Business Practices Change Warranting Tax Changes

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In the old days, and yes it is all relative, when plantations ruled the landscape of the territory and then later as a state, workers worked for the big companies be it a sugar plantation, a pineapple plantation or perhaps a cannery. And of course there were the big department stores and the utilities and financial institutions.

These large employers were vertically integrated in that they had every department from transportation to infirmaries to employee cafeterias, and in the really old days, housing. Today, the vast majority of businesses in Hawaii have fewer than ten employees. In many cases, these small businesses do not have the resources to do their own bookkeeping or for that matter providing all the paperwork required by various government agencies to be in business like the payment of health care benefits or various required insurance coverages like workers’ compensation and temporary disability benefits.


To the rescue has come a new way of providing employee administration including the payment of wages and benefits as well as withholding of taxes for employees. Called professional employment organizations these relatively new types of organizations grew out of what many remember as temporary employment agencies. These were companies to which businesses turned if they had a sudden surge in business or if a regular employee got sick or took vacation time off.

Professional employment organizations (PEO) literally take over the employment of persons who have been working for a particular small business or will be hired by the small business and they administer the payroll and benefits for the employees. Technically those employees become employees of the professional employment organization. The business for whom these employees work determines how much employees will be paid, the kinds of benefits afforded the employees while the PEO executes the policies and guidelines set by each business. The business then reimburses the PEO for all costs incurred for the employee such as the salary or wages paid, the employee benefit premiums, and the various types of insurance coverages required by government. For all of this, the PEO charges the business a service fee to cover its cost for administering the wages and benefits.

The problem that PEO’s have encountered is that this arrangement is not a tax exempt cost of reimbursement because a service fee is charged in addition to the amounts that are disbursed to employees and the various companies providing the employee benefits. Thus, the PEO has to pay the 4 percent general excise tax on not only its service charge or management fee, but also on the amount that is reimbursed for salaries and benefit premiums.

This is not a new issue. Measures have been introduced into the legislative hopper over the past six years to exempt the amounts that represent reimbursed wages and salaries and disbursements for employee benefits. But in every attempt, each try has met with failure. This despite the fact that a similar exemption was afforded to hotel management companies and orchard growers.

The hotel management company exemption was enacted more than ten years ago when it was realized that many national chains, such as Sheraton or Marriott, actually operated a property on behalf of the owner of the hotel. The management companies employed the housekeepers, bellmen, waiters, and waitresses. However, because the money taken in as room rentals for the hotel rooms or payments for meal services in restaurants went first to the owner of the hotel, the 4% general excise tax (and the 7.25 percent TAT on the room rentals) was paid by the hotel owner. The hotel owner then turned around and reimbursed the management company for the wages and benefit payments made to the employees or the benefit companies and then paid a management fee to the hotel operator.

Thus the 4 percent was paid twice on amounts that had the hotel operator also been the owner of the property would have had to pay only once. The legislature granted that exemption and a subsequent one to orchard operators and telecommunication companies because they recognized that this type of arrangement allowed a sense of stability and consistency for workers.

Much of the opposition in the past has come from unions who see this type of an arrangement as thwarting possible union organizing. However, continued opposition to this type of arrangement actually works against the creation of new businesses and new jobs. Times have changed and so should the tax law in this area.

”’Lowell L. Kalapa is the president of the Tax Foundation of Hawaii, a private, non-profit educational organization. For more information, please call 536-4587 or log on to”’

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