Baitis v. Department of Revenue of State

• Decision Date: 28 January 2004
• Docket Number: No. 03-189.,03-189.
• Parties: Hartmut and Inga BAITIS, Plaintiffs and Appellants, v. The DEPARTMENT OF REVENUE OF THE STATE of Montana, Defendant and Respondent.
• Court: Montana Supreme Court

83 P.3d 1278

2004 MT 17

319 Mont. 292

Hartmut and Inga BAITIS, Plaintiffs and Appellants, v. The DEPARTMENT OF REVENUE OF THE STATE of Montana, Defendant and Respondent.

No. 03-189.

Supreme Court of Montana.

Submitted on Briefs August 28, 2003.

Decided January 28, 2004.

For Appellants: Patrick Dougherty, Worden Thane P.C., Missoula, Montana.

For Respondent: Michele R. Crepeau, Montana Department of Revenue, Special Assistant Attorney General, Helena, Montana.

Justice JOHN WARNER delivered the Opinion of the Court.

I. INTRODUCTION

¶ 1 The District Court for the Fourth Judicial District, Missoula County, granted the Montana Department of Revenue's Motion for Summary Judgment denying the Baitis' relief. The Baitis' primary claim is that § 15-30-121(1)(b), MCA, allows them to deduct their federal self-employment taxes when calculating net income on their Montana state income tax return. Alternatively, the Baitis' claim that if they are not permitted to deduct their self-employment taxes, then the Department of Revenue should have adopted a rule explaining the Department's rationale for the disallowance.

¶ 2 We affirm the District Court.

¶ 3 We address the following issues on appeal:

¶ 4 1. Whether the self-employment taxes collected under § 1401 of the Internal Revenue Code are deductible under § 15-30-121(1)(b), MCA, in the calculation of net income for state income tax purposes.

¶ 5 2. Whether the Department of Revenue has an obligation under § 2-4-101 et seq., MCA, to formally adopt a rule systematizing its longstanding, informal policy which disallows the federal self-employment tax as a deduction under § 15-30-121(1)(b), MCA.

II. FACTUAL AND PROCEDURAL BACKGROUND

¶ 6 The parties have stipulated that there are no facts in dispute in this matter. All agree that the two issues of law set forth above are the only issues for decision. Hartmut and Inga Baitis (the Taxpayers), claimed an income tax deduction on their 1995 Montana income tax return for the amount they paid in federal income taxes in 1995. This figure included the amount they paid for their federal self-employment tax liability. The Montana Department of Revenue (the Department), disallowed the portion that was claimed for the self-employment tax liability. The Taxpayers contested the disallowance and the Department's hearing examiner affirmed the Department's decision. From there, the Taxpayers appealed to the State Tax Appeal Board and then to the District Court of Missoula County. Both of those bodies also affirmed the Department's decision. The Taxpayers now seek review in this Court.

III. STANDARD OF REVIEW

¶ 7 The standard this Court employs to review a district court's conclusions of law is whether the district court's interpretation of the law is correct. A district court's grant of summary judgment is reviewed de novo. Vitullo v. IBEW, Local 206, 2003 MT 219, ¶ 9, 317 Mont. 142, ¶ 9, 75 P.3d 1250, ¶ 9.

¶ 8 The standard of review for administrative decisions of state agencies is set forth at § 2-4-704, MCA. In pertinent part, the statute reads:

The court may reverse or modify the decision if substantial rights of the appellant have been prejudiced because:

(a) the administrative findings, inferences, conclusions, or decisions are:

(i) in violation of constitutional or statutory provisions;

(ii) in excess of the statutory authority of the agency;

(iii) made upon unlawful procedure;

(iv) affected by other error of law;

(v) clearly erroneous ...;

(vi) arbitrary or capricious....

IV. DISCUSSION

Issue One

¶ 9 The Taxpayers spend much effort attempting to persuade us that the self-employment tax is part of the federal income tax, and is therefore deductible under § 15-30-121(1)(b), MCA. Section 15-30-121(1)(b) allows a Montana state taxpayer to deduct from his computation of net income, "federal income tax paid within the tax year." The self-employment tax code sections, §§ 1401-1403, are located in Subtitle A of the Internal Revenue Code (I.R.C.), which is entitled "Income Taxes." The Taxpayers believe that the physical location of the self-employment code sections is dispositive of the issue. They believe that Treas. Reg. § 1.1401-1 supports their contention. That section reads in pertinent part:

This tax shall be levied, assessed, and collected as part of the income tax imposed by subtitle A of the Code.... Since the tax on self-employment income is part of the income tax, it is subject to the jurisdiction of the Tax Court of the United States to the same extent and in the same manner as the other taxes under subtitle A of the Code.

