Testimony on Reasonable Compensation

Submitted to the Senate Ways and Means Committee on 9 Feb, 2010

SB 476 – Reasonable Compensation

I am writing this testimony in support of SB 476-FN-A, clarifying the business profits tax deduction for reasonable compensation.  Current law places the burden of proof for justifying “reasonable compensation” on the business owner(s).  Also, “in considering the reasonableness of a deduction claimed under this paragraph, the commissioner shall consider the claimed deduction in light of compensation for personal services of employees in positions requiring similar responsibility, devotion of time, education and experience in business organizations of similar size, volume and complexity.” (RSA 77-A:4 III).  In other words, the current laws base reasonable compensation on industry averages.

As an LLC owner I performed computational fluid dynamics simulations using detached-eddy simulation on unstructured grids to predict massively separated flows at high Reynolds numbers around full aircraft.  If this sounds unique, it’s because for several years I was the only one performing these kinds of simulations, and today only a handful of people in the world do it.  But I’m not alone – many small businesses provide unique services/products, or provide services/products in a unique way.  It’s the very definition of entrepreneurship to provide a unique product, or to do it in a superior way.  So in these cases there is absolutely no way for the business owner to prove with a preponderance of evidence that their compensation is reasonable by considering “experience in business organizations of similar size, volume and complexity” when there is no such other business.  And why should a business providing superior service be compared to industry averages?  Does N.H. want to encourage mediocrity?

SB 476 shifts the burden of proof to where it belongs – onto the State.  Just laws should always presume the citizen is innocent until proven guilty, but the current statutes do just the opposite.  The current guilty until proven innocent approach encourages abuse by the State since the State has a vested interest in auditing and disallowing compensation. The recent extension of the Interest and Dividends tax onto LLC’s further increases the motivation of the State to audit aggressively, in order to collect the now lucrative 13.5% combination from the business profits tax (8.5%) and the interest and dividends tax (5%).  With the burden of proof on the side of the State, we’re likely to see businesses set up elsewhere rather than risk a 13.5% tax rate, which is far higher than surrounding states.  With unemployment at record highs, we can’t afford this, and must reform the compensation deduction by passing SB 476 and repealing the so-called LLC tax.

Jim Forsythe, PhD
Forsythe Consulting, LLC