit. Ark. Code Ann. § 26-18-301 (Supp. 2019). Arkansas

Comprehensive Individual Income Tax Regulation § 1.26-51-504(a) was

promulgated for enforcement this tax credit and gives the following instruction:

When the gross income of an Arkansas resident includes income derived from sources outside the State of Arkansas, such as property or business activity, the Arkansas income tax liability shall first be computed as if all of the Arkansas resident's income was derived from sources within the State of Arkansas. However, a credit shall be allowed against the resident's Arkansas income tax liability in the amount of any income tax actually owed by the resident for the tax year at issue to any other state or territory. Any credit given shall not be allowed to exceed what the tax would be on all the Arkansas resident's income, from wherever derived, if such tax was calculated using Arkansas income tax rates. No credit shall be allowed against the resident's Arkansas income tax liability unless the resident can clearly show that he or she would be subject to double taxation on a portion of his or her income unless the credit is allowed. Example: Mr. and Mrs. Jones file a full year resident return in the state of Arkansas. Mr. Jones works in Arkansas and earns $30,000. Mrs. Jones works in Oklahoma and also earns $30,000. Mrs. Jones paid $1,500 tax to Oklahoma. The Jones' file as status "4" married filing separate on same return. Mr. Jones Mrs. Jones Income $30,000.00 $30,000.00 Arkansas Tax $1,364.00 $1,364.00 Total Tax $2,728.00 Personal Credits ($40.00)

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Other State Tax Credit* ($1,364.00) Tax Liability $1,324.00 [Emphasis supplied.] Initially, it is necessary to see if the example within the applicable rule

favors either side’s position with respect to the calculation of the limitation

applied to the other state tax credit.

To understand the calculation of Mrs. Jones’ Arkansas tax liability with

regards to the income, some context is necessary since the current

Comprehensive Individual Income Tax Regulations were issued in 1997. In 1997,

taxpayers were generally allowed a standard deduction of $1,000. Ark. Code Ann.

§ 26-51-430(b)(1) (Repl. 1997). Additionally, the tax rates were imposed as

follows:

1. On the first $2,999, the tax was imposed at one percent (1%); 2. On the next $3,000, the tax was imposed at two and one-half percent

(2.5%); 3. On the next $3,000, the tax was imposed at three and one-half percent

(3.5%); 4. On the next $6,000, the tax was imposed at four and one-half percent

(4.5%); 5. On the next $10,000, the tax was imposed at six percent (6%); and 6. On the remaining income of $25,000 or more, the tax was imposed at

seven percent (7%). Ark. Code Ann. § 26-51-201(a) (Repl. 1997).

Following the law applicable at the time of the governing rule, it is

apparent that the calculation of Mrs. Jones tax liability includes the allowance of

the $1,000 Arkansas standard deduction. While a strict application of applicable

tax rates results in a calculated Arkansas tax liability of $1,360.06 (after the

application of standard deduction and before tax credits). The applicable 1997

Tax Tables (which utilize the average tax amounts across $100 increments)

provide a total tax liability of $1,364.00 for Status 1 filers with incomes between

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$30,000 and $30,100. Based on this analysis, it is apparent that Comprehensive

Individual Income Tax Regulation § 1.26-51-504 instructs that deductions must

be considered in the calculation of the limitation applied to the tax credit

authorized under Ark. Code Ann. § 26-51-504 (Supp. 2019). Additionally, it is

apparent that rule calculates the limitation by calculating the additional Arkansas

tax liability that results from the inclusion of the income and utilizes

that amount as the limitation on the other state tax credit.

Even if I were to find ambiguity11 whether the limitation for the other state

tax credit12 should be calculated with or without applicable Arkansas income tax

deductions, that ambiguity is clearly resolved by the applicable rule. Additionally,

the associated statute has not materially changed since the adoption of the

applicable rule.

The Taxpayer’s Representatives have cited Morley v. Pitts, 217 Ark. 755,

233 S.W.2d 539 (1950) for the position that applicable Arkansas deductions

should not be considered in the calculation of the limitation placed upon the

asserted other state tax credit. That case addressed the situation where a taxpayer

desired to claim certain business deductions for expenses incurred within Illinois

on his Arkansas income tax return. The Department objected to those deductions

asserting that the recently adopted other state tax credit should bar the Taxpayer

from also claiming associated business deductions for the creation of the out-of-

state income. The Arkansas Supreme Court rejected that proposition explaining

that other state tax credit does not mention or attempt to limit otherwise

11 It should be noted that the calculation of “what the tax would be on the outside income” would naturally include consideration of offsetting tax deductions allowed under Arkansas law. 12 Additionally, tax credits must be narrowly construed with doubts resolved against the application of the tax credit. Ark. Code Ann. § 26-18-313(b) and (f)(2) (Supp. 2019)

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allowable income tax deductions for out-of-state income. Consequently, that

Taxpayer was allowed use both the Arkansas income tax deduction for necessary

and ordinary expenses and the other state tax credit if applicable. It is uncertain

whether that taxpayer paid any income taxes to the State of Illinois for his drilling

activities. The Morley decision does not stand for the proposition that the

limitation imposed on the other state tax credit must be calculated without

considering associated Arkansas tax deductions for out-of-state income within

Arkansas. In fact, that case does not discuss the proper calculation of the other

state tax credit. The citation of the Morley decision by the Taxpayers’

Representatives is not persuasive.