¶ 10 The Department does not dispute that the self-employment tax is imposed upon a portion of a self-employed person's income. Neither does the Department dispute that the federal self-employment taxes are levied, assessed, and collected along with the normal federal income taxes. The Department does dispute the significance these facts have in relation to the nature of the taxes themselves. According to the Department, the nature and purpose of a tax is what defines a tax. The argument is then that the self-employment tax is in the nature of an employment tax, not an income tax. Its purpose is not to tax the privilege of pursuing personal wealth, as is an income tax. Its purpose is to fund the Federal Old-Age, Survivors, and Disability Insurance Trust Fund (OASDI), which in turn will provide a self-employed person a substitute for earned income when he is no longer able to remain self-employed.

¶ 11 We agree with the Department for the following reasons. First, we concur in the Department's assessment that the federal income tax and the federal self-employment tax are distinct entities, regardless of their conjoined collection procedures. Second, we agree with the District Court's observation that the state of Montana has authority to interpret its own tax code in the manner it so chooses, without being bound by the vagaries of the federal tax code. We address each reason in turn.

¶ 12 Varied Histories and Purposes of the Income Tax and the Social Security Tax

¶ 13 Congress passed the first federal income tax in 1861. 37 Cong. ch. 45, 12 Stat. 292, 309. It provided for levy and collection of three percent (we should be so lucky) of each individual's annual income, from whatever source derived. This tax law was renewed several times between 1861 and 1872, when it expired. 41 Cong. ch. 255, 16 Stat. 256. These original income tax acts grew out of the Civil War, were considered legitimate as having been passed in a time of extraordinary exigency, and were "part of the system of taxing incomes, earnings, and profits adopted during the late war, and abandoned as soon after that war was ended as it could be done safely." Pollock v. Farmers' Loan & Trust Co. (1895), 157 U.S. 429, 573, 15 S.Ct. 673, 686, 39 L.Ed. 759, 816,superseded by U.S. Const. amend XVI. The income tax was brought back in 1894. 53 Cong. ch. 349, 28 Stat. 509. But in 1895, with the United States at peace and with no national crises portending, the U.S. Supreme Court declared the income tax invalid as not following the constitutionally mandated rules of apportionment and uniformity. Pollock v. Farmers' Loan & Trust Co. (1895), 158 U.S. 601, 637, 15 S.Ct. 912, 920-921, 39 L.Ed. 1108, 1126,superseded by U.S. Const. amend XVI. In 1909, Congress was again poised to enact an income tax. Because of the Pollock decisions, however, there was sure to be a problem with the tax in the courts. Brushaber v. Union P.R.Co. (1916), 240 U.S. 1, 18, 36 S.Ct. 236, 242-243, 60 L.Ed. 493, 501. To avoid this problem, President Taft proposed the Sixteenth Amendment, which was ratified in 1913. The Sixteenth Amendment to the U.S. Constitution nullified the holdings of the Pollock cases, and authorized the U.S. government to impose income taxes without regards to apportionment or population per state. Shortly after ratification of the Sixteenth Amendment, Congress enacted the Tariff Act of 1913, which included an income tax. 63 Pub.L. No. 16, 38 Stat. 114.

¶ 14 Since then, the word "income" itself has gone through several loose, court-made, definitions. In Bowers v. Kerbaugh-Empire Co. (1926), 271 U.S. 170, 174, 46 S.Ct. 449, 451, 70 L.Ed. 886, 888, the U.S. Supreme Court said income was "gain derived from capital, from labor, or from both combined...." In Comm'r v. Glenshaw Glass, Co. (1955), 348 U.S. 426, 431, 75 S.Ct. 473, 477, 99 L.Ed. 483, 490, the U.S. Supreme Court defined income as "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." While these definitions help explain various court rulings, it is almost beyond dispute that the working definition of income, at any given point in time, is whatever Congress says it is. Such wide latitude is based on the broad language of Internal Revenue Code § 61(a) which says, gross income is "all income, from whatever source derived...." The U.S. Supreme Court is typically quick to defer to Congress' authority in this arena, stating in Commissioner v. Schleier (1995), 515 U.S. 323, 327, 115 S.Ct. 2159, 2163, 132 L.Ed.2d 294, 301, "We have repeatedly emphasized the `sweeping scope' of [§ 61]." Whatever Congress' current definition of income may include, it is beyond question that Congress can tax it, with very few exceptions. The well-accepted meaning of the phrase "income tax" is that it is a tax on the activity and privilege of obtaining income, justified by the needs of a state to equitably distribute the burden of paying for government. New York ex rel. Cohn v. Graves (1937), 300 U.S. 308, 313, 57 S.Ct. 466, 467, 81 L.Ed. 666, 670. It includes an unpleasantly large chunk of money every employee sees taken from his paycheck. I.R.C. § 1(a)-(d). It includes taxes on early or lump sum distributions from qualified retirement plans. I.R.C. §§ 72(t) and 402(e)(4)(D). It includes capital gains taxes, I.R.C. § 1(h), and various others. The common denominator...