New Income Tax On Small Business Owners Will Cripple New Hampshire’s Recovery

But last December the state Department of Revenue Administration sent Gosselin a tax bill for $165,000 — money the 72-year-old snowbird said he simply doesn’t have. The properties are no longer producing income and worth less than the mortgage, according to Gosselin.

Gosselin sold his business to undertake these passive investments “because I wanted to retire completely without having any headaches. Now I have more headaches then I ever had to deal with. I never expected the state to go after me.”

It isn’t just Gosselin who the state is “going after.” The DRA thus far has notified 30 investors that they owe a total of $5 million under the state’s unique interpretation of what is known as a Section 1031 exchange. The agency has begun auditing returns as far back as 2005.

The state, without promulgating any rules or passing any laws, retroactively has started to tax something that no other state taxes: capital gains that are reinvested through LLCs under rules spelled out by the Internal Revenue Service.

“They swept 30 taxpayers into a black hole,” said George Foss III, a Littleton escrow agent who facilitates such exchanges. “It’s not a rule — it’s a tactic to raise more money. There is nothing in writing about this. Nobody was warned, no notices to accountants or attorneys. This is what gets me mad. It’s just sticking it to these people.”

IRS interpretation

Foss isn’t the only one who is upset. The New Hampshire Association of Realtors has met with Governor Lynch. Legislation has been introduced in the House and the Senate. Administrative appeals are flying. And lawsuits – perhaps even class actions — appear to be next.

According to Revenue Commissioner Kevin A. Clougherty, the department isn’t doing anything new. It is simply closing an existing loophole that ironically was brought to the agency’s attention by an IRS ruling saying that such an interpretation is permissible.

“The intention isn’t to approach these things as revenue-driven. This is the law and we have to enforce it,” he said.

Section 1031 is part of the IRS code governing the reinvestment of capital gains. Just like homeowners, who don’t have to pay capital gains on a property they sell as long as they buy another house in a certain amount of time, real estate investors can use the same method in deferring taxes on such gains.

However, real estate investors often have to buy and sell property under different entities. They sometimes must satisfy lenders that those entities are free from various liens and encumbrances, or they sometimes want to limit liability against the owner personally, as well as to protect his or her other business holdings.

The IRS ruled that it would “disregard” the different names of an entity selling the property and the entity buying a property as long as the ownership of those entities are basically the same.

However, explained Clougherty, New Hampshire is different, because it doesn’t have a personal income tax, and its business profit tax is imposed on entities only. So when an investor buys a property under one entity and sells it under another, the money isn’t reinvested as far as the state is concerned. Instead, it is a capital gain that should be reflected in the company’s profits for that year.

“Our rules didn’t change,” said Santo Presti, director of auditing at the DRA. “The federal government made a ruling of how disregarded entities were to be treated, and a lot of companies made a business decision to proceed. They all got extensive (and expensive) advice but nobody asked us.”

Legislative remedy

But Foss, and many others involved in 1031 exchanges are not buying it. Foss said that the IRS has allowed them since 1996, and the state has been going along with them as well, until the budget crunch of last June, when the department hinted that it was looking into them, along with other loopholes it was trying to close.

Some other states have tried to tax exchanges when the first sale originated out of state, but those states have reversed themselves when they understood what a chilling effect it has had on business investments, said Foss. In any case, Foss said, those states all made such changes by law. They didn’t just start assessing taxpayers.

“The department has no authority to deviate from a taxpayer’s gross business profits as reported for federal income tax purposes without a statutory adjustment,” wrote Christopher J. Sullivan, an attorney who represents several investors appealing the DRA assessments in an article he wrote about the issue.

But thus far, the statutory adjustment proposed is aimed at reversing what DRA is doing. On the Senate side, Sen. Lou D’Allesandro, D-Manchester, has submitted a bill that would require the state to recognize the federal 1031 rule, retroactively effective until 2005.

“What we are asking for is the treatment they have always received from the IRS and the state,” D’Alessandro said. “We ought to be consistent in how we treat these people.”

A similar bill was proposed in the House by Rep. Carol McGuire, R-Epsom.

“People are being assessed for back taxes for following federal rules. That seems ridiculous to me,” said McGuire.

Foss said he gave a presentation about the situation on Sept. 17 to Governor Lynch. According to Foss, the governor said he would talk to the commissioner and get back to him and others following the matter. Foss said he hasn’t heard anything since.

Clougherty said Lynch did talk to him.

“He just told us to enforce the tax law. We got no specific direction about this. He doesn’t work that way.”

As for the legislation, Clougherty said he would provide information but not take a position. “Bureaucrats don’t make the laws. We just explain them and enforce them.”

When asked for comment, Lynch’s spokesperson Colin Manning said, “We strive to make sure that our tax system is fair to everyone, and this is an issue that we will continue to look at.”

‘Fishing for money’

Meanwhile, Ronald Gosselin, former owner of the 40,000-square-foot Gosselin Plaza on Manchester’s West Side, awaits the outcome from his Arizona winter residence.

The Manchester property had been in Gosselin’s family since 1952, but he expanded it over the years and was involved in numerous family businesses there, such as Gosselin Hardware, as well as the Mother Goose restaurant.

But as he got older, the long hours took their toll, so he sold off the Manchester holdings one by one, to avoid being “the richest man in the graveyard.”

The plaza was sold in 2007, and he used the $2.3 million in proceeds to invest in three projects — a shopping mall in Georgia, a Comfort Inn in New York and some college apartments in Iowa. Each investment was under a different LLC, but all were owned by Gosselin Plaza, the same company that owned the shopping plaza, of which Gosselin was the principal.

“You didn’t want to put all my eggs in the same basket,” he said.

Foss was the “qualified intermediary” for the deal — a legal requirement to make sure that the funds from the sale were not intermingled with other funds and went directly to another investment.

For Gosselin, however, the deals turned sour, along with the economy. Gosselin said that he was told they were worth more than they actually were, and when distributions stopped said he lodged a complaint with the U.S. Securities and Exchange Commission against the broker involved.

On top of this, Gosselin is spending thousands of his shrinking retirement pool fighting the New Hampshire Department of Revenue Administration. Gosselin was the first to be audited, so there was no way, he said, that he could have known this would be a problem.