Nonresident Withholding, Six Years Later

by Tom Yamachika, President, Tax Foundation Hawaii

If you have, or know of, a partnership, estate, or trust that does business in Hawaii and has investors, owners, or beneficiaries that reside outside of Hawaii, then you might want to read this.

About a month ago, the Department of Taxation issued Tax Information Release 2025-03 to provide guidance on a legal requirement that such entities withhold state income tax on behalf of their nonresidents.  (S Corporations already have a withholding requirement in place.)

When I first saw this TIR, I thought I was having a senior moment because I didn’t recall any withholding legislation that passed recently.  It turns out that the legislation was enacted in 2019, six years ago.  At the time, the Department issued an announcement saying that it wasn’t ready to implement the requirement yet, so taxpayers could relax and not have to worry about it for the time being.

In June of this year, the Department published Announcement 2025-02 telling us that the delay was over and the withholding requirement was now live, along with a few new tax forms, namely the Form N-4P and Schedule NP for partnerships and the Form N-4T and Schedule NT for trusts and estates.  Apparently, several taxpayers had some good questions about the new withholding regime.  TIR 2025-03 and Announcement 2025-02 provide some sensible answers.

Does an entity have to withhold when the owner or beneficiary is an entity, like another partnership?  No, because the withholding requirement applies only to owners or beneficiaries who are nonresident individuals.  But if the owner entity is in turn owned by a nonresident individual or individuals, that owner entity might have a withholding requirement as well.

Does an entity have to withhold when it makes a passthrough entity election to pay tax on behalf of its (resident and nonresident) owners or partners?  No, as long as the tax gets paid according to the requirements of the PTE election.

The law says that withholding needs to be made at the highest individual rate (11%).  Will that amount be required even if the out-of-state taxpayer is going to wind up owing much less in tax?  No, the Department will look the other way as long as the amount withheld is a reasonable estimate, the estimated amount is paid, and the entity has records showing why it withheld a lesser amount.  The Department, understandably, may get a little testy if it thinks the nonresident owes a bunch of tax and no one pays it.

Are quarterly payments required to be made, like those required to pay estimated tax?  No, the withholding payments are not estimated tax so they don’t have to be paid quarterly.  If an entity finds it more convenient to pay quarterly, however, the Department will be happy to take the money.  Entities can pay online using Hawaii Tax Online, or on paper with Form N-201V.

The remaining question, that I think lawmakers should be asking, is why it took six years for the Department to get its act together to implement this requirement.  Certainly it isn’t reasonable to expect the Department to turn on a dime each time the Legislature enacts something new.  When the bill was being considered by the 2019 Legislature, the Department asked for the law to be made effective for taxable years 2020 and afterward to allow the Department time to make the necessary system changes.  Lawmakers didn’t agree and made the law effective for taxable year 2019.  As a result, the Department seems to have snail-walked the implementation of this law.  It remains to be seen, however, who will have the last laugh.