The Kentucky General Assembly adopted H.B 366 and H.B. 487 making substantial changes to the state’s tax code. The changes are estimated to increase tax revenue by $396 million for the state’s 2019-2020 biennium. The bill makes numerous changes to income tax, sales and use tax; and also attempts to simplify compliance and administration of Kentucky state taxes. The following is a summary of the most impactful changes:

Mail Order and Internet Sales – Effective for transactions occurring on or after July 1, 2018, any remote retailer selling tangible or digital property to a purchaser in Kentucky, must collect use tax if: (a) the seller had 200 or more such transactions in the previous or current calendar year; or (b) the seller’s gross receipts from such transactions exceed $100,000 for the previous or current calendar year. This law is nearly identical to similar laws passed in the last year by multiple other states including Indiana. The Supreme Court decision in Wayfair v. South Dakota will determine whether this portion of the new law is constitutional.

Sales Tax on Labor or Installation of Taxable Property or Services – Kentucky’s definition of “gross receipts” and “sales price” for sales and use tax, now specifically includes the amount charged for labor or services for the installation/application of tangible personal property, digital property, or services sold. Previously, as long as the labor or service portion of the invoice was separately stated, it was not subject to sales and use tax. This exclusion remains, but only for labor or services associated with installation, repair, or maintenance of personal property used directly in manufacturing or industrial processing (if not otherwise exempt under the exemptions for raw materials, industrial supplies/tools, or machinery for new and expanded industry).

Sales and Use Tax on Extended Warranty Services – Sales and use tax is now imposed on the furnishing of extended warranty services for service contracts sold on or after July 1, 2018 in which the property the service agreement provides is subject to sales/use tax or the motor vehicle usage tax.

Individual Income Tax – For tax years beginning on or after January 1, 2018, Kentucky has replaced its graduated tax brackets with a flat 5% tax for all filers. Several changes were made to the calculation of Kentucky AGI including a reduced retirement distribution exclusion, a 100% addback for any federal 199A deduction, elimination of the Kentucky DPAD, and elimination of several itemized deductions (medical costs, state and local taxes paid, investment interest, casualty and theft losses, etc.). Conformity to the Internal Revenue Code was updated, leaving limits for §179 at $25,000 and disallowing any bonus depreciation. The $10 personal credit for each individual and dependent was also eliminated.

Corporate Income Tax – Matching the changes to individual income tax rates, Kentucky’s corporate rate was changed to a flat 5% for years beginning on or after January 1, 2018. Also like the individual changes, the domestic production activities deduction was eliminated; and conformity to federal depreciation/expensing was updated to leave the $25,000 limit on §179 and no bonus depreciation in place. The biggest change to corporate tax is a move to a single factor sales apportionment formula from a three factor apportionment formula for multi-state taxpayers. There are very limited exceptions to using the new single factor apportionment and taxpayers may also petition the department of revenue for use of an alternative method if the new method does not accurately/fairly represent the company’s activities in Kentucky. Along with this change, Kentucky is moving to market based sourcing for any sales other than sales of tangible property (services, rentals/leasing, licensing of property, etc.). A throwout rules has also been adopted for market based sales assigned to states where the taxpayer is not taxed on those sales.

Ad Valorem/Property Taxes – Kentucky has created a credit allowed against individual, corporate, and limited liability entity taxes for any taxpayer who pays personal property taxes on inventories. The credit is effective for tax years on or after July 1, 2018 for any taxes paid on or after January 1, 2018. If the credit is earned by a pass-through entity, the credit may be used the offset the companies LLET due, with any remainder passed through the owners. Kentucky has also created a property tax exemption for computer software with the exception of prewritten software. This provision is effective for assessment period beginning on or after January 1, 2019.