 We're back, we're back on a given Tuesday for more tax. You love tax, don't you? You better learn about tax, because it's coming for all of us, the tax man comeths. And this is just the opposite of the tax man. This is Tom Yamachika, he's the president of the Hawaii Tax Foundation. Welcome back, Tom. Thanks for having me on the show. So here we are, just settling in after that incredible episode in Congress. In fact, all episodes these days in Congress are all incredible, about the Tax Reform Act, okay? And today, let's look at some of the implications that have been rolling out over how that affects Hawaii. And I'm sure there'll be other things that'll roll out later. But let's talk about the corporate rates that have been changed at the Fed. Let's talk about this section 199A. And let's see if we can understand what the Fed did and how it affects us. Okay, well, first of all, we kind of start off with the proposition that C corporation, what we call C corporations, what you may call corporations. You know, businesses that operate in corporate form, they throw off dividends. And they usually have a lot of shareholders maybe trade on an exchange, whatever. Okay, their top tax rate went down from around 35% to 21%. So it's a big, big drop. That's on net income. On net income. Of the corporation, the C corporation. That's right. There are other kinds of corporations and other vehicles to operate a business in. So there are S corporations, which some people may think of as sub-chapter S, which is what they were called when the terminology first came out. And there are limited liability companies, there are partnerships. Most businesses are conducted in one of those forms, which you call pass-through forms. So in those forms of business, the entity itself doesn't pay tax or income tax. They may pay other kinds of tax like payroll tax or GE or whatever. But they don't pay income tax, instead, their owners do. So it's a pass-through, and the owner reports the income that was earned by the entity. That's correct. Now, because under Trump tax, the individuals who own the businesses are taxed at higher rates, up to 37%, their rates didn't go down so much as the corporate rates did. The way they make up for it is by saying, okay, if you as an individual owner are getting business income or part of a business's income, we, the tax code, will give you a deduction for some of that income. So that would make it just as if the tax rate was a little bit lower on that kind of income. So for example, if you, and I'm just using round numbers, if you have $150,000 of income from all sources, you get $100,000 from a business, the basic deduction that you're entitled to get is 20%. So instead of being taxed on $150,000, you would get 20% of the 100 as a deduction. So you'd be taxed on the 130. Right. So you get 20% of that 100 part, the part you got from a corporation or a pass-through company. A pass-through company. Pass-through company, like an LLC. You take 20% of what you receive from there and you deduct that against your whole income, your entire income. In this case, 150 is your entire income. You get the 20% deduction off the 100. Now your taxable income, so to speak, your taxable gross income, I suppose, is 130,000. That's right. Okay. So if you're making a lot of money and you would normally be exposed to the 37% rate, you get the benefit of this 20% deduction and your tax rate drops to maybe 30%. Okay. So it's still not as good as 21, but it's getting there. It's throwing a bone. Right. Well, but the other thing that you have to keep in mind is that even for corporations, they have this double tax issue, which is that after they pay tax, they pay dividends to their shareholders and the shareholders get taxed again. On the same money. On the same money. Yeah. Right. And this is at the individual rates now. So that's on the other side of the coin. Right. If you have a C corporation, the C corporation pays tax at the corporate rate of now 21%. And when all of that's done, the net is filtered through by dividends to the owners, the stockholders, and the stockholders pay their individual income tax on the amount that comes to them. So it's a double tax. It always has been a double tax. Right. It's a little less at the corporate level. Well, it's much less. It's almost half at the corporate level these days. So that sort of counterbalances what you were saying under this 20% deduction a minute ago, right? Right. That's the other side of that coin. So if you took the same amount of earnings and you passed them through both levels of tax, full boat, you would wind up paying an effective tax rate of a little over 40%. With the C corporation and the dividends. C corporation and dividends. 