Governor Josh Green, M.D. of Hawaii signed a bill on June 1, 2023, allowing partnerships and S corporations in the state to elect to pay income tax at the entity level. With this legislation, Hawaii aligns itself with the majority of states that already permit similar elections for pass-through entities. The law will be effective from January 1, 2024, and applicable to taxable years beginning after December 31, 2022.
Starting from taxable years commencing after December 31, 2022, partnerships and S corporations can make an election to be taxed as an electing pass-through entity. Each taxable year requires a separate election. The election must be signed by all current members of the entity or an authorized officer, manager, or member who confirms their authority under penalty of perjury. Once the election is made, it becomes irrevocable for that taxable year and binds all partners, shareholders, and members of the electing pass-through entity.
In the context of this law, a “member” refers to a shareholder of an S corporation, a partner in a general partnership, limited partnership, or limited liability partnership, or a member of a limited liability company treated as a partnership or S corporation for federal income tax purposes.
The electing pass-through entity will be subject to tax based on the sum of all members’ distributive shares and guaranteed payments of Hawaii taxable income, calculated under the law. This sum is multiplied by the highest applicable tax rate for individuals. However, the distributive shares and guaranteed payments of members who are corporations are excluded from the tax calculation. If the electing pass-through entity incurs a net loss, it can carry it forward to subsequent tax years until exhausted as long as it remains subject to the tax.
Nonresident individuals who are members of an electing pass-through entity are not required to file an income tax return for a tax year if their only Hawaii income stems from electing pass-through entities and those entities file and pay the tax due under this law.
Each electing pass-through entity must provide each member with a report of their pro rata share of the tax imposed for each tax year. Members subject to the elective pass-through entity tax are entitled to a credit equal to their share of the tax paid. However, any excess credit exceeding the member’s tax liability is non-refundable. Additionally, members claiming the credit cannot deduct the Hawaii state income taxes paid on their distributive share or guaranteed payment of income from the electing pass-through entity from their Hawaii state taxable income.
Hawaiian resident or part-year resident members subject to the Hawaii elective pass-through entity tax are eligible for a credit for their pro rata share of taxes paid to another state or the District of Columbia. This credit applies if the taxes paid to another state or the District of Columbia result from a tax that the Director of Taxation determines to be substantially similar to the Hawaii elective pass-through entity tax.