Bar News - February 19, 2014
Tax Law: DRA Issues New Ruling on S Corporation Conversions
By: Justin T. Vartanian
The New Hampshire Department of Revenue Administration’s (DRA) first declaratory ruling since 2009 offers S corporations with New Hampshire resident shareholders a significant opportunity for potential long-term tax savings.
Distributions from an S corporation to its New Hampshire resident shareholders are currently subject to New Hampshire’s 5 percent interest and dividends tax. By converting to a multi-member limited liability company (LLC) that elects to be taxed as a corporation, the entity’s owners can receive distributions that are no longer subject to the interest and dividends tax, without changing the way it reports or pays taxes.
The DRA’s ruling is based on an S corporation undergoing a statutory conversion under New Hampshire law to become an LLC, and the statutory conversion qualifying federally as a so-called tax-free “F” reorganization. At the state level, this requires the filing of a certificate of conversion and the formation of a new LLC with the New Hampshire Secretary of State’s Office. Federally, the S corporation must prepare and adopt a plan of conversion satisfying the tax-free “F” reorganization requirements.
If the conversion is properly documented and executed, then it will not trigger any tax liability with respect to the New Hampshire business profits tax or business enterprise tax. Because the transaction is structured as a conversion, which involves a single entity (rather than a merger, for example), the conversion does not trigger the real estate transfer tax for real estate holding entities.
Timing is everything. Provided the resulting LLC timely elects to be taxed as a corporation following the conversion, its federal “S” election will remain in effect and the LLC will continue to report and pay its state and federal taxes as if it had remained a corporation, with no short-period returns required. Equally as important, the resulting LLC will retain all of the state and federal tax attributes of the S corporation, allowing tax credits and loss carry-forwards of the converted S corporation to remain available to the LLC following the conversion.
Although the tax savings can be substantial for S corporation shareholders currently subject to the interest and dividends tax, there are several traps for the unwary along the way, and due diligence is required to determine whether the conversion may trigger unintended consequences which outweigh the potential tax benefits. Careful coordination with the S corporation’s tax advisors, insurance carrier, and business partners is required to ensure a successful and seamless transition.
Justin T. Vartanian is a corporate associate at Devine, Millimet & Branch and can be reached at (603)695-8635 or email@example.com. He represents businesses and non-profit organizations in business and tax-related planning, controversies and transactions.