40%. Yeah. Now that's more than 21%. Yeah. But it's way better than before. Yeah. Now how does that compare to an LLC or a pass-through entity? Yeah, it would be about 30%. 30%. So we actually do better. Yeah. By the way, a pass-through entity would include a REIT, right? Yes, it would. A real estate investment trust organization. Yes, it would. Such as the shopping centers and HRPT, Commonwealth properties that own a lot of property. Yeah, but those would be a little bit different because, you know, number one, the corporation wouldn't pay tax. Right. And the individual, the owners of the REIT, the stockholders of the REIT would pay tax. But they would get the 20% deduction on the REIT dividend. Which is pretty good. Which is a really good deal. Yeah. So what does this mean to us? What does it mean to a small business who is incorporated? What does it mean to us? I'm focused on small business because I think, as you said in your article in Civil Beat, most of what happens is in small businesses in this country. So if you are, say, a small retail business versus a small CPA firm, how does it differ? How does it affect the owners? Well, it would affect the owners. It's a very complicated formula. It took me days to figure it out. And it's based on how much taxable income you ultimately get. If you married filing a joint and get more than $400,000, the benefit pretty much is phased out. If you're a CPA or a consultant or that kind of service business. If you're a regular business like a retail store, it would not be phased out, but it would be limited by the amount of wages you pay. Yeah. So that's better. Again, that would depend. I mean, if you are a retail business and you don't pay wages, you have independent contractors coming in, you'd have a problem because you'd be limited by your W-2 wages and you don't have any. Right. So, I mean, it's a very complex calculation. Business owners should be, I think, getting in touch with their tax advisors to find out, what's going on here? What would be best for me? Should I make changes in how I do business? That kind of thing. Yeah. Oh, yeah. So it's not only how you report it, it's not only going through that complicated formula for, when does this go into effect for tax year 2017 or 2018? For 2018. So it just took effect. Just took effect, meaning that our calculations are different starting next April, not this April. Yeah, this April you'd be filing a tax return based on 2017. The old law. Yeah, and that's under the old law. Okay, so not only do you get in touch with your tax professional about this for next year's returns, but also maybe you should change the way you do business. How would you change the way you do business? Like some people, if they're in, for example, if you're in a C Corporation and you've traditionally paid out all of your earnings at the end of the year through bonuses or other kinds of compensation, you may want to consider doing an LLC form or an S Corporation form. So you can instead of having the workers of the Corporation get salary which is fully taxable at the individual rates, you make it so that they can get some profit distributions where you can get the 20% deduction. So how hard is it to do that to make that change from a C Corporation to a pass-through Corporation? Well, yeah, again, it's very complicated. It depends on your individual situation and you shouldn't be talking about it. So this is a real benefit to the tax professionals, isn't it? Well, maybe. Maybe a financial. But is this what we expected? I mean, we were, not that I ever bought it, but we were led to believe this would be a positive thing for business, for business. Is it really a positive thing for business? Is it a positive thing for business nationally? Is it a positive thing for business locally? What we've seen in terms of when the National Tax Foundation ran the numbers on just normal people, middle-income people, they found that every Hoy resident, middle-income Hoy resident would be getting $800 more in their pocket on average per family. So, yeah, everybody's better off. Yeah, for $800 for the average Hawaii resident nationally, is it the same? Nationally, it's less because middle-income families nationally tend to get less. Yeah, well, let me throw a little bit of a curve on that. Right after this tax reform bill was passed, it was within hours, days, a couple of days, Paul Ryan stood up and said, gee whiz, now that we're not going to charge you $800 in tax and for corporations a lot more reduction than that. We find we don't have enough money to pay for the social safety net. So we're going to be looking in 2018 for ways to reduce the social safety net because we're going to have the money because we just gave it all back to you because we believe in smaller government and also smaller social safety net. So that includes a risk of reduction of social security, Medicare, Medicaid, and