Hawaii's unique tax wrinkle

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(FORTUNE Small Business) -- Dear FSB: I live in Hawaii and do teleradiology from other states. I want to start an LLC for myself. Do I need to apply for a state license in Hawaii because my place of business is in Hawaii, or can I form the LLC in another state to save on taxes? Would I still have to pay general excise tax to Hawaii because of my physical presence?

- Guy Takahashi, Honolulu, HI

Dear Guy: A rainbow of things make Hawaii special: Waikiki Beach. The "Aloha Spirit." The excise tax.

The state of Hawaii has no sales tax. It does, however, have an excise tax for the privilege of doing business in Hawaii.

"It's unique to us," says Caroline Kim, director of the Small Business Development Center in Honolulu. There's a 4% (4.5% on Oahu) tax on the gross income of retail sales of goods, services, contracting, commissions, rent, interest and other activities.

The tax is 'origin-based,' depending on where the actual work is done, Kim says.

But you're in luck: In 1999, state legislators changed the tax law to help Hawaii become more competitive in the world market. Act 70, Session Laws of Hawaii 1999 (enacted in 2000), exempts from the excise tax service and contracting activities that are performed in Hawaii and then exported out of Hawaii for resale, use or consumption. In other words, you only pay tax on your earnings for work you do in Hawaii that will be used locally.

"If you're working here, receiving reports to be read from out of state, reading them here, then sending them back, you're subject to this provision for exported services and do not have to pay the excise tax on that work," says Lynn Garcia, tax specialist at the State of Hawaii Department of Taxation.

You will, though, have to pay the tax on reports you receive to work on from within the islands, she says: "Just deduct out the ones that were sent from out of state."

As for licensing, "you absolutely must have a state license here in Hawaii," says Kim. "That's where you're actually doing your business. You must register it here. The companies that are sending you the reports to work on need it as proof you are a legitimate business, so that they can pay you."