On April 27, 2018, the Kentucky legislature voted to override Governor Matt Bevin’s veto of the comprehensive tax reform. Though many developments have emerged from the tax bill, the most significant include a flat five percent corporate tax rate, the adoption of single-sales factor apportionment formula and market-based sourcing, mandatory combined reporting for unitary groups, expansion of the sales and use tax base, and economic nexus for remote retailers. The legislation, HB 487, also updates Kentucky’s conformity date with the Internal Revenue Code (IRC). For tax years beginning on or after January 1, 2018, Kentucky will conform to the IRC, effective December 31, 2017.
Kentucky’s decision to opt for a flat five percent corporate tax rate sees the Commonwealth move away from its previous progressive system that imposed rates ranging from four to six percent, depending on the corporate taxpayer’s net income. Compared to many other states, Kentucky’s corporate tax rate will remain relatively low under the new law.
The legislation’s adoption of a single-sales factor apportionment and the use of market-based sourcing for sales of tangible personal property is consistent with the nationwide trend seen over the last decade or so. The market-based sourcing rules are largely based on the provisions in the revised Article IV of the Multistate Tax Compact adopted by the Multistate Tax Commission in 2015. Previously, Kentucky utilized a three-factor apportionment formula with a double-weighted sales factor and sourced the sales of other tangible personal property using the costs-of-performance method. While many states have elected to phase-in single-sales factor over several years, Kentucky’s apportionment formula will be based only on the sales factor immediately for tax years beginning on or after January 1, 2018.
The bill also enacts mandatory unitary combined reporting for corporate taxpayers. While specific guidance is in place regarding entity inclusion within a combined group, the Kentucky Department of Revenue has been given discretionary authority to require other members of the affiliated group to be included.
For sales and use tax, effective July 1, 2018, extended warranty services and labor services related to the installation of tangible property will be subject to Kentucky sales and use tax. However, Kentucky will no longer impose its sales and use tax on modifications or enhancements made to prewritten software if the price for the modification or enhancement is separately stated on the invoice or other statement provided to the purchaser.
Finally, Kentucky has expanded the definition of a “retailer engaged in business in this state” to include remote retailers that derive more than $100,000 in sales to Kentucky customers or have 200 or more sales to Kentucky customers. This enactment of economic nexus is far-reaching and has implications for many states. The current constitutional nexus standard for sales and use tax is a physical presence test established by Quill Corp. v. North Dakota (1992). However, Kentucky, along with many other states, are awaiting the decision of the U.S. Supreme Court in South Dakota v. Wayfair, Inc, which may abrogate the standard established by Quill with an economic nexus standard. For more information on the “Kill Quill” effort, read my blog “‘Kill Quill’ Effort Moves Forward at U.S. Supreme Court.”
If you have any questions regarding tax reform in Kentucky, please contact our state and local tax advisors or Michael L. Colavito Jr. at 301.231.6200.