other things too because all of a sudden in the second shoe drops just a few days later and we find we don't have the money and incredible. And I wonder if they knew that. I guess they did. I'm sure they did. Yeah, this is all part of a plan. So now we here in Hawaii, we may have benefited more than other states with the $800 average reduction in taxes, but we still have to perform under the social safety net to help our people because we care. As opposed to other states, maybe don't care as much. We as a democratic state with big heart liberal values, always, always, you know, it's a wonderful thing about Hawaii, we care. We're not going to let those poor people suffer. So we're going to make up the spread. And to make up the spread, assuming no contributions or reduced contributions from the Fed, where does it come from? It has to come from us, the taxpayers. Yeah, it has to come from the rest of us. So $800 reduction is going to wind up. We're in the state, we're going to have to cover it and maybe more, don't you think? Oh, I think there's some possibility that's going to happen. Yeah. We were talking a little bit earlier about what's going to happen in our legislature once they consider how to conform or not to conform to the federal changes. We do know that yesterday, the governor's package of bills was introduced, including one from the Department of Taxation. Okay, hold right there because that's a cliffhanger. And whenever we see a cliffhanger, we take a break and we tell the people that if they want to find the answer to the cliffhanger question, they have to wait for this break to be over. Okay, as I raise my hand, we will take a break and I raise my hand a second time, we'll be back. And we'll hear the answer to Tom Yamachika's cliffhanger question. Hey, Aloha. Standard Energyman here on ThinkTech Hawaii where community matters. This is the place to come to think about all things energy. We talk about energy for the grid, energy for vehicles, energy and transportation, energy and maritime, energy and aviation. We have all kinds of things on our show, but we always focus on hydrogen here in Hawaii because it's my favorite thing. That's what I like to do. But we talk about things that make a difference here in Hawaii, things that should be a big changer for Hawaii. And we hope that you'll join us every Friday at noon on Standard Energyman and take a look with us at new technologies and new thoughts on how we can get clean and green in Hawaii. Aloha. Aloha, I'm Keeley Iakina and I'm here every other week on Mondays at 2 o'clock p.m. on ThinkTech Hawaii's Hawaii Together. In Hawaii Together, we talk with some of the most fascinating people in the islands about working together, working together for a better economy, government and society. So I invite you into our conversation every other Monday at 2 p.m. on ThinkTech Hawaii Broadcast Network. Join us for Hawaii Together. I'm Keeley Iakina. Aloha. Okay, this is Tom Yamachika, the president of the Tax Foundation of Hawaii. I'm Jay Fidel, ThinkTech. It's Community Matters. We're talking about tax. You better listen, okay? We're back. We're back. So yeah, you know, so what we have is we have the tax reduction that gives our citizens here in Hawaii a reduction on the average for what, middle class, maybe upper middle class, $800 per annum or something like that. Different for different people. But at the same time, you know, we're left with a burden because the general plan in Washington seems to be reduced the size of government. And that means reduced the size of the social safety net. And since we care about the social safety net, we're going to have to make it up out of our own state funds, which is not so easy because we're already behind. We're not at Puerto Rico yet, we're already behind with tens of billions of dollars of unliquidated, unpaid liabilities here. So we're going to have to find the money. And that's the problem that is presented by Tom's question. What are we going to do? What would the governor say that he wanted to do in his state of the state message? He wants to help the homeless. Okay, well that's part of the safety net. So the question that I was presenting before the, you know, before the break was what are we doing in our legislature about this? And yesterday the governor's package was introduced, there was a bill from the Department of Taxation regarding to internal revenue and formality. And what that was was plain vanilla. And by that, I mean we have a law that says we conform to the federal law as it is in effect on December 31, 2016. That's existing law. So we changed the 2016 to 2017. That's all it does. What that does in practical effect is it'll pick up all of the Trump tax provisions on base broadening. So you would get rid of miscellaneous itemized deductions. You