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Jamie C. Yesnowitz
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On March 26, 2019, Kentucky enacted legislation, H.B. 354, repealing the bank franchise tax and amending the combined reporting provisions enacted last year.1
On April 9, 2019, Kentucky enacted related legislation, H.B. 458, which made technical changes to H.B. 354 and additional substantive changes.2
As part of the combined reporting amendments, the legislation provides publicly traded corporations with a deferred tax deduction that offsets the effects of the combined reporting changes for financial statement reporting purposes. The legislation also extends the deadline for filing extended corporate income tax returns, advances the Internal Revenue Code (IRC) conformity date, increases the IRC Sec. 179 deduction expensing limits and conforms the estimated income tax payment rules to the federal rules. Furthermore, the legislation imposes a sales tax collection requirement on marketplace providers and amends provisions concerning the taxation of services. Many of the changes relate to the major tax reform legislation that Kentucky enacted last year.3
Corporate income tax
Corporate income tax replaces bank franchise tax
Beginning on or after Jan. 1, 2021, financial institutions will be subject to the corporation income tax and the limited liability entity tax (LLET) instead of the state bank franchise tax.4
Financial institutions also will be subject to all applicable local government franchise taxes. Similarly, savings and loan associations will be subject to the corporation income tax and the LLET rather than the savings and loans tax.5
Any financial institution or savings and loan association operating on a fiscal year basis must file a short-year corporation income tax and LLET return and pay any tax due for the period beginning Jan. 1, 2021, through the end of the entity’s normal fiscal year. The Kentucky Department of Revenue is directed to promulgate administrative regulations to detail the sourcing of receipts related to financial institutions.6
For tax years beginning or after Jan. 1, 2019, legislation enacted lasted year requires members of a unitary business group to file combined reports.7
The recent legislation provides enhancements and technical changes to the unitary business filing requirement.8
The definition of “combined group” is amended to provide that a combined group may include only corporations, the voting stock of which is more than 50% owned, directly or indirectly, by a common owner or owners.9
Under existing law, a combined group’s total income includes the entire income and apportionment factor of any member that is doing business in a tax haven.10
As amended, “tax haven” does not include a jurisdiction that has entered into a comprehensive income tax treaty with the U.S.11
The amended legislation clarifies that a combined report generally must be filed on a water’s-edge basis.12
In computing the combined gross receipts and income from all sources of all members, the unitary business must eliminate entries for transactions among the members.13
As amended, the statute provides that net operating losses (NOLs) may be shared among members of the unitary group.14
A combined group’s total income does not include the income and apportionment percentage of a member that earns at least 80% of its income from sources outside the U.S., the District of Columbia or any U.S. territory or possession.15
Finally, if a tax treaty exists, non-U.S. corporations with 20% or more of their income from other group members are excluded from the combined group.16
Existing law allows an affiliated group to elect to file a consolidated return that includes all members of the affiliated group.17
As originally enacted, the consolidated return election was binding on both the Department and the affiliated group for eight years.18
The recent legislation reduces the mandatory election period to four years.
Further, the legislation provides publicly traded corporations with a deferred tax deduction that offsets the effects of the combined reporting changes for financial statement reporting purposes.19
For tax years beginning on or after Jan. 1, 2024, and lasting for ten years, a combined group is entitled to a deduction from the combined group’s entire net income equal to one-10th of the amount necessary to offset the: (i) increase in the net deferred tax liability; (ii) decrease in the net deferred tax asset; (iii) or aggregate change from a net deferred tax asset to a net deferred tax liability.20
This deduction is limited to publicly traded companies, including affiliated corporations participating in the filing of a publicly traded company’s financial statements prepared in accordance with GAAP, as of Jan. 1, 2019.21
The deduction may not be adjusted as a result of any events happening subsequent to the calculation, including any disposition or abandonment of assets.22 Any combined group intending to claim the deferred tax deduction must file a statement, Schedule DTD, with the Department by July 1, 2019.23
Due date for filing extended returns
A corporation may be granted an extension of seven months to file its income tax return provided the corporation, on or before the due date for paying the tax, requests the extension and pays its estimated tax.24
Previously, the extension was limited to six months.
General income tax provisions
IRC conformity advanced
For taxable years beginning on or after Jan. 1, 2019, Kentucky is adopting the IRC as in effect on Dec. 31, 2018.25
For taxable years beginning on or after Jan. 1, 2018, but before Jan. 1, 2019, Kentucky continues to adopt the IRC as in effect on Dec. 31, 2017.
