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This article originally appeared in the September issue of Dateline: NH. It has been updated to address quarterly payments that are due at the NH Dept. of Revenue Administration (NH DRA) this month.
By Scott W. Ellison, Esq.
In June, Governor Lynch signed the budget for the State of New Hampshire for the ensuing year, which included as a revenue-raising measure a change in the taxation of distributions from Limited Liability Companies (LLCs). New Hampshire has long had a 5 percent tax on interest and dividend income, but distributions from LLCs have, until now, remained outside of this tax. This change will now tax distributions from LLCs to the same extent that such payment would be taxed if it were paid under similar circumstances by a corporation.
LLCs are a form of business entity that is very popular for many types of business, particularly as real estate holding companies. Many automobile dealerships, while perhaps operating as corporations, hold title to their real estate in LLCs. Thus, this recent change to the tax law caused many dealers to raise an eyebrow and wonder how the change affects them.
This modification to the tax law poses the most significant change to LLCs that have owners who are passive investors and do not provide services to the LLC. By definition, dividends are paid out of profits (or in certain circumstances out of debt financed by the entity, which is included in a list of issues needing to be addressed, issued by the Department of Revenue Administration on August 17, 2009). But if the LLC pays compensation to its owners in exchange for their services, paying compensation has the effect of reducing or eliminating the profit pool and, just as is the case for corporations, these payments for services are recognized as legitimate compensation and not taxed as dividends. If, after payment of all expenses, including compensation to owners, the LLC has no profits remaining, it is difficult to see how there could be distributions that are taxed as dividends. A quick look at the LLC’s business tax return filed with the state of New Hampshire will reveal whether the LLC ended the year with any profits, because if it did, then the profits will be set-forth for the calculation of the Business Profits Tax.
| A quick look at the LLC’s business tax return filed with the state of New Hampshire will reveal whether the LLC ended the year with any profits, because if it did, then the profits will be set-forth for the calculation of the Business Profits Tax. |
This is not to assume away the issue however, as whatever is paid as compensation must still be reasonable. The state of New Hampshire has frequently and regularly challenged the use of compensation to owners to reduce taxable profits when the amount paid is “excessive.” In the case of LLCs, the amount distributed to owners will be “deemed compensation” only in an amount equivalent to the value of the personal services provided by an owner to the LLC. So this is not a new issue – excessive amounts of compensation always posed a tax risk in that there was potential liability for the Business Profits Tax to be assessed on any excessive amount – the risk is now more serious as the Interest and Dividends Tax may be assessed in addition to any amount of Business Profits Tax levied on profit distributed as excessive compensation.
So the reason why this change is more significant for LLCs with outside passive owners is apparent – there is no basis on which to assert payments to such owners that constitute compensation, and thus those payments would now be subject to the Interest and Dividends Tax. When deciding whether services are provided, actions such as negotiating leases, collecting rent, and paying expenses such as debt service, taxes, insurance and utilities, keeping the books, and overseeing maintenance and landlord improvements should be remembered. However, with regard to LLCs for whom no services are provided, accumulating excess funds in these entities would appear inadvisable, which might lead some dealerships to question whether rental payments paid to these LLC holding companies, if in excess of debt service, truly reflect fair market value rent.
A couple of other very important aspects of this tax change should be noted: (1) previously, certain LLCs themselves were required to pay the Interest and Dividends tax at the entity level, which will now be discontinued; instead, the owners will pay taxes on any interest or dividend income if it is distributed out to the owners as a dividend; and (2) the change is retroactive for all tax years beginning on or after January 1, 2009.
This latter aspect bears emphasis, and is a questionable procedure for making policy. Even though this change to the tax did not become law until June 2009, it applies to distributions that were made as far back as January 2009. Thus, a distribution that was made in January 2009, with the expectation that it would not be subject to the interest and dividends tax because such was the tax treatment at the time, is now found to be subject to the tax. Many tax practitioners object to this type of retroactive tax implementation, as it makes proper tax planning impossible if the rules can be changed after the fact, but nonetheless the Courts have upheld such retroactive statutory tax changes in the past.
| Many tax practitioners object to this type of retroactive tax implementation, as it makes proper tax planning impossible if the rules can be changed after the fact, but nonetheless the Courts have upheld such retroactive statutory tax changes in the past. |
If a taxpayer will have annual interest and dividends tax liability in excess of $500, then the taxpayer is required to file quarterly estimated payments or risk being assessed penalties for underpayment of taxes. This is particularly time sensitive, as a quarterly payment was due September 15, 2009. If a taxpayer did not have any tax liability in the prior year, there will not be a penalty assessed for underpayment, but any liability (even if below the $500 threshold requiring filing) will be sufficient to make the taxpayer subject to the penalty. To avoid penalties, by the September 15, 2009 the taxpayer is to have paid an amount at least equal to 75% of the prior year’s tax liability. The other filing dates are April 15 (by which an amount equal to 25% of the prior year’s liability was to have been paid), June 15 (an amount equal to 50% to have been paid), and January 15, 2010 (by which an amount equal to the entire 2008 tax liability should be paid).
The nuances of this tax change are not completely established yet, and New Hampshire’s Department of Revenue Administration is hoping to issue final regulations interpreting and implementing this change in accordance with their rule-making procedures by mid-November 2009. So until then, dealers should keep their fingers crossed, monitor the rules making process, get involved, and hope for the best!
Scott W. Ellison, Esq. is a member of the business law firm of Cook Little Rosenblatt & Manson pllc. He can be reached by telephone at 603-621-7122 or by e-mail at s.ellison@clrm.com.
If you have any further questions, please contact me at 800-852-3372 or e-mail me at pmcnamara@nhada.com.
Sincerely,
Peter J. McNamara,
President
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