Here’s the truth about the ‘LLC tax’
Most of what has been written about the so-called “LLC Tax” is not true. A recent change in the law to close a loophole is being characterized as an unfair tax on the self-employed and small businesses, even though the change is unlikely to affect them.New Hampshire has never taxed earned income (wages), but in 1923, it started taxing unearned income with the enactment of the interest and dividends tax.The intent was to tax the wealthy; they were the people with substantial interest and dividends. In the intervening 86 years, more people have become subject to the tax, as the interest and dividend income of the middle class has increased, and as the Legislature has failed to adjust the personal exemption amount ($2,400) for inflation.New Hampshire also taxes business income through the business profits tax. Small businesses are subject to that tax, but most do not pay it because a small-business owner typically sets his salary so that the business income is reduced to zero. The business owner paying herself a salary pays no income tax because New Hampshire does not tax earned income, and the business pays no income tax because all of the profit of the business is paid out in salary.However, if a business is a corporation, profits paid to an owner as dividends are subject to the interest and dividends tax.In 1993, a loophole was created when the Legislature legalized limited liability companies, or LLCs. When an LLC paid profits to its owners, those payments were called distributions instead of dividends, and the recipient did not have to pay interest and dividends tax on them.The resulting unfairness is easy to understand. Consider two identical businesses – one a corporation, and one a LLC. Both pay business profits tax if they show any profit after paying salaries to employees and owners. Profits paid to the owner of the corporation are “dividends” and subject to the interest and dividends tax. Profits paid to the LLC owner are nontaxable “distributions.”Earlier this year, the Legislature closed this loophole by changing the definition of dividend. Now, all distributions of profits from any business entity – corporation, LLC, partnership or business trust – are considered “dividends” that are subject to the interest and dividends tax.Here is the truth about the “new LLC tax:” • There is no new LLC tax. LLCs do not have to file any new tax returns. The change is in our existing interest and dividends tax. • Small-business owners who pay their profits to themselves as salary are subject to no additional taxes. (The legislature is working on a bill to clarify what is a reasonable salary, as opposed to a large profit masquerading as salary.) • The change in the law will not affect 95 percent of those who own an LLC. Most business owners pay no interest and dividends tax on the profits from their business because those profits are considered salary rather than dividends.Of course, some owners of large, profitable LLCs are making a lot of noise because they don’t want to pay their share of taxes. Some politicians have joined the chorus, and have done their best to spread misinformation. (For the record, I will be paying interest and dividends tax this year for the first time, because I receive unearned income from a real estate partnership.)Some business owners who are paying the interest and dividends tax for the first time may ask themselves why they have to pay income tax while others do not. Many of our retirees, who saved for their retirement and pay tax on their dividends and interest, ask themselves the same question.But that takes us back to 1923 and the decision to tax only unearned income. And that’s a debate for another day.Mark Fernald, a former state senator from Sharon, was the Democratic nominee for governor in 2002.