What You Ask

by Tom Yamachika, President, Tax Foundation Hawaii

In my position here at the Tax Foundation, I get to meet and speak with quite a few tax professionals.  Like you and me, they’re human, they don’t know everything, and part of their job is finding out answers that they don’t know off the top of their heads.

When they have state tax questions, for example, it’s natural for them to call the Department of Taxation to see if somebody will answer those questions.  The Department is a source of information, the information is right most of the time (sometimes through no fault of the Department, as explained below), and it’s free all the time. 

I’ve seen a number of the questions asked, because sometimes the professionals will write them down in an email and send them in.  And, in my experience, sometimes they fall into a trap.  Here are some of the traps I’ve seen.

The question isn’t specific enough.  If they asked the Department whether the sale of drugs is exempt from General Excise Tax, for example, their answer probably would be “no.”  Most common drugs are not exempt.  But if they’re prescription drugs sold to patients using them, an exemption does apply.

Many questions mix up the tax with a retailer’s charge to recoup the tax.  “Why do I have to pay 4.712% tax if the tax law only allows for 4.5%?” you might ask.  This is because the retailer has to pay the tax, not the customer, and if the retailer passes the tax on to the customer (most do) then the retailer has more income.  A retailer charging a customer 4.5% tax on a $100 invoice for a total of $104.50, for example, will find that the tax due is 4.5% of the $104.50 that the customer paid, not only on the $100. The 4.712% rate corrects for this quirk.

The question suggests the answer the professional is worried about.  This tempts the responder to follow it (it’s the answer most favorable to the responder’s employer, after all).  For example, questions were sent in about the recently enacted passthrough entity credit, which allows a partnership or multi-member LLC, for example, to pay tax that otherwise would be paid directly by the owners.  This is to avoid limitations on deducting the taxes on the owners’ federal returns.  One questioner came to the Department asking whether the tax deduction would be limited anyway on the owner’s return because the partnership was an investment of the owner instead of a business where the owner put in substantial labor.  The Department’s agent was apparently convinced by the “worst possible outcome” in the question and decided to run with that, agreeing that the deduction would be limited.  Instead, the answer probably is that the partnership paid the tax, so it took the deduction; the owner will then pay tax on the net amount of income reported by the partnership, and the owner doesn’t need to worry about the deduction on the individual return.

The moral of the story is that when you go to ask the government agency a question, whether you are a tax practitioner or just an interested person, you really should do your homework previously, so you have a good idea of what the relevant facts are and what the answer should be.  Of course, it’s quite possible that you will miss something and that the answer will be different.  That person on the other end of the line deals with tax law every day and has probably responded to similar questions in the past.  But you will have a much smaller chance of getting the wrong answer because you didn’t ask the right question.