Hawaii Administrative Rules
Title 18 - DEPARTMENT OF TAXATION
Chapter 235 - INCOME TAX LAW
Subchapter 1 - GENERAL PROVISIONS
Section 18-235-5-03 - Deductions connected with gross income from Hawaii sources

Universal Citation: HI Admin Rules 18-235-5-03

Current through August, 2024

(a) This section applies to all taxpayers, pursuant to section 235-5(c), HRS, and section 265 (with respect to expenses and interest connected with tax-exempt income), IRC.

(b) In computing the taxable income of a taxpayer subject to tax on Hawaii source income only:

(1) Deductions connected with Hawaii source income shall be allowed.

(2) Deductions connected with out-of-state income shall not be allowed.

(3) Pursuant to section 235-7(e), HRS, no deduction is allowed for interest paid or accrued on debt incurred or continued:
(A) To purchase or carry bonds if interest paid by the bond issuer is out-of-state income or is exempt from taxation under section 235-7(a), HRS;

(B) To purchase or carry property owned outside of the State; or

(C) To carry on a trade or business outside of the State.

(4) Deductions from Hawaii adjusted gross income that are not connected with particular property or income, such as medical expenses, shall be allowed only to the extent of the ratio of Hawaii adjusted gross income to adjusted gross income from all sources.

(5) Adjustments to income that are not connected with particular property or income shall be allowed only in the proportion determined under the following formula.
(A) Determine the aggregate amount of the adjustments not connected with particular property or income.

(B) Determine Hawaii source income and subtract all adjustments to income other than those included in (A).

(C) Add the amount in (A) to adjusted gross income from all sources.

(D) The ratio of (B) to (C) is the proportion of the adjustments that are allowable.

(6) Deductions are connected with a particular kind of income if the deductions would be allocable to that income under the principles of section 265 (with respect to expenses and interest connected with tax-exempt income), IRC, and section 1.265-1(c) (with respect to allocation of expenses to a class or classes of exempt income), Treasury Regulations.

Example: T, a single person aged 60, is a nonresident owning rental property in the State from which T derives $3,500 of gross income during the taxable year and incurs $500 of associated expenses, such as general excise and real property taxes. T also has paid $1,500 in interest on a mortgage on T's personal residence in Iowa. T's adjusted gross income from all sources is $12,000. During the taxable year, T's expenses of medical care, qualifying as such under section 213 (with respect to medical, dental, and similar expenses), IRC, are $1,000.

(1) Because the $500 in expenses is attributable to the rental property in Hawaii, the entire amount is allowed as a deduction. T therefore has $3,500 - $500, or $3,000, in Hawaii adjusted gross income.

(2) Because the $1,500 in interest is connected with real property outside Hawaii, no part of that amount is allowed as a deduction against Hawaii income.

(3) The $1,000 of medical expenses, wherever incurred, is not connected with any particular property or income. Thus, it shall be prorated by applying the ratio of Hawaii adjusted gross income to adjusted gross income from all sources. In this case the result is ($3,000/$12,000 x $1,000), or $250. If T does not take the standard deduction, T may deduct medical expenses in excess of 7.5 percent of T's Hawaii adjusted gross income. Because 7.5 percent of $3,000 is $225, T's medical expense deduction for Hawaii purposes is limited to $250 - $225, or $25.

(c) If a taxpayer is taxable only upon Hawaii source income and the taxpayer's deductions connected with out-of-state income exceed the amount of out-of-state income, the excess shall not be deductible against Hawaii source income and shall not be carried over or carried back to offset Hawaii source income in any other taxable year.

(d) If a taxpayer is a part-year resident, the following procedure shall be followed.

(1) Income shall be allocated between the period of residence and the period of nonresidence, under section 18-235-4-04.

(2) Deductions shall be allocated between those connected with income allocable to the period of residence, and those connected with income allocable to the period of nonresidence. Deductions shall be allocated in the same ratio as the connected income, unless the taxpayer demonstrates to the satisfaction of the department of taxation that the result materially distorts Hawaii income.

(3) Deductions connected with income allocable to the period of residence shall be allowed.

(4) Other deductions shall be allowed or disallowed under the principles in subsections (b) and (c), but in applying those subsections to a part-year resident, Hawaii adjusted gross income shall include all income and adjustments allocable to the period of residence.

(5) If a joint return is filed by two taxpayers neither of whom was a resident for the full taxable year, the period of residence shall be the period in which either spouse was a resident, and the period of nonresidence shall be the period in which neither spouse was a resident.

Example: T, an unmarried cash basis calendar year taxpayer, was a resident of Arizona on January 1, 1993. T moved to Hawaii on April 1, 1993, and continued to work as an insurance agent. T is a Hawaii resident for the remainder of 1993. T received $20,000 as gain from the sale on March 20, 1993, of Arizona real property held for investment. T earned commissions of $25,000 for policies sold after April 1, 1993. T earned initial and renewal commissions of $12,000 for policies sold before that date, $4,000 of which T earned before April 1, 1993. In addition, T had signed a business consulting contract with one Arizona client, for which T was paid an additional $1,200 for services rendered throughout the year. (For analysis of T's income, see section 18-235-4-04(a), Example.)

