As you may know, the Department of Taxation submits every year a bill to conform our Hawaii income tax laws to the changes (mostly income, exclusion, and deduction items) made by the Congress in the previous year. This year, the conformity bill, S.B. No. 3004, S.D. 1, H.D. 1, C.D. 1, was passed by the Legislature, and the Governor is expected to sign this measure into law. The following is a list of the major conformity items in this year's bill:

• Adopts Internal Revenue Code (Code) section 1(h)(3) relating to the reduction of net capital gain for investment income taken into account;
• Adopts expanded IRAs for active pension plan participants;
• Adopts nondeductible Roth IRAs which allow the tax free accumulation and distribution of income;
• Adopts Code definition of activities for home offices;
• Adopts the above the line deduction for interest expense on higher education loans up to $1,000;
• Adopts augmented charitable contribution deduction for gifts of computers from C corporations to elementary and secondary schools; similar to charitable contributions of inventory for the care of the ill, the needy, and infants;
• Adopts new phase-in schedule for deduction of health care insurance expenses by the self-employed; 100% deduction by 2007;
• Adopts Code section 121 which allows the exclusion of $250,000 ($500,000 for marrieds) of gain upon the sale of a principal residence. Effective for sales and exchanges made after May 6, 1997. In addition, section 235-2.4(n), HRS, allowing roll-overs of gain by purchasing a replacement residence is repealed;
• Adopts Code section 685 which allows pre-need funeral trusts to file tax returns on behalf of the beneficiary and to pay the income tax on the income earned during the taxable year. Effective for tax years ending after August 5, 1997; and
• Requires Code sections 6240 to 6255 to be operative and relates to simplified audit procedures for electing large partnerships.

• Amends section 235-71, HRS, to clarify that the alternative tax for corporations in Hawaii remains the same and the Code amendments allowing the use of the lesser of net capital gain or taxable income do not apply; and
• Does not adopt the Code's new safe harbor provisions for the underpayment of estimated tax penalties for taxpayers with adjusted gross incomes over $150,000. The federal Taxpayer Relief Act of 1997 amended the safe harbor percentages for the preceding year's tax liability to 105% for years 1998-2000; 112% for year 2001; and 110 for year 2002 and thereafter. The bill keeps constant the safe harbor percentages of 90% of the current year's tax or 110% of the preceding year's tax for this AGI level.

Each provision of the bill is effective upon approval for taxable years beginning after December 31, 1997, unless otherwise noted.

Please note that the Legislature again decided not to conform to the itemized deduction for long-term care insurance premiums and expenses (an item from the 1996 federal legislation).

For questions concerning this year's conformity bill, please call Johnson Lau at 587-1562. For a complete listing of conforming and non-conforming items, please refer to our digest of the 1997 federal tax laws which may be obtained at any of our forums and workshops, or by calling Jo-Ann Shintani of the Rules Office at 808-587-1530.

/s/
RAY K. KAMIKAWA
Director of Taxation

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