State seems to be shifting away from small-business owners
I remember when New Hampshire was decidedly pro-small-business. It’s not anymore.
New Hampshire historically maintained a favorable climate for business start-ups. There was no income tax. There was no sales tax. The quality of life was high, making it a great place to attract and retain employees. Even now, after all the new fee increases, the filing fees in New Hampshire for limited liability companies and corporations are dwarfed by those charged by the commonwealth on our southern border.
But the atmosphere in which companies do business in New Hampshire has changed over the last couple of years. The financial pressure associated with running the state government has spawned a mindset among state regulators and legislators that is, in fact, anti-small business. Business taxes and fees have been increased repeatedly. To maximize the collection efforts, the state has auditors of all shapes and sizes from all sorts of departments and divisions out in force, and they are waging war with our small businesses.
The first harbinger of this change in mindset appeared on my radar screen in 2007, when the Legislature amended the workers’ compensation statute to change the definition of “employee.” The avowed purpose of that change was to “protect” workers who should be classified as employees from being classified as independent contractors by evil employers.
Of course, while the Legislature was protecting workers, it was also shoring up the state workers’ compensation fund by forcing employers to reclassify these folks as employees and to pay into the fund. Even better from the fundraising perspective, by broadening the definition of “employee” and seeking out violations, additional BET tax revenue could be generated. What a legislative bonanza: raising revenue while protecting employees. What politician would vote against that?
That statute became effective in January, 2008, and from my perspective as a business lawyer, New Hampshire is now crawling with state auditors examining the payroll records of small businesses. Their mission: to ferret out businesses that have people working as independent contractors who are now properly categorized as employees under the expanded definition of employee. Once caught, the companies are fined and penalized.
So, in the guise of protecting workers, the state is aggressively seeking fee income from small businesses, and at the worst possible time. The reality is that small businesses caught in this trap will not retain these contractors as newly classified employees, because they cannot afford to.
The reality is that the reclassified contractors, thanks to the state effort to protect them, will be trying to find new work.
There have always been businesses that have abused the independent contractor laws. Those businesses ought to be penalized. But thanks to the revised statute and the newly aggressive mindset of our regulators, the independent contractor in New Hampshire is dead and buried. The truth is that the statute sets forth a list of qualifications to be an independent contractor that cannot possibly be met. The list is an expanded version of the one traditionally employed by the IRS when they examined the issue. Frankly, it is a sad joke, and if you own a small business that utilizes independent contractors, you need to stop, and fast. The auditors are coming.
So we have killed the independent contractor in New Hampshire, and my fear is that the limited liability company might just be next. Limited liability companies were created by statute in New Hampshire in 1993, and since that time have become the vehicle of choice for most new companies.
They also proved extremely popular for use as entities to own and hold commercial real estate. LLCs work well, especially in a state like New Hampshire, where there is no income tax. Owners have been able to get revenue out of the LLC and into their pockets without paying income tax. That sounds like the New Hampshire way, does it not?
But thanks to the collection-minded state regulators and budget-conscious legislators, the halcyon days of the LLC in New Hampshire are officially over. New Hampshire accountants and New Hampshire commercial real-estate developers will tell you that state regulators declared war on LLCs a couple of years ago. Many have engaged in painful battles with the New Hampshire Department of Revenue Administration that center on whether distributions made by LLCs to their owners ought to be taxed as dividends, and therefore should be swept up under the New Hampshire interest and dividends tax. The fight centers on what distributions are deemed “reasonable” by the state regulators.
But our state representatives during this last fiscal session presented the regulators with the regulatory equivalent of manna from heaven: statutory support for their collection efforts in the form of an amendment to the state interest and dividends tax. Under the new statute, New Hampshire LLC owners will pay a 5 percent tax on certain distributions they receive from their LLC. That sure sounds like an income tax to me.
In fairness, the regulations underlying the amendment have yet to be finalized. We are not yet certain of exactly what portion of distributions will be taxed. But here is one man’s shocking prediction: the regulations will be broad enough to sweep all sorts of previously untaxed LLC distributions into the realm of the taxed. And it won’t involve just real-estate holding entities.
So there you have it. From my perspective as a business lawyer, our small businesses are at war with the state of New Hampshire. They are being attacked by an aggressive corps of regulators armed with new statutory authority to help them squeeze more revenue out of New Hampshire’s small businesses.
I do not pretend to know the answer to New Hampshire’s budget issues, but I do know this: if the anti-small business regulatory climate in New Hampshire continues on its current course, the state will quickly lose its reputation as a healthy place for small business. And that will be a shame, on several levels.
Scott Flegal is a business lawyer and mediator. Visit him online at www.flegal.com or www.negotiationworks.org.