(1) On January 15, 1993, T paid $100 to renew T's Arizona insurance agent's license. None of the $100 is deductible against Hawaii income because the license only relates to out-of-state income received when T was a nonresident.

(2) T incurs $3,600 in business expenses connected with T's business as an insurance agent, but the expenses cannot be connected to specific sales of policies. As explained in section 18-235-4-04(a), Example, $33,900 of the $38,200 of commission income is allocable to T's period of residence. Thus, ($33,900 / $38,200) x $3,600, or $3,195, of the expenses are allocable to the period of residence and are deductible as trade and business deductions. Because the remaining commission income is out-of-state income allocable to a period of nonresidence, the remaining $405 of expenses is not deductible unless T demonstrates to the satisfaction of the department that the result materially distorts income.

(3) T pays $2,000 to an accountant to prepare T's tax return. T's adjusted gross income from all sources is $20,000 - $1,500 + $38,200 - $3,600, or $53,100, and T 's Hawaii adjusted gross income, which includes T's out-of-state income earned while T was a Hawaii resident, is $33,900 -$3,195, or $30,705. Because T's tax return preparation expenses are not connected with particular property or income, the amount allowable in Hawaii is ($30,705 / $53,100) x $2,000, or $1,156. The tax return preparation expense is a miscellaneous itemized deduction subject to the 2 percent floor of section 67, IRC. If T does not take the standard deduction and has no other miscellaneous itemized deductions, T may deduct the amount in excess of 2 percent of Hawaii adjusted gross income, so the deductible amount is $1,156 - (0.02 x $30,705) = $542.

(e) This subsection applies to payments of alimony or separate maintenance.

(1) As used in this subsection:

"Alimony" means the same as "alimony or separate maintenance payment" in sections 71(b) (with respect to alimony and separate maintenance payments) and 215 (with respect to deduction for alimony and similar payments), IRC.

"Contributing spouse" means the spouse, or former spouse, who pays alimony.

"Recipient spouse" means the spouse, or former spouse, who receives alimony.

(2) Alimony is included in the gross income of the recipient spouse where:
(A) The recipient spouse is a resident;

(B) The recipient spouse became a resident after attaining the age of sixty-five and before July 1, 1976, and either the contributing spouse is a resident or the payments are attributable to property owned in the State that is transferred (in trust or otherwise) in discharge of a legal obligation to make alimony payments; or

(C) The recipient spouse is a nonresident, the contributing spouse is a resident, and the payments are attributable to property owned in the State that is transferred (in trust or otherwise) in discharge of a legal obligation to make alimony payments.

(3) Alimony is deductible from the income of the contributing spouse as follows:
(A) If the contributing spouse is a resident for the full taxable year, the payment of alimony is deductible in full; or

(B) If the contributing spouse is not a resident for the full taxable year, the payment of alimony shall be prorated under subsection (b)(4) to yield the deductible amount.

(f) This subsection applies to deductions by individual taxpayers for contributions to pension, profit sharing, stock bonus, and similar plans.

(1) An individual's deduction for contributions to a retirement plan, such as that under sections 219 (with respect to retirement savings), 404(a)(8) (with respect to deduction for contributions of self-employed individuals), or 408 (with respect to individual retirement accounts), IRC, shall be allowed only to the extent that the deduction is attributed to compensation earned:
(A) In this State, or

(B) While the individual was a resident.

(2) As used in this subsection, "compensation" means the same as in section 219(f)(1), IRC.

(3) An individual's deduction for contribution to an individual retirement account shall be presumed to be made pro rata from all compensation earned during the taxable year in which the contribution is deductible.

(4) A rollover contribution, as described in section 219(d)(2), IRC, shall not be reduced or disallowed under this subsection.

(5) For rules to determine where compensation is earned, see section 235-34, HRS.

Example: In 1994, T earned $30,000 in California while residing there and working for BMI Co. On May 13, 1994, T moved to Hawaii to work for Exrox Co. and earned $20,000 during 1994. After the move, T rolled over the entire BMI Co. retirement plan balance to an individual retirement account (IRA). T established another IRA in Hawaii and contributed $2,000 on April 1, 1995, that is deductible for federal purposes in 1994. T is a part-year resident. Under paragraph (4), T's establishment of the rollover IRA is not subject to tax. Under paragraph (3), the $2,000 IRA contribution is prorated between all compensation sources. Hawaii compensation is $20,000 and total compensation is $50,000. Thus, $2,000 x ($20,000 / $50,000), or $800, is considered to be from Hawaii compensation and is thus deductible in Hawaii.

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