Senators hurrying to stop DRA from taxing restaurants on value of tips left for employees

CONCORD — The state has taken to hustling for tips, but yesterday the Senate Ways and Means Committee took steps to stop tax collectors including tips earned by employees in calculating the state tax liability of their employers.
The committee, at the urging of the New Hampshire Restaurant and Lodging Association, unanimously agreed to prepare legislation that would reaffirm the original intent of the Legislature to exclude tips from the compensation component of the Business Enterprise Tax (BET) and forestall the New Hampshire Department of Revenue Administration (DRA) from requiring firms include tips when calculating their taxes. The issue arose earlier this year, when after excluding tips from collections for nearly two decades, DRA began informing businesses that they must be factored into their tax returns.
Senator Andrew Hosmer (D-Laconia), who sits on the Ways and Means Committee and co-sponsored the measure, said that most of the restaurants in the Lakes Region he contacted were unaware of the issue.
Enacted in 1993, the BET is levied at a rate of 0.75-percent against commercial entities based on the compensation paid to employees, interest paid to creditors and dividends distributed to owners which together comprise the "enterprise value tax base." In writing rules to administer the tax, DRA followed the statute, which stipulates that taxable compensation consists solely of payments made by businesses to their employees, by expressly excluding tips from the tax base. Among payments not considered compensation, according to the agency's rules, were "tips to an employee in the course of employment by an employer provided that such amounts are not deductible expenses for the employer."
In 2008 DRA amended its rules to include most tips in the tax base. One revised rule provides that wages subject to federal income tax withholding as reported on an employee's W-2 form are deemed taxable compensation while another rule excludes tips amounting to less than $20, which are exempt from federal withholding. Although the DRA changed its rules, it did not immediately enforce them and continued to advise taxpayers, in both its guide and on its website, not to include tips in calculating their tax liability.
But, earlier this year businesses received letters from the Audit Division of DRA informing them of discrepancies between the wages they reported to the New Hampshire Department of Employment Security (DES) and those reported on their BET returns to DRA. The letters noted that tips accounted for the variances and reminded employers that the compensation element of the BET includes all tips in excess of $20. DRA proposed adjustments to tax returns, asking firms to remit the amount due by March 8, or, if they disagreed with the adjustments, to provide an explanation accompanied by payroll records for 2009, 2010 and 2011. The agency said that firms that failed to reply would be assessed with interest.
Last week Senators Bob Odell (R-Lempster), Jeb Bradley (R-Wolfeboro), Lou D'Allesandro (D-Manchester) and Hosmer sponsored the amendment to House Bill 520, which would establish a committee to study introducing Keno, to exempt tips from the BET, which was heard by the Senate Ways and Means Committee yesterday.
Melinda Cyr of DRA told the committee that she believed the original intent of the Legislature was to include tips of more than $20 in the BET, but since the rules did not specifically refer to the relevant section of the federal tax code, there was considerable confusion. "Some businesses paid tax on tips and others didn't," she said. After changing the rules in 2008 and conducting audits, DRA found the discrepancies between the BET returns filed with DRA and the W-2 forms filed with (DES). She suggested that excluding tips would lead to applying the BET, which was intended to tax all businesses uniformly, differently to different businesses, which could raise constitutional issues.
When asked to measure the impact of excluding tips, Cyr said that the agency lacked sufficient data to offer even "a best guess." However, she explained that in 2011 compensation represented $15.8-billion, or 5.9-percent of the total tax base of the BET of $18.4-billion. She assured the committee that DRA would forgive back taxes and only apply the new rule in the future.
John Daigneault, an accountant with Leone, McDonnell & Roberts of Wolfeboro, said that his firm counted some 45 restaurants with aggregate annual sales of near $80-million among its clients. "Never once before February 2013 did DRA seek to tax tips under the BET," he said, "because the tax was not meant to include tips." He estimated that taxing tips would cost his clients about $75,000.
Chris McDonough, owner of the Fratello's restaurants in Laconia and Manchester and the Homestead restaurant in Bristol, estimated that tips amounted to approximately $1.1-million, or some 40-percent, of compensation at his three restaurants. He emphasized that "we have no control over tips because our customers decide how much to tip" and questioned how he could be taxed on a transaction over which he has no control."
Jeff McLynch, executive director of the New Hampshire Fiscal Policy Institute, countered that state law allows employers to pay $3.27 per hour to employees receiving more than $30 a month in tips, treating tips as compensation to comply with the minimum wage of $7.25 per hour. Excluding tips from the BET, he said, would enable employers "to treat tips in two different ways, both to their benefit."
Speaking for the Restaurant and Lodging Association, Henry Veilleux explained that tips fall into two categories. Gratuitous tips, he said, are paid to servers by customers — not employers — in amounts they deem appropriate. Service charges, on the other hand, are paid by the customer to the business, generally for hosting large parties or events, then distributed among employees by the employer. Service charges, he acknowledged, are included in the BET because they are paid by the employer while gratuitous tips, which are not paid by employers, are not.
According to the statute, Veilleux said, the tax base consists of "the sum of all compensation paid or accrued, interest paid or accrued and dividends paid by the business enterprise." The intent of the Legislature to exclude gratuitous tips, he said, is clear. The rule treating gratuitous tips as compensation, he added, is inconsistent with the statute.
While the committee agreed to proceed, Senator Jim Rausch (R-Derry) suggested that rather than amend HB-520, which appears an expendable bill, they find another vehicle with a greater chance of succeeding, most likely the so-called companion bill to the budget.