Quandary ahead as state digresses from conformity
For more than 35 years, the state has adhered to a policy of conforming with the federal income tax code as a means to reduce administrative and compliance costs for both the tax department and taxpayers.
Prior to 1977, if someone wanted to learn whether a federal code provision was applicable for state income tax purposes, he would need to search through nearly 20 years of public laws, as Hawaii adopted some provisions and amended others for state purposes.
When legislators realized using federal law to determine if a federal provision was operable for state tax purposes was impractical, they decided to conduct a study to determine what was or was not applicable for state purposes, then list those sections of federal law that applied to Hawaii. This task took nearly a year to accomplish, but it formed the basis for today’s conformity to the federal code. Rather than listing sections of the federal law effective for state tax purposes, the conformity provision announces that all of “subtitle A of chapter 1” of the federal code is operable for state income tax purposes except for the list of provisions listed in the statute. This way the practitioner must merely check if the section of the federal law he is trying to apply is on the list.
A couple of years ago, as the state sank into the morass of a budget shortfall, lawmakers turned a blind eye to many of their own policies, including its adherence to maintaining conformity between state and federal law as a means to generate additional revenue.
Although the federal government had recently repealed a limitation on the amount of itemized deductions, at the end of 2009, Hawaii lawmakers thought it might be a good way to raise the revenue needed to fill the gap. During the 2011 session, lawmakers adopted a temporary limitation on the amount of itemized deductions that could be claimed by high-income taxpayers. They imposed a limit of $50,000 in itemized deductions under section 68 of the Internal Revenue Code on couples with $200,000 of federal adjusted gross income; $25,000 for taxpayers filing a single return or married persons filing separately with an adjusted income of $100,000 or more; and $37,500 for taxpayers filing as a head of household with an adjusted income of over $150,000. The limitations were applicable to tax years beginning after 2010 and not for tax years beginning after Dec. 31, 2015.
When lawmakers tried to impose such limits in 2010, the proposal was nixed by then Gov. Linda Lingle, who called it “a de facto tax increase that will adversely hurt certain individuals and businesses at a time when we should be encouraging investment and spending to recharge the economy. The tax increase not only impacts taxpayers, but also disincentivizes activities such as charitable giving and home ownership. Since itemized deductions are allowed for qualifying medical and dental expenses, contributions to qualifying charitable organizations, payment of certain taxes, home mortgage interest, and qualifying job related expenses, capping the deduction will act to discourage these expenses. Nonprofit and charitable organizations that depend on contributions to serve needy populations are particularly concerned that their ability to raise funds through donations and charitable giving would be adversely affected.”
One of the unintended consequences of the limitation on itemized deductions was for charities that benefited from the good hearts of taxpayers who donated thousands, if not millions of dollars, to see those donations disappear. Charities and other nonprofit organizations took this phenomenon to lawmakers in the first year after adoption, noting they were losing generous benefactors. And while lawmakers held a hearing on the issue in the middle of the session, the issue went nowhere.
Finally, the plea was made to the administration, which proposed a change this past year. With pressure from nonprofit organizations and charities, the bill sailed through this year’s session. The bill lifted the limitation of itemized deductions with respect to charitable contributions and became law. However, the overall limit on all itemized deductions will remain through 2015.
Lowell L. Kalapa is president of the Tax Foundation of Hawaii.