News has been piling up about many of the bills that made it through this year’s legislative session.  We will be discussing some of those in the weeks ahead.  But this week we will be focusing on some of those bills that almost made it to the end but fell off just before the finish line. Some of us will be saying, “Good riddance!” while others, perhaps, will be bemoaning the loss.

HB 2504, for example, would have bumped up the cigarette tax another $0.02 per cigarette to $0.18. The University of Hawaii sponsored it, primarily because earmarks off the cigarette tax go to special funds that are used to benefit the UH School of Medicine. Disagreements quickly arose as to where the extra funds were going to go and the uses to which they would or could be put. The bill went to a House-Senate conference committee, but they were unable to reconcile differences in the bill versions.

SB 3176 was sponsored by the Department of Taxation. It would have provided that when a taxpayer is under audit, the auditor requests documents, and the documents aren’t produced by a certain deadline after the request, then, unless the department allows more time, the documents can’t be used in any appeal from the auditor’s assessment. Many tax practitioners strongly opposed the bill, saying among other reasons that the courts make their own rules on when to exclude evidence. Ultimately, House and Senate conferees couldn’t work out their differences.

HB 2653 would have amended the Hawaii estate tax to allow interests in successful family-owned businesses to pass to next generation family members tax-free. The businesses launched a considerable public relations campaign, including several op-eds, in support of the bill.  However, some in the progressive wing of the Democratic Party were outraged at the prospect of tax breaks being given to the wealthiest of the wealthy. In the end, the bill was set to go to conference committee but the House failed to appoint conferees.

HB 2686 and SB 3234 would have increased the transient accommodations tax on vacation rentals and the conveyance tax on all property sales by unspecified amounts, with the new money raised to establish funds to stabilize property insurance. The new funds would be conceptually similar to the Hawaii Hurricane Relief Fund and would provide insurance of last resort for hurricane damage and lava inundation. One problem was that as the bill was going through the process, people couldn’t figure out exactly how much money needed to be raised. The sections of the bill calling for tax increases kept moving through the session without the blanks being filled in.  In the Senate, the Ways and Means Committee turned the bill into one requiring a study to be conducted by the insurance commissioner. Ultimately, no agreement was reached on how to proceed.

And, last but not least, HB 2570 would have required out-of-state attorneys appearing in a local court or arbitration to have a GET license number and agree to pay tax. Apparently, a number of such firms came in, left, either didn’t know or didn’t care about our local tax, and didn’t pay it.  This bill went to conference committee and the Senate did not appoint conferees. But that doesn’t mean that out-of-state law firms are going to get a free pass. The Hawaii state judiciary testified that they will impose the same requirements using the courts’ regulatory powers over attorneys.

In the coming weeks, we’ll be highlighting some of the bills that did pass and are making their way to the governor’s desk.

Those of you watching the Legislature probably know that we are now in the home stretch.  Both the House and the Senate have had a chance to consider bills, and this is the stage of the legislative session where differences get worked out between House and Senate versions of bills.  It also has little public involvement.  No more testimony is allowed, and the meetings that conference committees have are held either to stall for more time or simply announce the results.  Here are three of the more consequential bills that are still alive.

HB 2404, a “Green Affordability Plan” bill, seeks some reform for our income tax brackets, many of which haven’t been touched since the 1960’s.  The current version, the Senate draft, bumps up the standard deduction, personal exemption amounts, and all of the tax brackets.  It also contains language automatically adjusting those brackets for cost-of-living increases, just as the federal tax code does.  The latest House version of the bill contains no cost-of-living adjustments and replaces all of the current income tax brackets with blanks.  The House version also amends the current household and dependent care services tax credit to—no surprise here—a formula with blank amounts in key places, and it also contains language saying that if the taxpayer’s credit claim is disallowed, the taxpayer is barred from claiming the credit again for two years (ten years if the disallowance was due to fraud).  The Senate version leaves the credit alone.

SB 1035, a bill from last year that was pulled from the dumpster when this year’s versions died, exempts health care professionals from the general excise tax when Medicare, Medicaid, or TRICARE is paying for the care.  This year’s bill, HB 1675, would have exempted health care professionals from the GET when acting in the capacity of a primary care provider.  Most of the testifiers, including some state agencies, came out in favor of the bill because they believe the tax contributes to the acute physician shortage that we are facing.  Also, as the Foundation testified, the current system has some unfairness because health care delivered by the state’s major hospitals is exempt from the tax while smaller clinics and sole practitioners, which are the lifelines for those in rural areas and some Neighbor Islands, get hit with GET at the full rate.  Some of our prior coverage on this issue can be found here.

Then, there is HB 2653, relating to the estate tax.  This bill was being pushed by a coalition of family-owned businesses, who argued that the Hawaii estate tax, which kicks in at a much smaller dollar amount in Hawaii than the federal estate tax, could have the effect of breaking up successful family-owned businesses, closing them, or causing them to be sold to persons outside of Hawaii.  The current version of the bill would create a deduction for “qualified family-owned business interests” that are inherited.  It would also double the “applicable exclusion amount” so it is the same as under the federal tax code.  This bill is a bit more controversial; some organizations and individuals have strongly objected to it, calling it tax relief for the wealthiest of the wealthy at a time when we have many unmet revenue needs, such as Maui wildfire relief.  Our prior coverage on this bill can be found here.