would get rid of probably personal exemptions. You know, but the way Trump tax works is you get base broadening but you reduce the rate, right? And that effect is beneficial for most people. On our side, you get base broadening but the rate stays the same. Which means we will pay more tax. Which means it's a tax hike. Yeah, we calculate our state tax. We're not going to have the benefit of all the deductions and changes that the Fed made, right? Right. So make no mistake about it. Yeah. That looking at a tax hike. Yes. Again. Yes. Here. Here. In Hawai'ine. That's correct. Yeah. Well, don't we need one, honestly? You don't have to answer that if you don't want. You want one? Okay. Do you want to pick one? I don't. Let me assure you I don't. Because if you want to pay more taxes, you can certainly write a check to the government and they'd be happy to accept it. You heard it here on ThinkTech. If you want to give them charity, they're an eligible charitable. Yes. So people think they need charity with all they do and don't do. But anyway, so okay, so I just want to get it straight. So what do you mean when you say you expand the base? What does that mean? By expanding the base, that means there are more dollars that are going to be taxed. Ah, okay. So your gross income is going to be higher because you don't have these various deductions and exemptions and exclusions and what have you. Right. Right. Right. So okay, so when you write your tax return, your 2018 gross revenue is going to be higher given the same circumstances than your 2017 tax revenue. Yeah. That tax revenue, yes. Okay. So when you say conform to all, conform to the federal changes, you mean we take it in the shorts on that because we lose all these deductions and exemptions. And we don't make up for it in the rate at the state level. We don't change our rates. We don't change the rate. So it's really simple. This bill must be really short, right? It's very short. It's two pages. Two pages. And that's all it says. Yeah, that's all it says. Okay. I guess it's brilliant from the point of view of trying to goose the rate, goose the tax we pay. Yeah. Simple. It's very, very simple. Anybody can see and you know, it's hard to start to fight with the bill that's simple, you know. So what kind of reaction have we had on this? What's your reaction, Tom? It was entirely what I was expecting. I was expecting them to pick up the base broadening which helps them and not change the rate, which doesn't help them. Yeah. So, you know, I always say, you know, the garden of the Finsicantini, what they do in Washington is coming for us. It's going to have an effect. And this is a big effect. This is a big effect. It's going to affect our, what do you want to call it, our tax economy here in Hawaii. It's going to affect what you're looking at and what we're reporting on our state tax return. That's right. I mean, we have, as you mentioned, all of these promises that we've made earlier. We've promised to pay for our state workers. We've promised to pay their pensions. We promised to pay health care for life. And we have to deliver. Huge burden. We have to deliver on these promises. Yeah, sure. Our state constitution even says that those promises are not subject to reduction. So that's really going to put the pressure on state government here. It's not only here. I mean, it's a problem across the nation. Yeah. Well, it's part of the Trump plan, the Republican plan. But let me add one other point to consider. And that is when you pay this higher state income tax, what you're talking about, you don't necessarily get the same deduction on your federal tax. That sounds like a circular thing. So now, after I've been charged more money at the state tax level because of this conformity bill conforming with the new Tax Reform Act, I pay more. But I don't get the same deduction for my federal tax. Wow. How does that work? Well, if you don't make very much, you know, it may not hurt you. If you're middle or upper middle class, your state direction is going to be limited to the 10,000, as I mentioned before. Well, the 10,000. Let's talk about that for a minute. Sure. So you get now, you cannot deduct more than 10,000 from the federal return, more than $10,000 of a combined number of what you paid to the state of Hawaii as income tax, plus what you paid to your respective counties, I suppose. As real property tax. As real property tax. Right. Now, the rate in Hawaii, as I recall, and it's unchanged by this conformity bill is 11%, right? Is that right? Right, that's the topic. Net personal income, that's what you pay. Okay, so if I have $100,000, you know, roughly speaking, I'm going to have a $10,000 state income tax bill. Well, I mean, if you make only $100,000, you're not going to get nowhere near the 11%, but you'll