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State/Federal Changes in Income Tax Coming
Income tax is a complicated enough subject already. Certain things are income and certain things are not income. Some expenses can be written off and others can’t. Under House Bill 1041, which isn’t law yet but is expected to become law, Hawaii income tax is going to be mirroring certain federal tax law changes and going its own way on some others.
No tax on second round recovery rebates: The CARES Act provided the first round of recovery rebates, or economic impact payments, of up to $2,400. In the 2020 session, our lawmakers passed legislation saying that, just like federal treatment, those payments would not be taxable income for state income tax purposes. This year’s bill considered the second round, namely the $600 payments, and provides that those are not taxable either. The third round of payments, the $1,400 payments provided under the American Rescue Plan Act (ARPA), was enacted early in 2021 and will be considered in the 2022 legislative session.
Tax on unemployment benefits: ARPA says that individuals can exclude up to $10,200 in employment benefits received in 2020. Hawaii is not going to copy the exclusion. It costs too much. If you received unemployment benefits in 2020, and you didn’t elect to have Hawaii tax withheld, you should look very seriously at paying estimated Hawaii tax.
PPP, EIDL, and other federal grants and forgivable loans are exempt, but associated expenses aren’t deductible: There has been a lot of news about the Payment Protection Program, Economic Injury Disaster Loans, and new specialized grants to help restaurants. Hawaii went on record as saying that when the federal government forgives these loans or issues grants under the PPP, the money will not be taxable income. The tax treatment of EIDL grants was not settled by the CARES Act, and the Consolidated Appropriations Act included a provision saying that those grants also would not be taxable income. Hawaii’s bill does mirror that treatment.
In the Consolidated Appropriations Act and ARPA, however, the Feds went one step further, and Hawaii won’t take that extra step. Here’s what happened.
When the CARES Act first gave us the forgivable PPP loans, the Internal Revenue Service issued a Notice, and later a Revenue Ruling, telling us that under the normal rules in the Internal Revenue Code, payment of expenses that give rise to loan forgiveness can’t be deducted for tax purposes. This is because expenses associated with taxable income are deductible, but expenses associated with tax-exempt income are not because that would result in a double benefit. There would be no advantage in deducting the expenses against the tax-exempt income, so the expenses would be deducted against other taxable income, which didn’t seem to be what Congress had intended at the time.
In the Consolidated Appropriations Act and ARPA, however, Congress included provisions saying that they would indeed give a double benefit to taxpayers. The issue for Hawaii lawmakers was whether they would conform to that benefit as well. Lawmakers found that copying that benefit would cost even more than providing the unemployment benefits exemption, so their decision was to decouple from that benefit as well.
No GET on loan forgiveness: Separately from the legislative process, the Department of Taxation concluded that PPP or EIDL grants or loan forgiveness would not be subject to GET and don’t need to be reported on GET returns. The ruling sounds like the Department is doing everyone a favor, but the conclusion does follow other precedent, called the “general welfare exclusion,” concluding that government payments made on the basis of need aren’t considered gross income, and thus wouldn’t be subject to GET.
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