How Hawaii Screws Small Business Taxpayers
- Anthony J. Charles, EA
- Feb 22
- 5 min read
The State of Hawaii has a reputation for being notoriously unfriendly to business. Not only does it seem to be okay with that label, but it has also gone to the level of shooting itself in the foot when it comes to state tax policy, discouraging economic diversification.
The hallmark of Hawaii’s anti-business climate is its general excise tax (GET). It’s imposed on transactions at every stage of the supply chain and applies to gross receipts instead of net profit. That means that every dollar handed to a business is taxed at 4.5% whether they keep it as profit or spend it on ordinary business expenses such as wages or supplies. That has in-and-of-itself killed any chance of a low profit margin industry from opening in Hawaii. A business with a 50% profit margin has effective GET rate of 9.0%, and that’s before any state income tax! A business can operate at a loss, as many startups do, and still owe the GET tax on every dollar they took in. There are no deductions and very few, rarely applied, exemptions for those doing business in Hawaii. Everything you import from the mainland, including services, is subject to the Use Tax, the identical twin of GET. As a quasi-sales tax on steroids, GET receipts account for 40-45% of the state’s tax revenue. This is compared with a national average of 25%. Much of it a consequence of our relatively low property tax revenues, due to the way the state’s school system is structured. The GET tax has all but limited Hawaii’s economy to tourism, professional services, military, and civil service.
As far as tourism goes, the state levies the transient accommodations tax (TAT) on the gross rental receipts of resorts and hotels, the state having already killed the short-term rental industry for homeowners. The 10.25% TAT is an attempt to bring in revenue from tourists who come to Hawaii. The economy that has built up around the military presence is a function of national geopolitical strategy and has little to do with state tax policy.
So, it comes down to professional services, which encompasses most of the islands’ small businesses and self-employed, everywhere from real estate agents and bookkeepers, to food truck operators and dentists. The state has all but given that entire sector the middle finger. Unlike the W-2 world, the small business / self-employed sector of the economy is responsible for paying their income taxes via quarterly estimated tax payments at both the federal and state levels. Tax professionals and fiscal policy makers know that this group of taxpayers (especially the ones with variable income) have always had trouble keeping up with timely estimated tax obligations, usually culminating in a balance due at tax time.
The Hawaii Legislature knows this all too well. So, what did they do? While the W-2 workers are safe with their withholding and often receive a refund, small business owners will typically submit, and automatically receive, a 6-month extension of time to file their taxes. The federal government gives all American taxpayers this extra time with no questions asked. If they have a balance due after April 15th, then the IRS will assess a 0.5% per month failure-to-pay penalty plus interest. If a taxpayer has a hard time paying their balance, they can work out a payment plan and get their penalty rate cut in half to 0.25%. The IRS will work with you as long as you communicate with them.
The problem is that you need to prepare your federal tax return in order to do your state tax return. This is where Hawaii gets dirty. Many people do not understand that Hawaii’s "automatic" extension of time to file is contingent upon having no balance due at tax time. If you have any balance due, your deadline to file is April 20th. Sure, you will get your federal extension, but most self-employed people put taxes on the back burner after sending in their federal extension in March or April. That is a fatal decision. In nearly all cases, the self-employed taxpayer does not know they have a balance due, because it hasn’t been calculated yet. In fact, the reason they have no idea how much trouble they’re in is because they have not prepared their profit and loss (P&L) statement for the previous tax year. Lack of bookkeeping is very expensive indeed. That is a very common item of procrastination among non-W-2 workers. It can, and often does, cost thousands of dollars in penalties.
The key to what happens hinges upon understanding the failure-to-file penalty, a separate, and much larger sibling of the failure-to-pay penalty. It is 5% per month, or part of month, of your balance due after the due date of your return. It maxes out in 4.5 months, at 25% of your unpaid balance. The state rakes in additional revenue of up to 25% of the annual state income tax bill of self-employed taxpayers. Hawaii will also add estimated tax penalties and interest, but so does the federal government. This is one reason why 1099 taxpayers should have access to a protective withholding mechanism. This oversight is a product of predictable human nature, not flagrant disregard of tax laws. The state knows exactly who this tax law will affect, how much they will get from it, the psychology behind it, and they deliberately capitalize on it. And all of this occurs in the most expensive state in the country… already in the top 3 highest tax burdens of all 50 states plus DC. The Hawaii extension of time to file regulations should be amended to align with federal rules.
Governor Green and the Legislature did an excellent job passing the Green Affordability Plan II (GAP II) tax cuts in 2024. Because of them, Hawaii is on a path of redemption in terms of state tax policy. However, we still have a long way to go. Finding an alternative to the GET would take a lot of political capital, which may not be politically feasible right now. Exempting food and medicine from GET would be a good compromise. It needs to happen if Hawaii wants to diversify its economy. It would not be very hard to amend the extension of time to file regulations, and it should be done because it's the right thing to do for our neighbors who don’t have the luxury of consistent income, job security, and automatic income tax withholding.
GAP II is a historic state tax cut package that will be completely phased in by 2031.
