Bar News - February 15, 2017
Tax Law: Ending the Dreaded Basis Step-Up Addition Statute
By: Beth Fowler
For many years, one of the most controversial aspects of the New Hampshire business profits tax has been the basis step-up requirement triggered on the transfer of equity in a business. In the 2016 session, the NH Legislature amended the statute to clarify its meaning and resolve its onerous impact. Businesses can now choose the manner in which to report a basis increase.
Prior to 2016, the business profits tax statute required that, upon the sale or exchange of an interest in a business entity, the business adds to its gross business profits “an amount equal to the net increase in the basis of all underlying assets transferred or sold through the sale or exchange of the interest” (RSA 77-A:4 XIV, 2015).
Federal law applied to determine the increase in asset basis. The Department of Revenue Administration (DRA) regularly interpreted this provision to require additions to gross business profits whenever equity was sold in a business with an Internal Revenue Code Section 754 election, or when an IRC Section 338 election was made, to treat a stock sale as an asset sale.
Moreover, the DRA generally imposed the addition on the seller. Thus, the seller paid the additional tax while the buyer had the benefit of additional depreciation. This had a significant impact on business transactions. Frequently, sellers would demand an increase in purchase price to compensate them for their additional tax costs. Because this requirement is unique to New Hampshire, it was easy to overlook and difficult to explain to professionals not practicing regularly in New Hampshire.
The problems caused by the statute became public in late May 2015 when the Planet Fitness CEO testified before the Senate Finance Committee that Planet Fitness might leave New Hampshire if the Legislature did not revise the statute. Due to various factors, including the lack of time to address the issue in proper detail, the 2015 legislative session ended without a change in the statute.
The Legislature again addressed the issue in the 2016 session and, by the end of the session, replaced the old step-up requirement in its entirety. The new statute removes some ambiguity from the old statutory language and provides two options for business profits tax treatment of an equity sale triggering a federal basis increase. It is applicable for all sales or exchanges of business interests occurring on or after Jan. 1, 2016.
The new statute applies upon the sale or transfer of an ownership interest in a business organization, in a transaction where, for federal tax purposes, there is an increase in basis of one or more assets. In that situation, the default under the law is that the business does not recognize a basis increase for business profits tax purposes. Rather, in each year after the sale, the business adds to gross business profits an amount equal to the additional annual depreciation or amortization due to the federal basis increase. The business also claims the additional annual depreciation or amortization. The net result to the business is no additional annual business profits tax. However, the business may not consider the basis increase in determining gain or loss when it later sells an asset involved in the first transaction.
Alternatively, a business can elect to include the entire basis increase as an addition to gross business profits in the year of the transaction. A business makes the irrevocable election on a timely filed tax return. Upon making the election, the business includes the basis increase in determining gain or loss on a subsequent sale of the assets.
The new statute provides businesses a choice. A company can pay business profits tax on the basis increase in the year of the sale or exchange of the equity. Alternatively, it can delay payment until a subsequent sale, or deemed sale, of assets involved in the sale or exchange of the equity. A business can now consider its plans, and the time-value of money, to determine which option is appropriate. For example, a multi-state business having a small apportionment factor in New Hampshire planning to move additional people or property to the state might choose to report the full basis increase in the year of the transaction. Recognizing the basis increase in a year with a lower apportionment factor minimizes the resulting business profits tax. Most importantly, the business is now in control of this aspect of its New Hampshire tax liability.
Because of the financial impact of the election, attorneys should counsel clients to address the issue in any transaction involving a sale of equity in a business. It is also advisable to document in writing the parties’ agreement on whether or not the seller will elect immediate recognition of the entire basis increase.
Beth Fowler practices in the Tax Department of McLane Middleton. She can be reached by email.