Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states corporations are subject to a corporate income tax while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
Currently, four states, Nevada, South Dakota, Washington, and Wyoming, do not have a corporate income tax, and the same four states, along with Alaska, Florida, and Texas, have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Hawaii is like most states in that it has a corporate income tax, but unlike many states in that it does not have any franchise or privilege tax generally applicable to businesses. Thus, for the most part, unless your business is a traditional corporation (a C corporation), your business itself will not be subject to a state tax on income or net worth. However, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.
Hawaii taxes the income of corporations at a series of marginal rates ranging from 4.4% to 6.4%. The more specific breakdown is as follows:
- income up to $25,000 taxed at 4.4% rate
- income over $25,000 up to $100,000 taxed at 5.4% rate, less $250; and
- income over $100,000 taxed at 6.4% rate, less $1,250.
In addition, Hawaii taxes corporate net capital gains at an alternative rate of 4%. State tax returns are due on the 20th day of the fourth month after the close of the tax year. For companies whose tax year corresponds with the calendar year, this means returns are due on April 20th.
(Hawaii also allows taxpayers who own no property in Hawaii, whose only activities in the state consist of sales, and whose gross sales in the state do not exceed $100,000 to pay an alternative tax of .5% of gross sales. However, this option is not likely to apply to most Hawaii businesses.)
Let’s briefly look at additional details for five of the most common forms of Hawaii business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Hawaii corporations are subject to Hawaii’s corporate income tax at marginal rates ranging from 4.4% to 6.4%.
Example: For the latest tax year, your Hawaii corporation had a taxable income of $200,000 and no net capital gains. The corporation will owe Hawaii corporate income tax in the amount of $10,050 (first $25,000 taxed at 4.4% = $1,100; next $75,000 taxed at 5.4% less $250 = $3,800; remaining $100,000 taxed at 6.4% less $1,250 = $5,150).
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation generally is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each individual shareholder is subject to federal tax on his or her share of the corporation’s income. In other words, S corporations are “pass-through” entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.) Hawaii recognizes the federal S election, and Hawaii S corporations are not required to pay corporate income tax to the state. However, an individual S corporation shareholder will owe tax on his or her share of the company’s income.
Example: For the latest tax year, your S corporation had net income of $200,000. The $200,000 in net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your respective state tax returns; the rate will vary depending on your overall net income for the year.
Limited Liability Companies (LLCs). Like S corporations, standard LLCs are pass-through entities and are not required to pay income tax to either the federal government or the State of Hawaii. Instead, income from the business is distributed to individual LLC members, who then pay federal and state taxes on the amount distributed to them.
While LLCs are classified for tax purposes as partnerships by default (or, for single-member LLCs, “disregarded entities”), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject to Hawaii’s corporation income tax.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $200,000. The $200,000 in net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your own portions on your respective state tax returns; the rate will vary depending on your overall net income for the year.
Partnerships. Income from partnerships is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns.
Example: For the latest tax year, your partnership had net income of $200,000. The $200,000 in net income will be divvied up between you and your fellow partners, and you will each pay tax on your respective portions on your respective state tax returns; the rate will vary depending on your overall net income for the year.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income.
Example: For the latest tax year, your sole proprietorship had net income of $200,000. The $200,000 in net income is distributed to you personally, and you pay tax on that income on your individual state tax return; the rate will vary depending on your overall net income for the year.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Hawaii. However, if you’re doing business in several states, your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Hawaii, it may be subject to Hawaii taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Hawaii’s corporation income tax, check the Department of Taxation website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).