As a duly promulgated rule under the authority of Ark. Code Ann. § 26-18-

301 (supp. 2019), Arkansas Comprehensive Individual Income Tax Regulation §

1.26-51-504(a) is controlling authority in a case involving the calculation of the

limitation upon the other state tax credit. The interpretation of statutes by an

administrative agency, while not conclusive, is highly persuasive. Aluminum Co.

of America v. Weiss, 329 Ark. 225, 946 S.W.2d 695 (1997). An administrative

agency’s interpretation of a statute or its own rules will not be overruled unless it

is clearly wrong. Arkansas Dep’t. of Human Servs. v. Hillsboro Manor Nursing,

304 Ark. 476, 803 S.W.2d 891 (1991). The Arkansas Supreme Court has

recognized that administrative agencies are often required to interpret statutes

and rules. Walnut Grove School Distr. No. 6 of Boone County v. County Board

of Education, 204 Ark. 354, 162 S.W.2d 64 (1942).

Here, in compliance with the governing rule, the Department has

demonstrated that it incorporated the Taxpayers’ income as if it was all income

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was earned within Arkansas and calculated the additional Arkansas tax liability

resulting from that inclusion with all applicable deductions. That increase was

allowed as the other state tax credit upon the Taxpayers’ return. The Taxpayers

have not demonstrated that the Department’s calculation of the limitation of the

other state tax credit was in error and proven entitlement to a larger tax credit by

a preponderance of the evidence.

The Taxpayers’ Representatives asserted that the Taxpayers are being

subjected to double taxation of its income within Arkansas; however,

that assertion is not supported by the record. Initially, the assertion that

tax calculation results in taxation of a portion of Arkansas income is

not persuasive as that statement is contradicted by precedent from the

Court of Appeals and the Supreme Court of the United States. The record shows

that any increase in Arkansas income tax caused by the inclusion of the

income within the Taxpayers’ Arkansas return was completely offset

by allowance of the gambling loss deduction (in accordance with Arkansas law)

and the removal of the remaining residual increase in Arkansas state income tax

through the allowance of the other state tax credit.

Mr. Theis correctly argued that allowance of any credit in excess of

would begin offsetting the Arkansas state income tax associated with

other income sources included upon the Taxpayers’ Arkansas income tax return.

The Taxpayers have demonstrated that the earning of the income within

resulted in an increased total tax liability for the Taxpayers when all

state taxes are added. While it is unfortunate that tax treatment is

not as favorable as Arkansas’s with respect to the Taxpayer’s out-of-state income

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according to the Taxpayers’ Representatives’ calculations, another state’s tax

policy does not control the application of Arkansas law and policy as established

by the Arkansas General Assembly.

The refund denial is sustained after the adjustment agreed to by the

Department.

DECISION AND ORDER

After the adjustment, the refund denial is sustained. The file is to be

returned to the appropriate section of the Department for further proceedings in

accordance with this Administrative Decision and applicable law. Pursuant to

Ark. Code Ann. § 26-18-405 (Supp. 2019), unless the Taxpayers request in

writing within twenty (20) days of the mailing of this decision that the

Commissioner of Revenues revise the decision of the Administrative Law Judge,

this Administrative Decision shall be effective and become the action of the

agency. The revision request may be mailed to the Assistant Commissioner of

Revenues, P.O. Box 1272, Rm. 2440, Little Rock, Arkansas 72203. A revision

request may also be faxed to the Assistant Commissioner of Revenues at (501)

683-1161 or emailed to revision@dfa.arkansas.gov. The Commissioner of

Revenues, within twenty (20) days of the mailing of this Administrative Decision,

may revise the decision regardless of whether the Taxpayers have requested a

revision.

Ark. Code Ann. § 26-18-406 (Supp. 2019) provides for the judicial appeal

of a final decision of an Administrative Law Judge or the Commissioner of

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Revenues on a final assessment or refund claim denial; however, the

constitutionality of that code section is uncertain.13

DATED: April 16, 2020

13 See Board of Trustees of Univ. of Arkansas v. Andrews, 2018 Ark. 12.