At the end of this month, the Legislature wraps up and we see what gets sent to Gov. Green’s desk for signature or veto.

Those of you who like to watch the legislative process unfold have probably wandered through (virtually, perhaps) a number of committee hearings.  Seeing these, you have probably gotten a taste of the power that legislative committee chairs wield.  The more bills that need to go through the committee, the more powerful that committee is.  For that reason, the Senate Ways & Means Committee and the House Finance Committee are usually held out as two of the most powerful committees in our Legislature.

The House Finance Committee heard and passed out SB 3289, relating to the estate tax.  We recently profiled three bills that would fundamentally change how our estate tax works.  This bill was one of them. 

SB 3289 was placed on the calendar for Third Reading on April 9.  The House Order of the Day, summarizing which bills were up for vote, listed that the bill would be up for passage on Third Reading.

But then something else happened.

When the bill number was called, Rep. Nadine Nakamura, House Majority Leader, moved to recommit the bill to the Finance Committee, essentially killing it.  The motion was seconded by Rep. Kyle Yamashita, who happens to be chairman of the Finance Committee.  A voice vote was taken on the motion (although the House Republicans asked for a roll call vote, which would result in a list of all members and how they voted, there were not sufficient votes to order a roll call) and the motion passed without further discussion or comment.  The bill’s status on the Legislature’s website was then updated to add the line:  “Recommitted to FIN with none voting no and none excused.”  (This seems a tad misleading because there were indeed some “No” voices when the vote was taken, as one lawmaker pointed out immediately after the vote.)

Although the nature of the vote was somewhat unusual, nobody at all seemed surprised, especially the Finance Committee chair, even though his committee’s approval was being swatted down.  After watching the drama, or lack thereof, play out on YouTube, I became convinced that the proceedings, or at least this part of them, were prearranged.

What was shown here, ladies and gentlemen, were the big guns — a shadowy cabal known as “leadership” — making their presence known.  The House Finance committee is one of the most powerful committees at the legislature, but its work can be quietly and efficiently undone, as we’ve just seen. When the big guns come out, even the mighty submit.

In this part of the legislative session, where no public sessions are held except perhaps to announce the resolution agreed upon, the influence of the big guns is outsized. Conferees who are appointed by the House Speaker or the Senate President to work out differences with the other house can be discharged without notice or explanation, immediately catapulting the bill involved to its death.

We bring up these considerations not because we like SB 3289 (actually, we have concerns with it because it would essentially wipe out the estate tax) but because we wanted to illustrate how “leadership” works its magic in a way that is very difficult for the public to see and to hold any specific people accountable. 

There are a couple of measures moving in this year’s Legislature that are important for the many small businesses here that do business in passthrough entities (partnerships or S Corporations, mostly). 

So, here’s the problem.  The Tax Cuts and Jobs Act of 2016 put a $10,000 hard cap on individual taxpayer deductions for state and local taxes.  No limit is placed on other entities like corporations.

If an individual conducts business as an S corporation or a partnership (most small businesses are in that form), the state income taxes of the business aren’t paid by the business itself, but are instead paid by its owners according to their respective shares in the business; a 30% owner, for example, would include 30% of the business’s net income on the owner’s individual tax return.  But if state tax on that amount goes over $10,000, then the owner involved winds up with a non-deductible expense. This is an issue here in Hawaii because our individual income tax rates can go up to 11%, second highest in the nation.

Last year, lawmakers enacted a workaround.  They passed a bill providing a “passthrough entity election” (PTE election).  An electing company would pay 11% (because 11% is the highest individual tax rate) on its net income. The company, not the owners, would be able to deduct the 11% without limit, and the owners would get credited with their proportionate shares of the tax payment.  The Internal Revenue Service came out with some guidance, Notice 2020-75, that says this works.  So far, so good.

Hawaii’s bill, however, also had a feature that wasn’t so great. The credit was provided on a “use it now or lose it” basis; it couldn’t be refunded or carried to any other year. If it wasn’t used in the current year, any excess was lost.  This was harsh because the credit wasn’t for magic money that the State gives people for doing certain things that it considers socially desirable; it was for real money that the business paid to the State on behalf of its owners.

Most normal business owners don’t make nearly enough to drop into the 11% tax bracket.  For those people, the benefit from the federal deduction was often outweighed by the state tax forfeiture that would result from the “lose it” portion of the credit.

Put another way, the benefit from the PTE election was greatest when the taxpayer was wealthy enough to have income from sources other than the passthrough.  The excess credits would offset the tax from those other income sources and wouldn’t be lost.

Well, that is a screwed-up situation, probably not at all what our lawmakers intended.

The bills moving through the Legislature, HB 1803 and SB 2725, would help to solve the problem by allowing the excess credit to be carried forward to future years (both bills), or reducing the rate from 11% to 9% (House bill only).  Both changes appear to help with the problem presented.  Hopefully, lawmakers will consider these bills seriously as the legislative session advances.