by Tom Yamachika, President Tax Foundation Hawaii
This year’s legislative session, as in many others, considers many and varied forms of tax relief. Terms being bandied about include exemptions, deductions, and tax credits, and among tax credits there are the “CreditAbles” – refundable, nonrefundable, and assignable credits. This week we will take some of the mysteries out of those terms.
An “exemption” or “exclusion” describes something that normally would be subject to tax – an item of income, perhaps – and says it won’t count toward figuring your tax. A “deduction” describes something that may or may not be subject to tax in the first place – such as an expense – and will be subtracted when figuring your tax. For personal income tax purposes, for example, a payment you get from an employer to reimburse you for bills you paid on your employer’s behalf is exempt (payments from your employer are normally taxable), but interest you paid to the bank on your mortgage is a deduction.
Exemptions or deductions can be worth a little or a lot, depending on the tax rate. For state income tax where you are in the 8.25% bracket, for example, a $100 exemption or exclusion would change your tax bill by $8.25.
Tax credits don’t reduce the income on which the tax is based. Instead, tax credits reduce tax directly. Different kinds of CreditAbles work differently, however.
Refundable credits are functionally the same as cash. You can pay your tax bill with refundable credits, and if there are credits left over after all the tax is paid, the government will write you a check for the difference, just as if you paid your tax with the same amount of money. Typically, the Department of Taxation (DOTAX) doesn’t like refundable credits. They’re a lot of work, and involve more than one agency because under our system DOTAX can’t cut refund checks. Instead, a refund request needs to go through DOTAX’s checks and balances to the Department of Accounting and General Services, and those folks, after going through their own checks and balances, cut and mail the checks. I still wonder why DOTAX can’t cut its own checks.
Nonrefundable credits are a lot less work because they are like store coupons. You can pay your tax bill with nonrefundable credits, but if there are any left over after your tax for the year is paid, no check is forthcoming. Instead, you need to wait for another occasion to use the credits – next year’s tax, perhaps.
With assignable credits, the coupons can be bought and sold. The concept addresses nonrefundable credits that are earned by folks who typically don’t pay state tax, such as nonprofit charities or out-of-state organizations. A store coupon against tax is useless when you aren’t paying tax, but would be worth something to a person who does owe tax. In states that offer assignable credits, the credits typically trade at a small discount to compensate the buyer for the trouble it is going through. That’s one way a tax credit can be made valuable to a non-taxpayer without making the credit refundable.
Putting this knowledge to work, one of the earlier drafts of a bill being considered by our legislature made a certain credit refundable and assignable. We said it didn’t make sense. Who would want to buy or sell cash? Fortunately, the powers that be saw the absurdity and got rid of the assignability feature. It turned out that the bill author wasn’t thinking about having taxpayers make a market to sell the credits, but wanted something slightly different, which might be accounted for in the next bill draft.
That covers our list of CreditAbles. We trust that it will make the discussion of tax credits and incentives more understandable, and help make our tax system more tolerable.