Withholding, the Root of All Evil?

by Tom Yamachika, President, Tax Foundation Hawaii

Withholding is making someone who isn’t liable for tax, but who pays money to someone who is, responsible for collecting and paying the tax to the government. Employers, for example, must withhold federal and state income taxes out of wages paid to their employees. 

The government also makes the buyer withhold taxes on big property sales. The federal government requires withholding when property is sold by a foreigner. Our state government also requires withholding when property is sold by a nonresident. 

This year, we took withholding one step further by enacting Act 232, a law that requires partnerships, estates, and trusts to withhold on income distributed to nonresidents. That law went into effect at the beginning of this year, but the Department of Taxation has come out with Announcement 2019-08 saying that they won’t be ready to enforce that law until the beginning of next year.

Interestingly, the law does not apply to “publicly traded partnerships,” which are partnerships with so many partners that their partnership interests can be bought and sold on a stock exchange just like shares of stock. Under federal law, these partnerships are treated the same as corporations. The PTPs complained in testimony that it’s such a bother to make them withhold:

[T]he requirement to withhold tax on behalf of nonresidents would be an extremely burdensome requirement for PTPs. Federal law does require brokers to report to PTPs specific ownership information on units held in street name, including name and address. However, this information is provided only once a year….

In other words, enough information goes to the PTPs so that they can send out federal Forms 1099-DIV to their unit holders so they can include that information in their respective federal tax returns. In the same testimony, furthermore, the PTPs offered to file an annual information return reporting name, address, taxpayer ID number, and income sourced to the state for each unit holder. That offer got written into the law. So, the PTPs can send out information returns to everyone but it’s too much humbug to cut the State a check? Forgive me for laughing.

There was one more bill to require withholding – the so-called “AirBnB Bill,” which was vetoed. The bill would have required transient vacation rental platforms such as AirBnB, HomeAway, and Flipkey to withhold general excise and transient accommodations taxes on transient vacation rental units booked through those platforms. Tax compliance is the responsibility of the unit owners, but not everyone knows about or pays the taxes, so withholding would increase compliance.

The Governor’s veto message says, “While requiring the hosting platforms to collect and pay the taxes on illegal transient accommodation uses would not legalize these operations, there is concern that it could be viewed as legitimizing these operations.” This message sounds like he is trying to talk out of both sides of his mouth.

Withholding has nothing to do with legitimizing illegal activity. If business is being conducted, tax is owed and should be collected whether the business is legal or not. Remember, the tax laws didn’t legitimize Al Capone’s activity; instead, they put him behind bars.

Rather, the real issue seemed to be that the county passed zoning laws but wasn’t enforcing them, and the prospect of State withholding seemed to be a convenient way for the counties to put the issue on the State’s back. But, counties, how about this for a solution? Find advertisements for illegal vacation rentals, confirm by online search that they aren’t registered for tax, and then rat them out to the State Tax Office! Then you can use your people to enforce your laws against other illegal rentals.