‘Reasonable’ compensation goes under House panel’s microscope

Bill would give DRA greater authority to audit partnerships

A NH House bill that would likely require large partnerships to justify the compensation they pay to their partners earned the support of the state Department of Revenue Administration and received a polite reception from the House Ways and Means Committee Tuesday.

House Bill 1443, sponsored by Rep. Susan Almy, D-Lebanon, would leave in place the $75,000 “safe harbor” – the limit before the DRA could consider auditing a company for “reasonable” compensation.

But the bill would shift the burden of proof from the DRA to the taxpayer for businesses whose compensation rises above that safe harbor.

That was the way it used to be before 2011, but at the time lawmakers – in response to what was called aggressive DRA auditing – required that the agency prove by the preponderance of the evidence that a business was committing fraud before it could require that it pay up. To do so would require overworked staff at the Attorney General’s Office to issue a subpoena – a process that could take years to resolve, Almy testified.

According to the DRA, since the change, reasonable compensation claims jumped from $8 billion to $9.4 billion in 2011, meaning that any compensation beyond “reasonable” was avoiding the business profits tax.

Instead, businesses paid the 0.75 percent business enterprise tax, saving businesses – and costing the state – about $100 million, Almy said.

The amount of the deduction remained high in 2012, at $9.5 billion, and $9 billion in 2013.

$10 million in revenue

Though it’s not clear whether all of that jump was due to the change in the law, DRA Commissioner John Beardmore testified he has heard from accountants that many were advising their clients to take advantage of the loophole. If the bill passes, that advice would stop and it would be a “reasonable” estimate that the state would immediately pick up $10 million in annual revenue, he said.

In addition, the DRA does not assume the burden of proof in order to audit companies on any other tax, nor did he know of any other state that does so, said Beardmore.

“The department generally takes a pass at policy decisions,” Beardmore said, but “this is an anomaly. We are clearly an outlier.”

He did partly accept responsibility on behalf of the department for “probably going too far” in audits in the past. “We did not approach it in the most thoughtful way.”

The bill requires the department to prepare draft rules to change auditing practices in the future and to present. Beardmore said he agreed with that as well, to ensure greater transparency.

The measure also increases “lookback” provisions, allowing a cyclical business or startup to count the time put in by partners in earlier years.

However, the bill did not include Gov. Maggie Hassan’s proposal to double the safe harbor provision to $150,000.

“The reason I left it out was I was worried that they would leave that in and take the rest out,” Almy told NH Business Review after the hearing. “However, if the committee wants to put in $150,000, I would not oppose it, but something like $250,000 is too high. This was to relieve small businesses of bookkeeping requirements. When you get to that level, you need an accountant anyway.”

Almy said the problem is not caused by small businesses, but larger ones.

Kathleen Sher, who heads the DRA’s auditing division, backed Almy up. She said that some businesses were “claiming what on its face is unreasonable – millions of dollars.” She said they were “very, very highly paid individuals – people who make in excess of a half million, or a million dollars each.”

No one spoke against the bill, and committee members’ questions tended to be centered on clarifications on the existing law and how the bill would change it.