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DTC LAWYERS - DONAHUE, TUCKER & CIANDELLA, PLLC
Exeter Office:
Water Street Professional Building
225 Water Street
PO Box 630
Exeter, NH 03833
(603) 778-0686
Portsmouth Office:
111 Maplewood Avenue Suite D
Portsmouth, NH 03801
(603) 766-1686
Meredith Office:
56 NH Route 25
PO Box 214
Meredith, NH 03253
(603)279-4158
www.dtclawyers.com
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Inside this issue:
NH Reasonable Compensation
Deduction: New Rules
1-2
Recent Case Law regarding the NH 2-3
Real Estate Transfer Tax.
About Donahue, Tucker &
Ciandella
4
Contact us
4
A Professional Limited Liability Company
Volume 9, Issue 1 Spring 2012
NH Reasonable Compensation Deduction.
Like the federal income tax,
the New Hampshire Business
Profits Tax (BPT) is imposed
on New Hampshire corporations at the entity level. However, under the federal income
tax rules, corporations are
allowed a deduction for reasonable compensation paid to
its owners/employees.
The
reasonable compensation deduction reduces the entity
level tax. Because the federal
income tax does not tax sole
proprietorships, partnerships
and limited liability companies (LLCs) at the entity level,
there is no federal compensation deduction. Therefore, to
put them in parity with corporations for New Hampshire
purposes, the BPT allows a
deduction for reasonable compensation
for
owners/
employees of sole proprietorships, partnerships and LLCs.
Prior to law changes in 2010
and 2011, there was limited
guidance on how to determine
what was reasonable compensation for owners/employees.
With shrinking tax revenues
and tightening budgets, this
became the most widely audited issue by the New
Hampshire Department of
Revenue (DRA), resulting in
more taxes, interest and penalties. Bowing in part to the
pressure to make New Hampshire more attractive to busi-
nesses, the legislature amended the BPT rules to provide
guidance on how to determine
what is reasonable compensation. The four major changes
are:
Reliance on Federal Law.
Much of the guidance comes
from now being able to look
to the federal test for reasonable compensation under Internal Revenue Code Section 162
(a) and the well-developed
body of case law thereunder.
The case law under 162(a)
delineate a number of factors
to take into consideration, and
have been tested in the courts.
This new guidance brings
much more certainty and less
guesswork in determining
what is reasonable compensation for owners/employees.
New $50,000 Safe Harbor Deduction. Prior
law permitted each
proprietor, partner and
LLC member who performed services for the
business to take a
$6,000
compensation
deduction without being challenged by the
DRA, or having to
maintain records to
substantiate the deduction. Under the new
rules, the safe harbor
deduction amount is
increased to $50,000,
but it is per business or per
business group. While this
eases the record-keeping burden for many small companies, more profitable businesses or business groups will not
fall under the new safe harbor, and instead will have to
maintain records to substantiate each owner’s compensation deduction.
Return on Investment. Prior
law prohibited owners from
paying themselves compensation that was attributable to a
return on capital assets or
employees utilized in the
business. The new rule is a
slight deviation that is consistent with the federal test
under Code Section 162(a).
That test requires a return for
investors on the utilization of
Page 2
Commercium
NH Reasonable Compensation Deduction cont.
pany’s profits as a return on
those assets, and not take it
as compensation which reduces the company’s BPT
liability.
capital assets and employees.
Under the investor test, private investors expect a reasonable rate of return on the capital assets and employees utilized in the business. Therefore, companies that have
capital assets and/or nonowner/employees should reflect a percentage of the com-
Record Keeping Requirements:
(i) Compensation
Deduction of $50,000 or Less
- While businesses are not
required to keep records to
substantiate the $50,000 compensation deduction, they
still must be able to show
that at least one owner (who
is an individual) actually
performed services for the
business or business group
during the tax year. Therefore, companies that take this
deduction should have some
kind of documentation (i.e., a
calendar or log) that verifies
an owner performed services, what those services
were, and when they were
performed. (ii) Compensa-
tion Deduction over $50,000
- Businesses must attach to
the annual BPT return a
schedule allocating the compensation deduction among
the owners who performed
services.
Records should
keep track of the hours
worked and a description of
the services performed by
each owner.
Evidence is
best provided by contemporaneous records (such as
daily, weekly or monthly
logs), rather than records
created at the end of the year
or during an audit.
