Hawaii modifies the section 1202 100% tax exclusion on capital gains from the sale of QSBS. The state allows the original partial capital gains exclusion of 50%. The guidelines are still the same. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also 50% of the capital gains will be excluded state income taxes if all of the guidelines are followed.
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Hawaii QSBS Exemptions
Hawaii modifies the Section 1202 100% tax exclusion on capital gains from the sale of QSBS. The state allows the original partial capital gains exclusion of 50%. The guidelines are still the same. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also 50% of the capital gains will be excluded state income taxes if all of the guidelines are followed.
Specifically, language found under Hawaii Revised Statute § 235-2.45(e) states:
“(e) Section 1202 (with respect to partial exclusion for gain from certain small business stock) of the Internal Revenue Code shall be operative for purposes of this chapter, except that section 1202(a)(3) and (4) shall not be operative for purposes of this chapter.”HAW. REV. STAT. § 235-2.45(E)
Both Section 1202(a)(3) and (4) discuss the substitution of 50% to 75% and 75% to 100% based on when the original issuance of the qualified business stocks. With that being said, Haw. Rev. Stat. § 235-2.45(e) explicitly states that there will only be a 50% exclusion on the capital gains from any qualified small business stock.
Hawaii Capital Gains Tax Rates
Hawaii taxes both short- and long-term capital gains at a rate of 7.25%. However, in March of 2021, a bill passed through the Senate that would raise capital gains tax rates to 11% for some taxpayers.
In comparison, federal capital gains tax rates have 3 brackets for single taxpayers which are:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Entrepreneurship in Hawaii
Ideagist has a comprehensive list of startup accelerators and incubators as well as angel investor programs in the state of Hawaii.
Included on that list is Blue Startups, a venture accelerator in Hawaii known for “helping scalable-technology companies compete globally.” They aim to strengthen the economy by providing business opportunities and partnering entrepreneurs with the necessary tools for success.
Among other industries, the following industries in particular thrive in the state:
Tax Benefits besides QSBS for Hawaii Small Businesses
The Hawaii Business Development and Support Division lists the several tax benefits of owning a business within the state as such:
- No personal property tax
- Tax credit for purchases of capital goods
- No state tax on goods manufactured or sold out of state
- No stock transfer tax
- No unincorporated business tax
- Research and development state tax credit
Hawaii Opportunity Zones
Hawaii is home to approximately 25 Opportunity Zones.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to the Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Hawaii made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Refer to this map for the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Some Examples of Opportunity Zones in Hawaii include:
- DREAMHOUSE ‘EWA BEACH Public Charter School
- 196 Units of workforce housing
- 40+ Units of multifamily senior housing
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.