On July 1, 2009, Governor John Lynch signed HB2 (2009 Laws Ch. 144), which contained the State of New Hampshire’s $11.5 billion budget for the next two years. The budget law includes certain revenue raising changes to New Hampshire tax laws, including an important change to the New Hampshire Interest and Dividends Tax law (RSA 77-"I and D Tax"). The I and D Tax change now makes distributions from Limited Liability Companies ("LLCs") and partnerships subject to the 5% I and D Tax to the same extent as dividend distributions from corporations are currently subject to the tax. 

Prior to the enactment of HB2, distributions to owners of most partnerships and LLCs were not considered dividends for I and D Tax purposes and therefore were not taxable to the owners under the I and D Tax. Instead these business organizations were subject to I and D Tax at the entity level. The new legislation no longer taxes the entity, but now treats distributions from profits by all LLCs and partnerships, exclusive of distributions that are compensation for services, as subject to the I and D Tax to the recipient owners. Certain distributions out of debt financed by the entity also may be treated as taxable dividends, although this has yet to be clarified by the Department of Revenue Administration (DRA).

This tax change is significant for the many businesses that now operate in LLC or partnership form, and particularly for owners who are not actively engaged in the business of the LLC or partnership. In addition, many businesses hold their real estate in a separate LLC that leases property to the business and therefore receive passive rental income that may be distributed in part to the LLC members. Now, if a partnership or LLC makes a distribution to its owners out of profits, the distribution will be taxable to the owners who are New Hampshire residents as a dividend at a rate of 5%. Profits are to be determined in the same manner as earnings and profits are determined by corporations for federal tax purposes. In general, this means net profits of the business after deduction of expenses, including deductions for compensation to owners. Thus, if an LLC or partnership currently has business profits subject to NH business profits tax, distributions to its owners (other than compensation for the value of their services) will be I and D taxable as dividends.

This change to RSA 77 is effective for tax years beginning on or after January 1, 2009, meaning that it applies for all of 2009 for calendar year taxpayers.  Accordingly, distributions to owners made between January and June 2009 (before the budget law was passed!) may be taxable as dividends if the LLC or partnership has current or accumulated profits at the end of 2009. The New Hampshire Department of Revenue has issued a Technical Information Release (TIR 2009-008 dated July 16, 2009) explaining this I and D Tax change, and is now in the process of issuing regulations implementing the change. Businesses operating in the form of LLCs and partnerships should contact their tax advisors prior to making any further distributions that may be affected by the new law.