State & Local Tax Update: Kentucky's Response to Tax Reform

The Kentucky legislature recently passed significant tax law changes with House Bill 366* and House Bill 487**, including an overhaul to much of Kentucky’s corporate tax system and addressing the state’s conformity to the Tax Cuts and Jobs Act.

These bills broaden Kentucky’s tax base through various income and sales tax provisions and introduce a flat income tax rate. Highlights of the sweeping changes include:

Income Tax Changes

Internal Revenue Code Conformity

• Updated Internal Revenue Code conformity date to Dec. 31, 2017
• Did not adopt federal income tax changes enacted by the Tax Cuts and Jobs Act related to:
  • 100 percent bonus depreciation deduction under IRC Sec. 168(k) for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023; or
  • A $1 million and $2 million investment phase-out limit for the asset expense deduction under IRC Sec. 179
• Will decouple from the 20 percent pass-through entity deduction of IRC Section 199A

Apportionment, Filing Method, and Tax Rate Changes

• Enacted single-factor sales apportionment for tax years beginning on or after Jan. 1, 2018, replacing three-factor, double-weighted sales apportionment formula
• Adopted market-based sourcing rules for sales of other than tangible personal property for tax years beginning on or after Jan. 1, 2018
  • Receipts are in the state if the taxpayer’s market for the sales is in the state; generally based on delivery location of services; a throw-out rule applies if not taxable in state where receipts are assigned
• Clarified that for alternative apportionment, the party seeking the alternative method carries the burden to provide that another method is reasonable and the standard method does not fairly represent the taxpayer’s business activity in Kentucky
• Flattened tax rate of five percent for C corporations and individuals effective for tax years beginning on or after Jan. 1, 2018
• For tax years beginning on or after Jan. 1, 2019, required combined income tax reporting by corporations that are members of a unitary business group unless the group files a consolidated Kentucky income tax return
• Effective for tax years beginning on or after Jan. 1, 2019, corporation or pass-through entity returns that have gross receipts of $1 million or more must be electronically filed unless a waiver is submitted
  • “Gross receipts” means gross receipts reported by the corporation or pass-through entity on their federal income tax return filed for the same taxable year as the return due

Administrative Provisions

• Effective April 27, 2018, the deadline for notification of a final federal audit to Kentucky Department of Revenue is 180 days; previously it was 30 days
• For assessments issued on or after July 1, 2018, taxpayers will have 60 days (previously 45 days) from the date of the notice to protest in writing to the department

Creation of Business Inventory Tax Credit

• Created nonrefundable and nontransferable credit for state and local property taxes paid on business inventory
  • Credit may be applied to corporate income, personal income, and limited liability entity tax (LLET) for any taxpayer that, on or after Jan. 1, 2018, timely pays a property tax to the state or any political subdivision for property
  • Credit is phased in over four years:
    • 25 percent of inventory taxes paid for 2018
    • 50 percent of inventory taxes paid for 2019
    • 75 percent of inventory taxes paid for 2020
    • 100 percent of inventory taxes paid for tax years after 2020

Tangible Personal Property Tax Changes

• For assessment dates beginning Jan. 1, 2019, and forward, custom computer software will be exempt from state and local ad valorem taxes
  • Exemption does not include prewritten computer software

Sales Tax Changes

Broadening of Sales Tax to Certain Services

• As of July 1, 2018, the following services are taxable in Kentucky:
  • Services rendered in installing or applying the tangible personal property, digital property, or service sold, even if the charge is separately stated on an invoice
  • Landscaping services
    • Lawn care and maintenance
    • Tree trimming, pruning, or removal
    • Landscape design and installation
    • Landscape care and maintenance and
    • Snow plowing or removal
  • Janitorial services
    • Residential cleaning services
    • Commercial cleaning services
    • Carpet and upholstery cleaning services
    • Window cleaning services
  • Small animal veterinary services
  • Pet care services
    • Grooming
    • Boarding
    • Pet-sitting
    • Pet-obedience training
  • Industrial laundry services
    • Industrial uniform supply services
    • Protective apparel supply services
    • Industrial mat an drug supply services
  • Non-coin-operated laundry and dry cleaning services
  • Linen supply services
    • Table and bed linen supply
    • Nonindustrial uniform supply
  • Indoor skin tanning services
  • Non-medical diet and weight reducing services
  • Limousine services, if a driver is provided
  • Extended warranty services
    • Services provided through a service contract agreement where the service provider agrees to repair, replace, support, or maintain tangible personal property or digital property if:
      • The contract is purchased after July 1, 2018, and
      • The tangible personal property or digital property to be repaired, replaced, or maintained under the contract is subject to sales tax in Kentucky

Expanded Nexus – Remote Retailers

• Provides that a remote retailer, who is not a marketplace facilitator or referrer but who has no physical presence in Kentucky and sells tangible personal property or digital property delivered electronically to a purchaser in Kentucky, may be a retailer engaged in business in Kentucky if the remote retailer:
  • Delivered goods to Kentucky customers in 200 or more transactions, or
  • Its gross receipts from the sale of tangible personal property or digital property in Kentucky is more than $100,000 in the previous calendar year

Miscellaneous

• Expanded the definition of taxable admission to include fees paid for:
  • The right of entrance to a display, program, sporting event, music concert, performance, play, show, movie, exhibit, fair, or other entertainment or amusement event or venue, and
  • The privilege of using facilities or participating in an event, including bowling centers, skating rinks, health spas, swimming pools, tennis courts, weight training facilities, fitness and recreational sports centers, and golf courses, and include any combination of initiation fees, monthly fees, and membership fees
• Modified the definition of pre-written computer software to exclude separately stated modifications and enhancements

* Enacted into law April 13, 2018
** Enacted into law April 26, 2018