The governor of the US state of Hawaii, Josh Green, recently signed a bill (S.B. 2725) into law reducing its pass-through entity (PTE) tax rate to 9% on 19 June, 2024.  This bill amends the state’s PTE taxation law to apply to taxable years starting after 31 December 2023.

The purpose of this Act is to reduce the pass-through entity-level tax rate and to allow the tax credit to be carried forward to subsequent years to allow more small business owners to benefit from the entity-level tax election that Act 50 provided.

Act 50 allows partnerships and S corporations to elect to pay Hawaii income taxes at the entity level. Eligible members of an electing pass-through entity (PTE) will receive a Hawaii income tax credit for the pro rata share of PTE taxes paid.

Act 50 takes effect on 1 January, 2024, and applies to taxable years beginning after 31 December, 2022.

In 2023, Hawaii passed legislation permitting PTEs to opt for tax payments at the entity level instead of the individual level. This serves as a workaround to the USD 10,000 federal deduction threshold on state and local taxes. The law linked the entity-level tax rate to the state’s highest individual income tax rate, which is currently set at 11%.

However, under S.B. 2725, the entity-level tax rate has been reduced to 9%.

S.B. 2725 permits qualified members of electing PTEs to claim an income tax credit for their pro rata share of PTE taxes paid. This income tax credit can be applied against the member’s net income tax liability in future years until it is fully utilised.

According to section one of the bill, this amendment will help Hawaii’s small businesses by allowing taxpayers to deduct Hawaii state income taxes paid on their federal income tax returns.

Under previous legislation, qualified PTE members were unable to carry forward a tax credit that surpassed their income tax liability.