(Released on 4/14/13)
Most Hawaii taxpayers are sighing with relief as they have dropped their federal tax returns in the mailbox earlier this week but, at the same time, the madness of completing their state tax return is just around the corner.
It used to be a slam dunk for most taxpayers as they merely had to copy numbers off their federal tax return and put them on their state tax return. Except for some obvious differences, such as tax exempt interest on federal savings bonds, cost-of-living allowance payments, and exempt pay for National Guard service, the definition of income for federal tax purposes and state tax purposes was the same. That is until the state ran into a bump in the road a couple of years ago and decided to raise revenues to fill in the budget shortfall. Of course, lawmakers took aim at the most obvious, that being Hawaii’s visitors and immediately raised the hotel room tax or transient accommodations tax (TAT) and took all of the proceeds from the higher rate.
The higher rate of 9.25% was phased-in over a couple of years and is set to sunset or expire in the year 2015. The current administration would either like to make that 9.25% rate permanent or, wanting to test the waters, suggested this year that the rate be increased another two percentage points to 11.25%. Given that the deal to raise the TAT rate was cut between the legislature and the hotel industry, it seems that lawmakers don’t want to be accused of not keeping their word and the bills to either make the higher rate permanent or raise the rate even higher have hit the legislative graveyard.
In fact, lawmakers have taken the administration’s bill and moved up the sunset date for the higher rate from 2015 to July 1 of this year. With the state revenue picture improving, an earlier sunset date for the higher rate seems almost imperative.
But back to filing your state income tax return. If taxpayers didn’t notice it last year, lawmakers made some changes to the way you figure your taxable income a few years ago to help raise more money to fill up that budget shortfall. Apparently, one of the changes which elicited a sharp outcry was a limitation on itemized deductions for high-income earners. Those single taxpayers with federal adjusted gross income of $100,000 or $200,000 for joint filers can only deduct the first $25,000 of their itemized deductions – $50,000 for joint returns.
While limiting the amount one can deduct will, no doubt, increase the amount of one’s income that will be exposed to the state income tax, the idea had unintended consequences. In this case it was that those high- income earners are those who are in a financial position to make substantial and generous charitable gifts to the community nonprofits or charities. As a result, those charities and nonprofits besieged the legislature last year pointing out that the limitation on itemized deductions had discouraged many of their major donors from making those substantial and sometime “lead” gifts.
When the measure to repeal the limitation on charitable deductions did not pass last year, those same organizations made their concerns known to the administration and this year the governor’s office submitted a proposal to exempt charitable contributions from the limitation on itemized deductions. The proposal was incorporated into a legislative proposal and will be considered by a legislative conference committee. The limit on all itemized deductions is scheduled to sunset at the end of 2015.
Then there is the loss of being able to deduct state income taxes as an itemized deduction if taxpayers fall over the above thresholds specified for the limitation of itemized deductions. Proposed by the state administration two years ago, the argument made was that taxpayers don’t get to deduct their federal income taxes on their federal returns so why should the state allow high-income taxpayers to deduct their state income taxes on their state returns? Granted the move was to generate more income, but what was lost in the debate was the fact that this move deviated from the state’s intent to minimize the differences in the definition of income for state and federal tax purposes. Not only that, the deduction for state income taxes paid recognizes that the use of the money represented by the state income taxes paid – either in withholding or as a result of paying estimated taxes – was lost when paid to state government and the taxpayer had no economic benefit of the withheld tax amount. This change was made permanent and should be reconsidered as it represents one more difference between the state and federal definition of income.