If you have any questions
concerning these new rules
or what type of records to
maintain, you should consult with your tax advisor.
For more information you
may contact Attorney Joy
Riddell.
Recent Case Law regarding the NH Real Estate Transfer Tax.
Since 2003 the New
Hampshire Department of
Revenue
Administration
(“NH DRA”) has been fully
authorized by statute to aggressively apply and collect
the real estate transfer tax
upon a transfer of any interest
in a limited liability company
that holds New Hampshire
real estate. Whether a business owner is a developer of
real estate or merely the owner of the condominium unit in
which the business operates,
the tax is an additional expense that has to be considered in any sale or transfer of
a New Hampshire real estate
asset. This includes transfers
to merely facilitate financing.
Two recent cases decided
by the NH Supreme Court
regarding property owners
making transfers to new entities as a condition of obtaining financing illustrate both
the broad reach of the tax and
NH DRA’s aggressive efforts
to collect it, as well as the
very limited circumstances in
which it can be avoided.
In First Berkshire Business
Trust v. Commissioner, NH
DRA, 161 NH 176, the taxpayer which was audited by
NH DRA was unsuccessful in
challenging a Notice of Assessment
seeking
over
$200,000 in transfer tax. First
Berkshire owned a commer-
cial property in Manchester
and was in financial difficulty. To avoid bankruptcy, it
obtained a commitment from
Wells Fargo Bank for refinancing. The Bank, as a condition of making the loan
required First Berkshire to
create a single purpose entity; First Berkshire Properties,
LLC to: 1) take title to the
property from First Berkshire
by deed; and 2) be the borrower under the loan. First
Berkshire made the conveyance and subsequently refinanced again with another
lender which required that a
second LLC be created to
take title from the first LLC
Volume 9, Issue 1 Spring 2012
Page 3
Recent Case Law regarding the NH Real Estate Transfer Tax. Cont.
and to borrow the funds for the
second loan. NH DRA claimed
both transactions were subject
to the tax calculated at the fair
market value of the property.
First Berkshire claimed there
were
no
bargained-forexchanges subject to the tax and,
even if there was a taxable
transfer, the value of the transfer was $10.00 and other valuable consideration as stated in
each of the deeds.
The NH Supreme Court
agreed with NH DRA’s position. The Court held that because money and other consideration was exchanged, there
was a taxable transfer and that
NH DRA in its role as auditor,
charged with enforcing the tax,
could look behind the stated
price in the deed and determine
the actual price or consideration
based upon the fair market value of the real estate.
In Say Pease IV, LLC v. NH
DRA, (decided March 23, 2012),
a taxpayer in a similar financing
transaction, was successful in
qualifying the scope and reach
of the First Berkshire decision,
thereby avoiding an assessment
of the tax by NH DRA on its
47.5% interest in a property at
the Pease Tradeport with a value in excess of 10 million dollars. Say Pease IV was an entity
created by Two International
Group, LLC (“TIG”) and its
managing member Say Pease,
LLC, so as to meet the requirement of a lender of a $10.5 million mortgage loan that all of
the members of TIG be “single
purpose bankruptcy remote
entities” to protect the lender
from other potential creditors of
TIG or Say Pease, LLC. Say
Pease IV (“SPIV”) was formed
by the members of Say Pease,
LLC for the sole purpose of being a Managing Member and
Member of TIG and couldn’t
engage in any other business
activity as long as the loan was
outstanding. Say Pease’s 47.5%
interest in TIG was transferred
to SPIV under these conditions.
The NH Supreme Court considered NH DRA’s appeal of a
decision of the Superior Court
holding that the real estate
transfer tax didn’t apply because it was not a contractual
transfer and agreed with the
reasoning of the lower court
that there was not a bargainedfor-exchange of consideration.
The Supreme Court explicitly
distinguished its decision in
First Berkshire finding any benefit received by the transferee
SPIV was too attenuated to support a finding of consideration
under the statute.
Where does this leave the
business owner? In most situations the tax is going to apply to
the transfer of real estate or interests in a real estate holding
company even if the beneficial
ownership remains identical
after the transfer and the only
purpose is to obtain financing.
