State ex rel. Arizona Dept. of Revenue v. Driggs

• Decision Date: 28 May 1996
• Docket Number: CA-TX,No. 1,1
• Citation: 189 Ariz. 74,938 P.2d 469
• Parties: STATE of Arizona, ex rel. ARIZONA DEPARTMENT OF REVENUE, Plaintiff-Appellant, v. John D. DRIGGS and Gail D. Driggs, Defendants-Appellees. 94-0017.
• Court: Arizona Court of Appeals

Page 469

938 P.2d 469

189 Ariz. 74

STATE of Arizona, ex rel. ARIZONA DEPARTMENT OF REVENUE, Plaintiff-Appellant, v. John D. DRIGGS and Gail D. Driggs, Defendants-Appellees.

No. 1 CA-TX 94-0017.

Court of Appeals of Arizona,

Division 1, Department T.

May 28, 1996.

As Amended June 14, 1996.

Reconsideration Denied July 18, 1996.

Review Denied July 1, 1997. ^*

Grant Woods, Attorney General by Gail H. Boyd and Kimberly J. Cygan, Assistant Attorneys General, Phoenix, for Appellant.

Newmark Irvine, P.A. by Stephen C. Newmark, Phoenix, for Appellees.

FIDEL, Presiding Judge.

An error in the forms and instructions that the Arizona Department of Revenue issued for the taxable year 1986 led taxpayers John and Gail Driggs to overstate their deductions and understate their taxable income. In this tax appeal, the Department attempts to collect a resulting $1428.08 deficiency plus fifty percent of the interest normally collectable on that amount.

We consider the following issues:

1. Were the original forms and instructions mistaken?

2. If so, may the Department be equitably estopped from collecting a deficiency that it caused by its mistaken forms?

3. If not, may the Department at least be equitably estopped from collecting any interest on the principal deficiency amount?

I.

The Taxpayers filed an Arizona state income tax return for the taxable year 1986, using forms and instructions prepared and After concluding that its forms and instructions were inconsistent with governing statutes, the Department issued the Taxpayers a deficiency tax assessment. The Department later reduced the amount of the assessment, but the Taxpayers appealed. When the Arizona State Board of Tax Appeals ruled in the Taxpayers' favor, the Department appealed to the Arizona Tax Court. In a published opinion, State ex rel. Dep't of Revenue v. Driggs, 178 Ariz. 389, 873 P.2d 1311 (Tax 1994), the tax court granted the Taxpayers' motion for summary judgment, ruling that the Department was estopped from collecting any deficiency in these circumstances. The Department now appeals the tax court's ruling to this court.

                [189 Ariz. 76] disseminated by the Department.  Pursuant to Arizona statute, the Taxpayers deducted 1 from gross income the dividends they had earned on stock held in an Arizona corporation.  Arizona's tax statutes also permitted the Taxpayers to deduct the income tax they paid to the federal government, but--according to the Department--only to the extent that federal taxes were assessed on income that the State also taxed. 2  See Arizona Revised Statutes Annotated ("A.R.S.") § 43-961(5).  Thus, according to the Department, the Taxpayers should not have been able to deduct that portion of their federal income tax that was assessed on the dividend income from Arizona corporations.  However, the Arizona tax-return forms and instructions for 1986 (and for thirteen other years both before and after 1986) made no provision for reducing the federal-tax deduction by the amount of federal income taxes paid on dividend income from Arizona corporations.  Consequently, by properly filling out their state income-tax return, the Taxpayers took a larger deduction--and paid less tax--than the Arizona tax statutes permitted
                

II.

We first consider the Taxpayers' argument that the original forms and instructions were proper all along and that the Department is mistaken in claiming that any deficiency is due. The Taxpayers base their argument upon a distinction between deductions and subtractions and upon the wording of A.R.S. § 43-961, which reads:

In computing taxable income no deduction shall in any case be allowed in respect of:

....

5. Any amount ... that would otherwise be allowable as a deduction or an adjustment, which is allocable to one or more classes of income ... that is not required to be included in a person's Arizona adjusted gross income or Arizona taxable income.

According to the Department, § 43-961 precludes deduction of federal income taxes allocable to Arizona corporate dividends, because Arizona corporate dividends are a "class[ ] of income ... not required to be included in a person's ... Arizona taxable income." Id. But the Taxpayers respond that § 43-961 applies only to deductions, a term of art that does not include the federal-tax adjustment of A.R.S. § 43-1022(11), which falls within the separate and distinct category of subtractions.

