Publisher's Note: A taxing problem
By Jody Reese
Last summer the legislature and Gov. John Lynch passed a new tax without any public comment and seemingly at the last possible moment to fill a budget hole. The new five-percent tax is applied to earnings from New Hampshire-based limited-liability companies.
I’ve reserved judgment because I wanted to see how it would be applied. My basic principle on taxation is that it needs to be fair, and that means it treats income the same and doesn’t overly burden those at the lower end of the income scale.
This new tax doesn’t hit the poorest the hardest, but it doesn’t come close to being fair.
As far as I can tell (it’s hard to tell because rules about this tax are still unwritten), the five-percent tax applies to all net income above $50,000 from a New Hampshire limited-liability company. The idea behind taxing LLCs is that it mirrors the tax on interest and dividends. Legislators have claimed that adding LLCs to the interest and dividends tax is fair and closes a loophole people were using to get around paying that five percent. Many real estate investors used the LLC to avoid paying five-percent tax on earnings from their property.
Unfortunately, the new five-percent tax on LLCs just extended an already unfair tax — the one on interest and dividends.
Why is taxing dividends and interest unfair? Because in New Hampshire we don’t tax ordinary income. This means money I earn as an employee of this business isn’t taxed, but my investments in stocks are (as would be the sale of an asset, like a business). As an aside, the federal 15-percent tax on interest and dividends is also unfair but for the opposite reason — it taxes income at a lower rate than regular income earned on the job. This allows wealthy people to skirt paying taxes.
The new LLC tax is unfair in other ways: it was passed without public comment, and it doesn’t apply to owner-operator businesses and may not apply to professional partnerships.
Because the new tax is aimed at investors, some earnings from LLCs are set aside as non-taxable. The figure being tossed around is $50,000. This is unfair in that if I’m an investor in stocks, I don’t get the $50,000 exemption. It’s also unfair in how people in a business are taxed. Let’s say a business decides to share some of its growth with employees and uses the LLC form of corporate structure to bring in these employee-partners. The employee-partners would pay tax on any earnings above $50,000, while fellow employees who earn the same pay wouldn’t have to pay the tax.
However, the claims that this new tax is going to hurt investment or hiring are absurd. If you have no profits because you’re reinvesting in your business or hiring more people, then you won’t have to pay this tax. In fact, this tax may encourage more business owners to take less out of their business and treat it more like a growing asset.
This new tax only makes an unfair system worse. The real solution would be to eliminate property tax and go to an income tax. That wouldn’t solve issues surrounding how many services we want the state to perform, but it would make sure that residents paid their fair share.