Kentucky Enacts Apportionment Formula, Rate, Other Changes

The Kentucky Legislature voted to override Gov. Matt Bevin’s veto of legislation that made extensive changes to Kentucky corporate and personal income tax provisions.

IRC Conformity

The legislation updates the Internal Revenue Code (IRC) reference date for determining Kentucky income tax liability:

  • from December 31, 2015
  • to December 31, 2017.

The update applies to tax years beginning after 2017. It does not apply to any IRC amendments made after 2017, except those extending provisions that would otherwise expire on that date.

Depreciation and Expense Deductions

Kentucky does not adopt federal income tax changes enacted by the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97) that allow:

  • a 100% bonus depreciation deduction under IRC Sec. 168(k) for property placed in service after September 27, 2017 and before January 1, 2023; or a $1 million dollar and $2 million investment phaseout limit for the asset expense deduction under IRC Sec. 179.

Kentucky continues to require an addition adjustment by taxpayers who claim either federal deduction for tax years after 2017.

Taxpayers may claim a depreciation and IRC Sec. 179 expense deduction computed without regard to:

  • federal bonus depreciation; or
  • IRC Sec. 179 amounts exceeding $25,000 dollar or $200,000 investment phase out limits.

Elimination of Deductions

Effective for tax years after 2017, taxpayers computing Kentucky income tax liability may not subtract from their federal income base:

  • Master Tobacco Settlement payments;
  • the value of property leasehold interests donated and used for homeless shelters;
  • individual retirement income in excess of $31,110 (previously $41,110); or
  • premiums paid for an individual’s, spouse’s, or dependent’s health insurance coverage.

Individuals who itemize Kentucky deductions may not subtract federal itemized deductions for:

  • investment interest under IRC Sec. 163;
  • casualty or theft losses under IRC Sec. 164;
  • medical care expenses under IRC Sec. 213;
  • moving expenses under IRC Sec. 217; or
  • miscellaneous deductions (e.g., employment meal and travel expenses) under IRC Sec. 67.

The legislation does not eliminate Kentucky itemized deductions for:

  • mortgage interest and premiums; or
  • charitable contributions.

However, the legislation removes the dollar limits on itemized deductions for high income taxpayers.

Tax Rates

Kentucky imposes income tax on corporations and individuals at a flat rate of 5% for tax years beginning after 2017.

Corporations currently pay income tax at the rate of:

  • 4% on taxable income up to $50,000;
  • 5% on taxable income over $50,000 and up to $100,000; and
  • 6% on taxable income over $100,000.

Individuals currently pay income tax at the rate of:

  • 2% on taxable income up to $3,000;
  • 3% on taxable income over $3,000 and up to $4,000;
  • 4% on taxable income over $4,000 and up to $5,000;
  • 5% on taxable income over $5,000 and up to $8,000;
  • 5.8% on taxable income over $8,000 and up to $75,000; and
  • 6% on taxable income over $75,000.

Standard Apportionment Formula

Kentucky replaces its three-factor apportionment formula with a single receipts factor formula for tax years beginning after 2017. Corporations, partnerships, and limited liability companies (LLCs) currently apportion income from business in Kentucky and other jurisdictions using a formula consisting of a:

  • payroll factor;
  • property factor; and
  • double-weighted sales factor.

The new apportionment formula applies to “apportionable income” instead of “business income.”“Apportionable income” means all income that:

  • is apportionable under the U.S. Constitution; and
  • is not allocated to Kentucky.

The definition otherwise incorporates the same transactional and functional tests for determining whether income is “business income.”

Unlike the current sales factor, the receipts factor excludes income from treasury transactions (e.g., hedging and securities transactions)

Finally, the legislation amends numerous provisions to reflect the new single receipts factor formula. Those amended provisions cover apportionment rules for:

  • general partnerships and limited liability pass-through entities;
  • passenger airlines;
  • air freight forwarders;
  • regulated investment company services; and
  • securities brokerage services.

Market-Based Sourcing Rules

Effective for tax years beginning after 2017, businesses must assign or source certain receipts to the apportionment formula based on the market for the sales. The market-based sourcing rules apply to sales of other than tangible property. In general, if the taxpayer’s market for sales is in Kentucky, the receipts must be assigned to the state. If the taxpayer cannot determine the state or states of assignment using the market-based rules, the taxpayer may reasonably approximate the state of assignment.