However, the Say Pease decision shows the value of anticipating the issue and, with the
assistance of counsel and your
tax advisor, drafting transfer
documents that position you to
avoid or resist the tax. This is
an aggressive strategy, with
considerable risk, recognizing
that NH DRA can seek to impose a 100% penalty for intentional failure to pay the tax (the
penalty was sought in First
Berkshire but the Superior
Court found it was not warranted based on the then unclear
state of the law).
In some
unique cases like Say Pease,
where there is a layered LLC
approach and a very substantial
tax is at stake, an effort to analyze all aspects of how a contemplated transaction can be
structured to meet the “no consideration” standards laid out in
Say Pease can be justified.
Additionally, business owners, in making financing decisions, need to consider some of
the NH specific tax implications
of dealing with securitized commercial lenders who routinely
require such transfers to meet
the bankruptcy remote entity
requirement of the underwriters
for the bundled securities sold
that are collateralized by the
mortgages.
Those rates are
attractive, but especially in a
low rate environment, dealing
with your local commercial
lender may save you misery.
Finally, because the State is
so revenue starved, it is also
likely that NH DRA will pursue
legislative action to further clarify the definition of consideration in the statute so as to effectively render the distinction
drawn in Say Pease by the Supreme Court moot, and therefore reverse the outcome to
make such layered transfers
subject to the tax. This is another reason to stay in touch with
your counsel and tax advisor
who monitor such developments.
For more information, you
may contact Attorney Michael J.
Donahue. A version of this
article with more details on the
Say Pease decision can be found
at http://dtclawyers.com/wpcontent/uploads/CASE-LAWDEVELOPMENTS-INTERPRETINGREAL-ESTATE-TRANSFER-TAX.pdf
DTC LAWYERS
DONAHUE, TUCKER & CIANDELLA, PLLC
A Professional Limited Liability Company
Locations:
Exeter Office:
Water Street Professional Building
225 Water Street
PO Box 630
Exeter, NH 03833
(603) 778-0686
Portsmouth Office:
111 Maplewood Ave.
Portsmouth, NH
03801
(603) 766-1686
Meredith Office:
56 NH Route 25
PO Box 214
Meredith, NH 03253
(603)279-4158
For more information contact one of the following attorneys in our business practice group:
Attorney Lizabeth M. MacDonald
Email: lmacdonald@dtclawyers.com
Tel: (603)778-0686 Ext. 540
Attorney Douglas M. Mansfield
Email: dmansfield@dtclawyers.com
Tel: (603)778-0686 Ext. 519
Attorney Michael J. Donahue
Email: mdonahue@dtclawyers.com
Tel: (603)766-1686 Ext. 684
Attorney Katherine B. Miller
Email: kmiller@dtclawyers.com
Tel:(603)778-0686 Ext. 504
Attorney Denise A. Poulos
Email: dpoulos@dtclawyers.com
Tel: (603)766-1686 Ext. 689
Attorney Christopher T. Hilson
Email: chilson@dtclawyers.com
Tel:(603)778-0686 Ext. 509
Attorney Jessica L. Ecker
Email: jecker@dtclawyers.com
Tel: (603) 778-0686 Ext. 530
Attorney Joy V. Riddell
Email: jriddell@dtclawyers.com
Tel:(603)778-0686 Ext. 544
We’re on the web, at www.dtclawyers.com
Established in 1985, DTC Lawyers is one of New Hampshire’s leading law firms, with offices in Exeter, Portsmouth and Meredith. We are a full-service firm with our lawyers offering
personalized representation to small businesses, large institutions and individuals. We represent and advise our clients in the areas which include general business and commercial
law, municipal, development and real estate law, telecommunications, utility and internet law, employment and labor
law, family law, environmental law, appellate, litigation, bankruptcy, and probate/estate planning.
Our attorneys provide affordable, quality legal services and personal attention to small and large businesses, agencies,
boards, municipalities and individuals. Our focus on the client has enabled DTC to provide general counsel services,
as well as special representation on specific matters to our clients. It allows us to be trusted counselors and advisors as
well as advocates.
Our clients come from throughout New England. We represent many firms and individuals relocating to New Hampshire from across the nation.
The materials contained in this newsletter are for informational purposes only and not for the purpose of providing legal advice or a comprehensive
summary of recent developments in the law or treat exhaustively the subjects covered. For advice about a particular problem or situation, please contact an attorney of your choice. © 2012 Donahue, Tucker & Ciandella, PLLC
For back issues of the Commercium newsletter please go to our website at www.dtclawyers.com.