probably be paying 8% or so. 8%. Yeah. And then if I have a house, a common house, ordinary house worth, I don't know, what is the house worth these days? That's a moving target also. Yeah, but maybe, you know, $750 to a million. Okay, so maybe my tax is $2,500, $3,000. Yeah, so even there, you'd be budding up against the limit. Exactly. So you got $8,000 for income tax, $2,000 to $2,500 for property tax. Yeah. That's over $10,000. Yeah, it's over $10,000. Okay, so that means the excess over $10,000, you get no deduction for in your federal return in the year following. Right. Because it's one year lag. Right. So whatever I pay in year one is what I deduct in year two. Okay, now we are probably going to have to ultimately increase those taxes to pay for these unliquidated liabilities, these tens of billions. Some people estimate it at $40, $50 billion of unpaid. We're going to have to handle that. It's the rail, it's the homeless, it's the employee's retirement system, and all those wonderful benefits that we give to retired state employees. Yeah. So we need to, at the legislature, make some tough policy calls on what we're going to have money for or what we're not going to have money for, because the more we obligate taxpayers, at some point, taxpayers are going to either run out of money or they're going to pack up their bags and leave and go someplace else. Yeah. We're going to get there though, don't you think? We already have a net outmigration of people. Yeah. So some people already have made the decision. I don't know if it's because of tax or what, but that, hey, you know, Hawaii's not paradise. Not a tax paradise for sure. Yeah. So I mean, you know, I keep thinking of, the issue that keeps coming up in so many ways is priorities. You know, that the legislature has to have priorities and they need leadership in this governor or some other governor as to what priorities really count, how they should spend the money. A hundred million on affordable housing, another hundred million on affordable housing, on energy, on sustainability, on climate change. We have to spend money on climate change, or we'll be not resilient. And then when the storms come and they're coming next year, just in time for the tax increase, you know, we'll have to pay a lot of money either A, who make ourselves resilient, and that's expensive business, you know, dealing with inundation, or B, you know, dealing with the damage that a storm creates. And that's in the billions too, if it's a bad storm, you know, you know, cutting a swath through Honolulu, for example, that's a major expense to fix that. Look what happened. Yeah, or even you look at the normal problem of, you know, the shoreline's receding. Right. You have to do something. You can't just wait for Waikiki to wash away. That's right. You know, except the end of the tourist industry right there. So, you know, we're going to have to raise money for these things, hopefully on a planned basis, but maybe sometimes with the storms on an unplanned basis. And that means that taxes are going to have to go up a fair piece of change. And that means real property taxes, and it means income taxes, and then we'll be way over the $10,000 limit allowed. And I might throw in the fact that we're on our own, aren't we? What happened to Puerto Rico? The Fed did not step in and put any money down to fix Puerto Rico. There go Puerto Rico still in terrible shape. And that scenario could follow pretty much the same way here in isolated Hawaii. Yeah, who are you? Hawaii, who are you? Right, same thing. Yeah. So we'll have to raise it ourselves. And so, I mean, I think the point you made about people deciding to pack up is a real significant threat. Because as people pack up, then your, you know, statewide tax base goes down. Of course it does. I mean, the more people we lose, the fewer people there are to pay taxes on anything. Less tax receipts for the state, less revenue, less money to pay all the bills, increasing bills. So what's your advice at a legislature? Have a plan, make their priorities, be very, very careful about, you know, making these long-tailed commitments and for the ones that we already have, see about how you can rein them in. I mean, are we going to be stuck with these, you know, huge open-ended commitments forever? I mean, do the legislators know or care about that? I mean, at least they should have some awareness of what they are and, you know, where the money for that is coming from, or not. Yeah. Well, you've frightened my daytime. Thank you. Thank you so much for coming down. This is, we get to play the territorial theme for Puerto Rico now as a sort of going out music with photographs. Thank you very much, Time. I hope we can get you to come back soon and follow on this issue. It's really important. Thank you, Day.