Hawaii Governor Josh Green must now sign Senate Bill 1437 into law.
The Legislature has passed legislation that would cut taxes on Hawaii-based businesses — at no cost to the state government.
It sounds too good to be true, but Senate Bill 1437 does just that.
In short, the law allows members of “pass-through entities” such as partnerships and S corporations to deduct their state income taxes from their federal income taxes.
Partnerships and S corps differ from traditional C corporations in that their members pay taxes on their business income only once—at the individual level, not at the corporate level.
In the year The bill was introduced as a result of changes to federal tax law in the Tax Cuts and Jobs Act of 2017, which limits the amount of state income tax partnerships and S corporations can deduct from federal income taxes by $10,000.
In the year Until 2017, the law didn’t contain those deductions, so business owners in states with income taxes could reduce how much they owe the federal government by the total amount of their state’s income tax bill.
For example, say the owners of Pono Pok (a fictional neighborhood grocery store) owe $20,000 in income taxes to the federal government and $20,000 to the state of Hawaii.
In the year Until 2017, store owners could reduce their federal tax liability to zero by completely reducing the amount of taxes they pay to the state.
For entrepreneurs in states with unfavorable business climates, this discount was a big boon. But the Tax Cuts and Jobs Act of 2017 changed everything.
In response, many states are looking for creative ways to help their local business owners. They found that allowing members in a legal entity to pay tax at the legal entity level eliminates the withholding tax.
The IRS okayed this strategy in 2020, and more than 30 states have enacted corporate tax laws to date.
Technically speaking, SB 1437 would allow pono pok owners to pay their state’s individual income tax at the entity level. So now the business, not the owners, will be the legal entity that pays taxes, and the owners can reduce their state tax burden if they pay federal income tax.
It’s a complicated bill that means more to accountants and lawyers than anyone else, but it provides important benefits to Hawaii taxpayers by allowing the tax beginning in the 2022 tax year.
The bill does not address Hawaii’s cost-of-living challenges.
Given the scale of the benefits, The Wall Street Journal reported last year that business owners in the states were able to save more than $10 billion.
In Hawaii, about 15% of businesses will be organized as one entity or another by 2020 and account for more than 30% of Hawaii’s business receipts, according to the state Department of Taxation. So SB1437, if passed, will likely benefit entrepreneurs in Hawai’i as well.
Of course, even if signed by Gov. Josh Green, the bill won’t fix Hawaii’s fundamental cost-of-living challenges. Also, the federal 2017 deduction cap is set to expire in the 2025 tax year, so the benefits could be short-lived unless capital is restored.
But SB 1437 could certainly help Hawaii’s entrepreneurs at least a little, as well as restore the state’s reputation as a business-friendly place — which currently ranks 46th worst in the nation, according to a 2022 CNBC study.
And all at no cost to the state?
All that remains is for the governor to sign this bill.
Sign up for the free morning newsletter and get more information every day.