HB1803 would lower tax rate for small business owners

The following testimony was submitted by the Grassroot Institute of Hawaii for consideration by the House Committee on Consumer Protection and Commerce on Jan. 30, 2024.

Jan. 30, 2024, 1 p.m.
Hawaii State Capitol
Conference Room 329 and Videoconference

To: House Committee on Consumer Protection and Commerce
      Rep. Mark Nakashima, Chair
      Rep. Jackson Sayama, Vice-Chair

From: Grassroot Institute of Hawaii
           Ted Kefalas, Director of Strategic Campaigns


Comments only

Aloha Chair Nakashima, Vice-Chair Sayama and members of the Committee,

Thank you for considering HB1803, which would lower the tax rate applied to pass-through entities that opt to be taxed at the entity level under Act 50, SLH 2023, and would allow the credit under that law to be applied to multiple tax years.

Act 50, SLH 2023 allowed the owners of partnerships, S corps and other pass-through entities to pay income tax at the entity level instead of the personal level. This technical change lets the owners deduct their state income taxes from their taxable income for federal income tax purposes.[1]

However, as the findings in this bill note, small business owners who want to use this mechanism must pay tax at the highest individual income tax rate — currently 11%. This rate applies to single filers making $200,000 or more and joint filers making $400,000 or more.

The business owner gets a tax credit on their individual income tax equal to the amount the pass-through entity paid in taxes, but the credit is nonrefundable and cannot be applied to future tax years.

Because many small business owners electing to pay tax at the entity level might not owe a lot in individual income taxes, this can result in them not receiving the full value of the pass-through-entity mechanism. Section 1 of the bill notes that “the high tax rate and inability to carry the credit forward made it difficult for many small businesses to benefit from Act 50 as originally intended.”

For example, if Owner A had $100,000 in taxable income from his S Corp and elected to pay tax at the entity level, the S Corp would owe the state of Hawaii $11,000 — 11% of $100,000. If Owner A also had $40,000 in taxable income from another source, he would pay $2,317 — an effective rate of 5.79%.[2] He would then receive a credit of $2,317. The difference between the $11,000 and the $2,317 would not be refunded to Owner A.

On the other hand, if Owner B had $100,000 in taxable income to be paid by her partnership and worked a corporate job making $150,000 in taxable income, she would receive the full value of her credit. The partnership would pay $11,000 — generating a $11,000 credit — and she would pay $11,353 in individual income taxes. The credit would lower her individual income taxes to $353.

HB1803 would fix this problem for small businesses by lowering the tax rate to 9% and allowing the credit to be applied to multiple tax years.

Thank you for the opportunity to testify.

Ted Kefalas
Director of Strategic Campaigns
Grassroot Institute of Hawaii

[1]Final Guidance for the 2023 Tax Year: Hawaii Pass-Through Entity Tax,” Accuity, Nov. 3, 2023.

[2]Hawaii Income Tax Calculator,” SmartAsset, accessed Jan. 27, 2024. Calculated as a single-filer with one personal exemption.

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