In the waning moments of the 2009 New Hampshire legislative session, the legislature adopted a new revenue generation measure, providing for taxation of certain distributions from limited liability companies to New Hampshire owners. The law will subject the recipient of the distribution to reporting it as a dividend under the New Hampshire Interest and Dividends Tax.
The failure of the legislature to hold public hearings and to fully consider the tax proposal resulted in rushed, sketchy and unclear legislation, and the current public fury over the extension of the I&D tax to LLC and partnership distributions is largely a product of that process. It may well be that many legislators did not fully understand the tax when it was adopted. Nonetheless, it is clear that significant misunderstandings and even misinformation about the tax has been receiving a lot of play in the media.
Prior to the adoption of the new tax law, the New Hampshire Business and Industry Association and the New Hampshire Society of Certified Public Accountants requested clarification from the Department of Revenue Administration as to what the tax would and would not reach. The Department, which had been the source of the legislature’s last-minute inclusion of the tax in the budget bill, provided clarification in the form of detailed letters to the BIA and the CPA Society. The Department has not yet finalized the adoption of administrative rules that are necessary to determine exactly what distributions will and won’t be taxed. However, based on that pre-adoption clarification process, we believe that the following statement of what the tax was and was not intended to reach reflects the intent of the legislature and the Department:
- The law is not a new tax. Rather, the change is intended to subject “distribution income” that resembles dividend income to an existing tax, New Hampshire’s Interest and Dividends Tax.
- As the Governor has stated, the tax is intended to place businesses that operate as corporations on a par with businesses that operate as limited liability companies. More precisely, the objective of the law was to tax distributions made by limited liability companies and partnerships to their owners to the same degree—and only to the same degree—that dividends paid by corporations to shareholders are taxed as dividends.
- The tax will apply to recipients of LLC or partnership distributions, regardless of where the LLCs or partnerships making the distributions are located or under which state’s laws they are formed.
- Payments made to owner-employees of LLCs and partnerships that constitute compensation for the services of the owner-employees of the business are not intended to be taxed, any more than compensation paid to shareholder-owners is taxed. The uncertainty over what deductions will be allowed as “reasonable compensation” by the Department of Revenue Administration is a related and significant problem.
- We believe that the majority of New Hampshire LLCs, as well as the majority of New Hampshire corporations, are small businesses that do not make distributions to owners in the nature of taxable dividends, so those businesses simply will not be affected by the tax.
Much of the confusion surrounding the new tax is understandable. It is easy to say that LLCs and partnerships should be placed on the same footing as corporations and that distributions or dividends to owners of both should be subject to equivalent taxation under the New Hampshire Interest and Dividends Tax. However, because partnership accounting and partnership tax (LLCs are taxed as partnerships) is very complicated and differs significantly from corporate taxation, figuring out how to treat distributions made by those entities in the same manner as dividends paid by corporations is very complex. Our hope is that the Department of Revenue Administration’s rule-making process will sort that out. Assuming that the rules are adopted so as to effect what we believe to be the law’s intent, we do not believe that the tax will spell an end to New Hampshire LLCs, will not be unfair, and it will not put New Hampshire LLCs at a competitive disadvantage to LLCs operating in other states.