In the Arizona tax statutes, the term subtractions is used to describe "above-the-line" adjustments that reduce overall income to "adjusted gross income." The term deductions is used to describe "below-the-line" adjustments that further reduce adjusted gross income to "taxable income." Compare A.R.S. § 43-1022 (titled "Subtractions from Arizona gross income") with A.R.S. tit. 43, ch. 10, art. 4 (A.R.S. §§ 43-1041 et seq.) (titled "Deductions and Personal Exemptions"). Emphasizing this distinction, the Taxpayers argue that § 43-961 restricts "deductions" only in the refined, below-the-line sense of the word and does not apply to an above-the-line federal tax subtraction.

We note in passing that the 1986 forms did not comprehensively exclude the federal tax subtraction from the ambit of § 43-961, as would follow from the Taxpayers' argument. To the contrary, the forms provided for reduction of the federal tax subtraction to account for federal tax paid on many types of income not taxed by the State. The forms simply failed to provide for a reduction to account for federal tax paid on one particular type of income not taxed by Arizona--Arizona corporate dividends. Thus, the Taxpayer's argument, if correct, has implications far broader than may first appear. Not only would it validate the Department's 1986 treatment of federal taxes paid on Arizona corporate dividends; it would invalidate the Department's 1986 treatment of federal taxes paid on other forms of income not taxable in Arizona.

We conclude that the Taxpayers' argument is not correct. Rather, it is plain from the structure and language of § 43-961 that the word "deduction" in the opening phrase, "no deduction shall in any case be allowed," must be read in its inclusive, not its limited sense. We know this because subsection (5) limits "[a]ny amount ... that would otherwise be allowable as a deduction or an adjustment" (emphasis added), and because subsection (5) applies both to items of income "not required to be included in a person's Arizona adjusted gross income" (i.e., subtractions) and to items of income "not required to be included in a person's ... Arizona taxable income" (i.e., deductions ).

The Taxpayers have not offered an interpretation of A.R.S. § 43-961(5) that is consistent with their claim that that statute was correctly applied by the Department in its 1986 forms and instructions. We uphold the Department's conclusion that the form and instructions were erroneous.

III.

We next consider whether the Department can be estopped from collecting the deficiency assessment. The Taxpayers have unquestionably established the elements of erroneous representation and reasonable reliance. Had the Department issued proper forms and instructions, the Taxpayers would presumably have complied. The court's equitable impulse is constrained, however, by a considerable body of authority that precludes estopping the State from the collection of its revenues.

In Crane Co. v. Arizona State Tax Commission, our supreme court proscribed estoppel on constitutional grounds:

The general rule is that the state will not be estopped in the collection of its revenues by an unauthorized act of its officers. In the matter of collecting revenues, the state is acting in its governmental or sovereign capacity, and ordinarily there can be no estoppel. Were this not the rule the taxing officials could waive most of the state's revenue. The [Arizona] Constitution, Art. 9, Sec. 1, provides that the power of taxation (which must of necessity include collection) "shall never be surrendered, suspended, or contracted away." To hold that the commission by regulation may waive taxes which the law required to be imposed would be violative of this provision.

63 Ariz. 426, 441, 163 P.2d 656, 662 (1945) (citations omitted). Our courts have followed Crane Co. in numerous subsequent opinions. See, e.g., Duhame v. State Tax Comm'n, 65 Ariz. 268, 281, 179 P.2d 252, 260 (1947); Knoell Brothers Constr., Inc. v. Arizona Dep't of Revenue, 132 Ariz. 169, 172, 644 P.2d 905, 908 (App.1982). This court has recognized the continuing validity of Crane Co. as recently as PCS, Inc. v. Arizona Department of Revenue, 186 Ariz. 539, 542-544, 925 P.2d 680, 683-685 (App. 1995).

The Taxpayers, however, invoke one prominent exception to the general rule. In Tucson Electric Power Co. v. Arizona Department of Revenue ("TEP "), the Department tried to deny a taxpayer an otherwise appropriate deduction because the taxpayer, by following the Department's erroneous instructions, had omitted a prerequisite procedural step. 174 Ariz. 507, 516, 851 P.2d 132, 141 (App.1992). Finding estoppel available under these circumstances, the TEP court explained:

In advancing its estoppel argument, the taxpayer seeks to enforce, rather than Id. at 515, 851 P.2d at 140.

[189 Ariz. 78] avoid, the basic intent of the statute. The representations of the Department of Revenue that the taxpayer relies upon for its estoppel argument were not that the taxpayer's activities were not taxable. Rather, they related solely to a procedural matter....

The tax court adopted the Taxpayers' argument that this case should be governed by the TEP exception and not by Crane. The tax court explained:

the representations...