(a) This section applies to all taxpayers,
pursuant to section
235-5(c),
HRS, and section 265 (with respect to expenses and interest connected with
tax-exempt income), IRC.
(b) In
computing the taxable income of a taxpayer subject to tax on Hawaii source
income only:
(1) Deductions connected with
Hawaii source income shall be allowed.
(2) Deductions connected with out-of-state
income shall not be allowed.
(3)
Pursuant to section
235-7(e),
HRS, no deduction is allowed for interest paid or accrued on debt incurred or
continued:
(A) To purchase or carry bonds if
interest paid by the bond issuer is out-of-state income or is exempt from
taxation under section
235-7(a),
HRS;
(B) To purchase or carry
property owned outside of the State; or
(C) To carry on a trade or business outside
of the State.
(4)
Deductions from Hawaii adjusted gross income that are not connected with
particular property or income, such as medical expenses, shall be allowed only
to the extent of the ratio of Hawaii adjusted gross income to adjusted gross
income from all sources.
(5)
Adjustments to income that are not connected with particular property or income
shall be allowed only in the proportion determined under the following formula.
(A) Determine the aggregate amount of the
adjustments not connected with particular property or income.
(B) Determine Hawaii source income and
subtract all adjustments to income other than those included in (A).
(C) Add the amount in (A) to adjusted gross
income from all sources.
(D) The
ratio of (B) to (C) is the proportion of the adjustments that are
allowable.
(6)
Deductions are connected with a particular kind of income if the deductions
would be allocable to that income under the principles of section 265 (with
respect to expenses and interest connected with tax-exempt income), IRC, and
section 1.265-1(c) (with respect to allocation of expenses to a class or
classes of exempt income), Treasury Regulations.
Example: T, a single person aged 60, is a
nonresident owning rental property in the State from which T derives $3,500 of
gross income during the taxable year and incurs $500 of associated expenses,
such as general excise and real property taxes. T also has paid $1,500 in
interest on a mortgage on T's personal residence in Iowa. T's adjusted gross
income from all sources is $12,000. During the taxable year, T's expenses of
medical care, qualifying as such under section 213 (with respect to medical,
dental, and similar expenses), IRC, are $1,000.
(1) Because the $500 in expenses is
attributable to the rental property in Hawaii, the entire amount is allowed as
a deduction. T therefore has $3,500 - $500, or $3,000, in Hawaii adjusted gross
income.
(2) Because the $1,500 in
interest is connected with real property outside Hawaii, no part of that amount
is allowed as a deduction against Hawaii income.
(3) The $1,000 of medical expenses, wherever
incurred, is not connected with any particular property or income. Thus, it
shall be prorated by applying the ratio of Hawaii adjusted gross income to
adjusted gross income from all sources. In this case the result is
($3,000/$12,000 x $1,000), or $250. If T does not take the standard deduction,
T may deduct medical expenses in excess of 7.5 percent of T's Hawaii adjusted
gross income. Because 7.5 percent of $3,000 is $225, T's medical expense
deduction for Hawaii purposes is limited to $250 - $225, or $25.
(c) If a
taxpayer is taxable only upon Hawaii source income and the taxpayer's
deductions connected with out-of-state income exceed the amount of out-of-state
income, the excess shall not be deductible against Hawaii source income and
shall not be carried over or carried back to offset Hawaii source income in any
other taxable year.
(d) If a
taxpayer is a part-year resident, the following procedure shall be followed.
(1) Income shall be allocated between the
period of residence and the period of nonresidence, under section
18-235-4-04.
(2) Deductions shall
be allocated between those connected with income allocable to the period of
residence, and those connected with income allocable to the period of
nonresidence. Deductions shall be allocated in the same ratio as the connected
income, unless the taxpayer demonstrates to the satisfaction of the department
of taxation that the result materially distorts Hawaii income.
(3) Deductions connected with income
allocable to the period of residence shall be allowed.
(4) Other deductions shall be allowed or
disallowed under the principles in subsections (b) and (c), but in applying
those subsections to a part-year resident, Hawaii adjusted gross income shall
include all income and adjustments allocable to the period of
residence.
(5) If a joint return is
filed by two taxpayers neither of whom was a resident for the full taxable
year, the period of residence shall be the period in which either spouse was a
resident, and the period of nonresidence shall be the period in which neither
spouse was a resident.
Example: T, an unmarried cash basis calendar
year taxpayer, was a resident of Arizona on January 1, 1993. T moved to Hawaii
on April 1, 1993, and continued to work as an insurance agent. T is a Hawaii
resident for the remainder of 1993. T received $20,000 as gain from the sale on
March 20, 1993, of Arizona real property held for investment. T earned
commissions of $25,000 for policies sold after April 1, 1993. T earned initial
and renewal commissions of $12,000 for policies sold before that date, $4,000
of which T earned before April 1, 1993. In addition, T had signed a business
consulting contract with one Arizona client, for which T was paid an additional
$1,200 for services rendered throughout the year. (For analysis of T's income,
see section 18-235-4-04(a), Example.)
