HAR § 18-235-5-03 — Deductions connected with gross income from Hawaii sources

(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: HRS §235-5 HRS §235-5 HRS §235-5 §18-235-5-03 (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 per cent of T’s Hawaii adjusted gross income. Because 7.5 per cent 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.