For many taxpayers, the tax increases approved by this year’s legislature won’t be evident until they start filing their annual state income tax returns next year, and then only if they itemized their deductions as opposed to taking the standard
For many taxpayers, the tax increases approved by this year’s legislature won’t be evident until they start filing their annual state income tax returns next year, and then only if they itemized their deductions as opposed to taking the standard deduction which currently is set at $2,000 for individual taxpayers and $4,000 for joint filers.
Because the standard deduction is so low, most taxpayers itemize their deductions because either their state income tax liability is substantial or they make generous charitable contributions. For those taxpayers who own their own homes, the mortgage interest deduction also inflates the amount that can be deducted in calculating taxable income. All of these deductions are allowed under the federal Internal Revenue Code, and for years it has been the policy of the state to conform or mirror as many of these provisions as possible in an attempt to “conform” to the federal law.
Conformity with the federal law was adopted by the legislature way back before Hawai‘i became a state, at which time the federal internal revenue Code of 1954 was adopted as the starting point for the Hawai‘i income tax law. Throughout the early years of the state, changes to the federal Code were adopted as public laws were approved by Congress. However, after two decades of adopting federal changes to the Code in this manner, the process became pretty cumbersome in trying to figure out what was applicable for state income tax purposes and what was not.
In 1977, a study was undertaken to figure out what federal provisions were operative for Hawai‘i and which were not. At that time, researchers determined that there had to be a simpler way of maintaining conformity between the federal and state law. It was out of this realization that the current method of adopting federal law came about and the idea was surprisingly simple. Today the federal Code is adopted by rejection — Subtitle A of chapter 1 of the Internal Revenue Code, which contains most of the income tax provisions, is adopted each year except for a list of sections or provisions that are listed as not operable for state income tax purposes.
So all one has to do is to look through the list of non-operative sections to determine if those federal provisions do not apply for state income tax purposes. Then there is a list of federal income tax provisions which are operable for state income tax purposes, but may be limited in operation or application, such as the standard deduction and personal exemption, for which there are different amounts. Again, all one has to do is to look through those provisions to see if there is a peculiar and different way those provisions are applicable for state income tax purposes.
As a result of measures adopted by lawmakers this session, high-income taxpayers will not be able to deduct state income or sales taxes – those individuals with greater than $100,000 in federal adjusted gross income and couples with more than $200,000 in federal adjusted gross income. The deduction for state income and sales taxes will also be wiped out for all corporate income taxpayers. Further, the total of itemized deductions will be limited to $25,000 for single individuals with federal adjusted gross income of greater than $100,000 and to $50,000 for couples who have $200,000 or more of federal adjusted gross income.
There was a similar limitation on all itemized deductions at the federal level, but that limit expired at the end of 2009 and it was not renewed largely because Congress realized that the limit discouraged many from making charitable contributions which are the lifeblood of the nonprofit community. While the new limits at the state level may have the same effect, one has to wonder how the combination of eliminating the deductions for state income taxes will shift more deductions in the charitable contribution column.
While all consumers will be hit with a tax increase come July 1, 2011 because the exemption for activities like stevedoring, leasing of airline equipment, or the payment of construction subcontracting will disappear, consumers will just assume that businesses are taking them to the cleaners again as prices rise. However, come next January, and more than likely next April when taxpayers file their net income tax returns, the pain of the tax increases adopted by lawmakers will become more evident.
What is disturbing is that both the administration and the legislature are walking away from their pledge to conform the state income tax law to the federal law for nothing more than more tax revenues.
• Lowell Kalapa is president of the Tax Foundation of Hawai‘i, a private, nonprofit, non-partisan, educational organization established to research issues confronting governments in the area of public finance, taxation, and public administration. It is supported entirely by private contributions. Online: www.tfhawaii.org
