Commercium. SM Advertising A Newsletter for business clients and friends of DTC Lawyers. 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 To Subscribe to future issues of DTC Lawyers Newsletter, Commercium, visit our website at www.dtclawyers.com and send us an email. 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.