(1) On January 15, 1993, T paid $100 to renew
T's Arizona insurance agent's license. None of the $100 is deductible against
Hawaii income because the license only relates to out-of-state income received
when T was a nonresident.
(2) T
incurs $3,600 in business expenses connected with T's business as an insurance
agent, but the expenses cannot be connected to specific sales of policies. As
explained in section
18-235-4-04(a), Example, $33,900 of the $38,200 of
commission income is allocable to T's period of residence. Thus, ($33,900 /
$38,200) x $3,600, or $3,195, of the expenses are allocable to the period of
residence and are deductible as trade and business deductions. Because the
remaining commission income is out-of-state income allocable to a period of
nonresidence, the remaining $405 of expenses is not deductible unless T
demonstrates to the satisfaction of the department that the result materially
distorts income.
(3) T pays $2,000
to an accountant to prepare T's tax return. T's adjusted gross income from all
sources is $20,000 - $1,500 + $38,200 - $3,600, or $53,100, and T 's Hawaii
adjusted gross income, which includes T's out-of-state income earned while T
was a Hawaii resident, is $33,900 -$3,195, or $30,705. Because T's tax return
preparation expenses are not connected with particular property or income, the
amount allowable in Hawaii is ($30,705 / $53,100) x $2,000, or $1,156. The tax
return preparation expense is a miscellaneous itemized deduction subject to the
2 percent floor of section 67, IRC. If T does not take the standard deduction
and has no other miscellaneous itemized deductions, T may deduct the amount in
excess of 2 percent of Hawaii adjusted gross income, so the deductible amount
is $1,156 - (0.02 x $30,705) = $542.
(e) This subsection applies to payments of
alimony or separate maintenance.
(1) As used
in this subsection:
"Alimony" means the same as "alimony or separate maintenance
payment" in sections 71(b) (with respect to alimony and separate maintenance
payments) and 215 (with respect to deduction for alimony and similar payments),
IRC.
"Contributing spouse" means the spouse, or former spouse,
who pays alimony.
"Recipient spouse" means the spouse, or former spouse, who
receives alimony.
(2)
Alimony is included in the gross income of the recipient spouse where:
(A) The recipient spouse is a
resident;
(B) The recipient spouse
became a resident after attaining the age of sixty-five and before July 1,
1976, and either the contributing spouse is a resident or the payments are
attributable to property owned in the State that is transferred (in trust or
otherwise) in discharge of a legal obligation to make alimony payments;
or
(C) The recipient spouse is a
nonresident, the contributing spouse is a resident, and the payments are
attributable to property owned in the State that is transferred (in trust or
otherwise) in discharge of a legal obligation to make alimony
payments.
(3) Alimony is
deductible from the income of the contributing spouse as follows:
(A) If the contributing spouse is a resident
for the full taxable year, the payment of alimony is deductible in full;
or
(B) If the contributing spouse
is not a resident for the full taxable year, the payment of alimony shall be
prorated under subsection (b)(4) to yield the deductible amount.
(f) This subsection
applies to deductions by individual taxpayers for contributions to pension,
profit sharing, stock bonus, and similar plans.
(1) An individual's deduction for
contributions to a retirement plan, such as that under sections 219 (with
respect to retirement savings), 404(a)(8) (with respect to deduction for
contributions of self-employed individuals), or 408 (with respect to individual
retirement accounts), IRC, shall be allowed only to the extent that the
deduction is attributed to compensation earned:
(A) In this State, or
(B) While the individual was a
resident.
(2) As used in
this subsection, "compensation" means the same as in section 219(f)(1),
IRC.
(3) An individual's deduction
for contribution to an individual retirement account shall be presumed to be
made pro rata from all compensation earned during the taxable year in which the
contribution is deductible.
(4) A
rollover contribution, as described in section 219(d)(2), IRC, shall not be
reduced or disallowed under this subsection.
(5) For rules to determine where compensation
is earned, see section
235-34,
HRS.
Example: In 1994, T earned $30,000 in
California while residing there and working for BMI Co. On May 13, 1994, T
moved to Hawaii to work for Exrox Co. and earned $20,000 during 1994. After the
move, T rolled over the entire BMI Co. retirement plan balance to an individual
retirement account (IRA). T established another IRA in Hawaii and contributed
$2,000 on April 1, 1995, that is deductible for federal purposes in 1994. T is
a part-year resident. Under paragraph (4), T's establishment of the rollover
IRA is not subject to tax. Under paragraph (3), the $2,000 IRA contribution is
prorated between all compensation sources. Hawaii compensation is $20,000 and
total compensation is $50,000. Thus, $2,000 x ($20,000 / $50,000), or $800, is
considered to be from Hawaii compensation and is thus deductible in
Hawaii.
