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Allow use of Act 50 credit for multiple tax years

The following testimony was submitted by the Grassroot Institute of Hawaii for consideration by the House Committee on Finance on April 3, 2024.
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April 3, 2024, 2:15 p.m.
Hawaii State Capitol
Conference Room 308 and Videoconference

To: House Committee on Finance
      Rep. Kyle T. Yamashita, Chair
      Rep. Lisa Kitagawa, Vice-Chair

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

RE: SUPPORTING SB2725 — RELATING TO PASS-THROUGH ENTITY TAXATION

Aloha Chair Yamashita, Vice-Chair Kitagawa and other Committee members,

The Grassroot Institute of Hawaii would like to offer its support for the portions of SB2725 that would allow the credit created by Act 50, SLH 2023 to be applied to multiple tax years.

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

However, 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.

For example, if Owner A had $100,000 in taxable income from his S corporation and elected to pay tax at the entity level, the S corporation would owe the state $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.

This bill would help fix this issue by allowing the credit to apply to multiple years.

We would also ask the committee to consider lowering the tax rate to 9%, as proposed by HB1620 and HB1803. A lower tax rate would make this tax program more attractive to smaller companies.

Thank you for the opportunity to testify.

Ted Kefalas
Director of Strategic Campaigns
Grassroot Institute of Hawaii
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[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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