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Law in the Marketplace: Inside the uncertain I&D Tax

Written by: John M. Cunningham

Published in the Concord Monitor (2/13/2021)

Although New Hampshire boasts that, unlike most other states, it imposes no state income tax on its residents, it does impose an income tax on New Hampshire business owners, and it’s a significant one – namely, the New Hampshire Interest and Dividends Tax (the “I&D Tax”).

With exceptions I’ll explain below, this tax applies at a rate of 5% to interest and dividends received by New Hampshire residents from corporations, LLCs and other entities with “transferable shares” — a term I’ll also explain below. There are currently about 55,000 New Hampshire residents who are the owners of single-member LLCs. The question I will address below is whether these individuals are subject to the I&D Tax. As you’ll see, the answer is painfully uncertain; but the path to certainty may also be painful.

Here is what you should know about exemptions from the I&D Tax:

-- Each taxpayer subject to the tax has an exemption of $2,400.

-- Each taxpayer has an additional exemption of $1,200 if the taxpayer is married and if either spouse is 65 years of age or older on the last day of the taxable year.

-- Each taxpayer is entitled to an additional $1,200 exemption if the taxpayer is blind.

-- Each taxpayer is entitled to yet an additional $1,200 exemption if the taxpayer is less than 65 years old and is unable to work because of a disability.

Under the I&D Tax, the shares of all corporations, whether they have only one shareholder or multiple shareholders, are deemed to be “transferable,” regardless of the structure of the corporation in question or the contents of any shareholder agreement it may have. For this reason, all corporate shareholders who reside in New Hampshire are subject to the I&D Tax on distributions from their corporations except to the extent of the above exemptions.

As for LLCs, the regulations of the New Hampshire Department of Revenue Administration (the “DRA”) provide that LLC “shares” (called “membership rights” under New Hampshire LLC law) will be non-transferable and thus that distributions from these LLCs to their members won’t be subject to the I&D Tax except to the extent of the above exemptions only if the governing LLC act or their operating agreements provide either:

-- That members may not transfer their shares “without prior member approval”; or

-- That, upon any such transfer, the LLC in question must be dissolved. Unfortunately, the above DRA regulations affecting LLCs have many ambiguities.

-- For example, does a “member approval” have to be unanimous, or can it include approval by just one other member or by a majority of other members?

-- If the latter, does “majority” mean majority by number of members or by majority of contributions?

-- And do transfers under the DRA regulations only include transfers to third parties, or do they also include transfers to one’s children or other close relatives?

But perhaps the biggest ambiguity of all in the above DRA regulations is whether the I&D Tax applies not only to multi-member LLCs but also to single-member LLCs. To illustrate:

-- The DRA has never publicly stated its position about this ambiguity.

-- However, a leading former DRA manager has stated that the DRA believes that all distributions by single-member LLCs to their members, including distributions booked as compensation, are subject to the I&D Tax.

-- It can be argued that since the members of single-member LLCs completely control their LLCs, single-member LLC operating agreements are meaningless and a dissolution provision in such an agreement LLC must be viewed as legally invalid.

I happen to have strong opinions about all of the above ambiguities, and all of my opinions happen to be strongly pro-taxpayer. In particular, I feel confident that even the DRA will acknowledge that transfers of cash from a single-member LLC to its owner that are reasonably booked as compensation aren’t subject to the I&D Tax. And I’m reasonably confident that individuals who are members of single-member LLCs won’t owe the I&D Tax on distributions of their profits to them if their operating agreements contain a “dissolution” provision.

However, I also feel a duty to warn all of my clients who are members of single-member LLCs that they face at least a small risk of I&D Tax liability on distributions from their LLCs except to the extent of the above exemptions. I advise these clients that the only certain solution to this I&D Tax issue for individuals who are members of single-member LLCs is to admit a second member to their LLC. But, in my experience many members of New Hampshire single-member LLCs simply don’t want a second member. So they’re stuck with the above risk.

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