A taxpayer’s market for sales is in Kentucky if the receipts are from:

  • the sale, rental, lease, or license of real property located in the state;
  • the rental, lease, or license of tangible personal property located in the state;
  • a service delivered to a location in the state;
  • intangible property used in marketing a good or service that is purchased by a customer in the state; or
  • a contract right, government license, or similar intangible property that authorizes the holder to conduct business in a specific geographic area in the state

The sourcing rules for marketing intangibles also apply to intangible sales contingent on the productivity, use, and disposition of the property. All other receipts from intangible property must be thrown out of the apportionment formula.

A throwout rule also applies to the denominator of the receipts factor if:

  • the business is not taxable in the state where it assigns the receipts; or
  • the state of assignment cannot be determined using the market-base sourcing rules or reasonable approximation.

Alternative Apportionment

Kentucky allows or requires the use of alternative allocation or apportionment methods for tax years after 2017 under the same circumstances as current law. Alternative methods include:

  • separate accounting;
  • inclusion of additional factors; or
  • any other method that will result in the fair apportionment of income.

Effective for tax years after 2017, the party seeking an alternative method must prove that both:

  • the standard method does not fairly represent the taxpayer’s business activity Kentucky; and
  • the alternative method is reasonable.

In addition, the Kentucky Department of Revenue does not bear the burden of proof if there has been:

  • a material change of facts; or
  • a material representation of facts.

The department cannot withdraw permission to use an alternative method unless there has been:

  • a material change of facts on which the department relied; or
  • a material misrepresentation of facts by the taxpayer.

Under current law, the department cannot revoke a taxpayer’s election to use an alternative method for 5 years.

The department cannot impose a criminal or civil penalty on any taxpayer that reasonably relies on an alternative method required by the department.

Film Production Credit

The law amends the film production credit to:

  • remove commercials from credit eligibility;
  • impose a $1 million annual statewide cap for all taxpayers; and
  • make the credit nonrefundable and nontransferable.

The changes take effect for tax years beginning after 2017.

The credit applies to a portion of the eligible expenses incurred in Kentucky, including payroll, to film or produce:

  • feature-length films;
  • television programs;
  • industrial films;
  • documentaries; or
  • Broadway shows.

Taxpayers may claim the credit against the Kentucky:

  • corporate income tax;
  • limited liability entity tax (LLET); and
  • personal income tax.

Business Inventory Credit

The legislation creates a nonrefundable and nontransferable credit for state and local property taxes paid on certain business inventory. The credit is:

  • 25% of property taxes paid for the 2018 tax year;
  • 50% of the property taxes paid for the 2019 tax year;
  • 75% of the property taxes paid for the 2020 tax year; and
  • 100% of the property taxes paid for tax years beginning after 2020.

S corporations, partnerships, LLCs, and other limited liability pass-through entities may apply the credit against the Kentucky limited liability entity tax (LLET). A pass-through entity must pass the credit through to its members, partners, or shareholders according their distributive share of income.

KIRA, KIFA, and Angel Investor Credits

Effective April 13, 2018, Kentucky temporarily suspends income tax credits for:

  • businesses and individuals that revitalize existing Kentucky manufacturing, coal mining, and agribusiness facilities;
  • businesses and individuals that invest in venture capital funds to expand small businesses, provide new jobs, and encourage new products and technologies in Kentucky; and
  • individuals who invest in certain Kentucky small businesses with high-growth potential that are in engaged knowledge-based activity.

The suspension of the Kentucky Industrial Revitalization Act (KIRA), the Kentucky Investment Fund Act (KIFA), and angel investment program credits runs until July 1, 2022.

Personal and Dependent Credits

Effective for tax years after 2017, Kentucky no longer allows personal and dependent credits of:

  • $10 for single taxpayers and each taxpayer with a status of married filing separate returns;
  • $20 for married taxpayers filing joint returns; or
  • $10 for each dependent.

Kentucky retains a credit of:

  • $40 for each taxpayer who is 65 or older;
  • $40 for each taxpayer who is blind;
  • $20 for a taxpayer who is a member of the Kentucky National Guard at the end of the tax year;
  • $10 for an estate; and
  • $2 for a fiduciary, other than an estate.

Repealed Income Tax Credits

The legislation repeals:

  • the coal incentive credit for alternative fuel or gasification facilities;
  • the Kentucky Jobs Retention Act (KJRA) credit;
  • the alternative fuel, gasification, and renewable energy facilities credit; and
  • the Kentucky Environmental Stewardship Act credit.

Withholding Tax Exemptions

Kentucky no longer allows employees to claim withholding tax exemptions for tax years beginning after 2017.

Federal Audit Changes

The deadline for submitting a copy of a final federal audit determination to the Kentucky Department of Revenue is extended from 30 days to 90 days after conclusion of the audit.

Ch. 171 (H.B. 366), Laws 2018, effective April 13, 2018 and as noted
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CCHTaxGroup

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