The Importance of Conformity

by Tom Yamachika, President Tax Foundation Hawaii

Recently, Governor Green, without much fanfare, signed into law a number of bills that had been proposed by the Department of Taxation. Many of them covered relatively arcane subjects such as whether the Department had the authority to serve administrative subpoenas outside the State of Hawaii.  (The bill said that they can.)  One of them, however, in the course of just four pages does a heck of a lot of work.  It incorporates into Hawaii’s income tax law and estate tax law all of the changes to their counterpart Federal tax laws, except for those laws that are specifically treated a different way.  We call this concept “conformity.”

Why is conformity important?  Before the late 1970’s, Hawaii had its own income tax law that kinda sorta looked like federal income tax.  Resident individuals, namely most of us around at the time, had to contend with Form N-12, an income tax form that looked a little like a Form 1040 but had its own little quirks.

In 1978, however, our legislature enacted laws saying that our income tax law was going to follow federal law, basically to make income tax easier to deal with.  (And they would be easier to audit, too, if for example the IRS audited someone’s return and made changes, in most cases the changes would be reflected in Hawaii law so our state auditors could simply follow the federal auditors’ work.)  Our legislature would decide every year which federal tax laws they would follow, and which ones they wouldn’t. Those differences would be written out in the law books.

Much later, we massaged our estate tax laws to work the same way—every year the Department of Taxation introduces a bill to pick up all or some of the federal changes, and as a result our tax code for that tax also picks up the federal tax law except for certain changes that are written out in statute.

For income tax, for example, adjusted gross income is quite similar to federal AGI, especially for taxpayers who have all if their income earning activity here in Hawaii. Deductions for individual taxpayers are similar as well. That’s why in the late 1990’s the Department introduced Form N-11 to replace the N-12.  Instead of calculating state taxable income from scratch, it started with federal AGI and made adjustments to it. The N-11 is the form that most resident individuals file today.

For businesses, one of the most common differences is in the calculation of depreciation, which is already mind-numbing even without state differences.  Most states, including Hawaii, resisted the concept of “bonus depreciation,” which the Feds introduced in 2002 and which really never went away.  As a result, businesses with fixed assets normally need to calculate depreciation at least twice, once under federal rules and once under state rules.

For estate tax, the changes are a bit more radical.  This is because the federal system has an integrated estate and gift tax, while Hawaii has no gift tax. In addition, the federal code has a threshold of $13.61 million, meaning estates of lesser value generally don’t have to worry about federal estate tax; Hawaii’s lawmakers couldn’t stomach a threshold that high, and instead locked us into the federal threshold that existed in 2017, namely $5.49 million.

But in either case, it’s very helpful for taxpayers and tax practitioners to have a ready-made list of the differences between state and federal tax treatment.  It certainly beats having to do the taxes from scratch for both federal and state purposes.