IRC Sec. 179 Expensing
For property placed in service on or after Jan. 1, 2020, only the expense deduction allowed under IRC Sec. 179 in effect on Dec. 31, 2003, exclusive of any amendments made subsequent to that date, is allowed.26
Thus, the applicable limitation is $100,000 with a $400,000 phaseout. For property placed in service after Sept. 10, 2001, but prior to Jan. 1, 2020, the expense deduction allowed under IRC Sec. 179 in effect on Dec. 31, 2001, exclusive of any amendments made subsequent to that date, continues to apply. The applicable limitation is $25,000 with a $200,000 phaseout.
Estimated tax payments
For taxable years beginning on or after January 1, 2019, the estimated tax payment rules for corporate income tax, LLET, personal income tax and pass-through entity nonresident tax withholding are amended to conform to the federal estimated tax filing rules.27
Specifically, similar to prior law, every corporation and limited liability pass-through entity subject to corporate income tax or LLET must make estimated tax payments if these taxes can reasonably be expected to exceed $5,000 for the tax year.28
Also, individuals must make estimated tax payments if their: (i) gross income from sources other than wages upon which Kentucky income tax will be withheld can reasonably be expected to exceed $5,000 for the taxable year; or (ii) adjusted gross income can reasonably be expected to be an amount not less than the amount for which a return is required to be filed.29
However, for individuals, no estimated tax is required if the tax liability can reasonably be expected to be $500 or less.30
Pass-through entities are required to withhold income tax on the distributive share of each nonresident partner or corporation that is doing business in Kentucky only through its ownership interest in the pass-through entity.31
For tax years beginning on or after Jan. 1, 2019, estimated tax payments generally must be made at the same time and calculated in the same manner as estimated tax payments for federal income tax purposes under IRC Secs. 665432
but certain exceptions are provided to address federal and Kentucky tax differences.34
Corporations and limited liability pass-through entities filing on a calendar year basis must pay four equal installments of estimated tax on April 15, June 15, September 15 and December 15.35
Individuals must pay four equal installments of estimated tax on April 15, June 15, September 15 and Jan. 15 of the following year.36
For tax years beginning after Dec. 31, 2018, pass-through entities are no longer required to make a declaration but are still required to make the payments.37
Previously, Kentucky had its own estimated tax payment requirements that substantially differed from the federal requirements.38
Sales and use tax
For transactions occurring on or after July 1, 2018, tax reform legislation enacted last year expanded the definition of “retailer engaged in business in this state” to include remote retailers selling tangible personal property or digital property transferred electronically to purchasers in Kentucky if during the previous or current calendar year there are: (i) 200 or more separate transactions; or (ii) sales exceeding $100,000 in Kentucky.39
For transactions occurring on or after July 1, 2019, the recent legislation expands the sales tax collection requirement for sales by remote retailers to include retail sales facilitated by a marketplace provider40
on behalf of the remote retailer.41
The general sales thresholds discussed above also apply to marketplace providers.42
By the first day of the calendar month beginning no later than 30 days after either threshold is reached, the marketplace provider must: (i) register for a sales and use tax permit number to report and remit the tax due on the marketplace provider’s sales; (ii) register for a separate sales and use tax permit number to report and remit the tax due on all of the sales it facilitates for one or more marketplace retailers; and (iii) collect the tax.43
The marketplace retailer is relieved of all liability for the collection and remittance of the sales or use tax on sales facilitated by the marketplace provider.44
When a remote retailer’s product is sold through a marketplace, the marketplace provider that facilitated the sale must file the return and remit the tax due on those sales.45
Taxation of services
For transactions occurring on or after July 1, 2018, last year’s tax reform expanded the sales tax base to include a number of services.46
For transactions occurring on or after July 1, 2019, the recent legislation extends the resale exemption that applies to tangible personal property to newly taxable services.47
For persons selling newly taxable services prior to Jan. 1, 2019, gross receipts from the sale of these services are excluded from sales tax if they were less than $6,000 during the 2018 calendar year.48
A similar exclusion is provided for persons that first begin making sales of newly taxable services on or after Jan. 1, 2019 if the gross receipts from the services are less than $6,000 within the first calendar year of operations.49
For both exemptions, when gross receipts from these services exceed $6,000 in a calendar year: (i) all gross receipts over $6,000 are taxable in that calendar year; and (ii) all gross receipts are subject to tax in subsequent calendar years. These exemptions do not apply to a person also engaged in the business of selling tangible personal property, digital property or services that were taxable before 2018.
With this legislation, Kentucky significantly tweaked the state-specific tax reforms adopted last year. This legislation will have a large impact on financial institutions and savings and loan associations because they will become subject to the general corporate income or LLET beginning on January 1, 2021. Kentucky likely will issue administrative regulations to address the imposition of corporate income tax and LLET on these entities and clarify topics such as the sourcing of revenue for apportionment purposes.
One of the most significant aspects of last year’s tax reform legislation was the change to mandatory unitary combined reporting for tax years beginning on or after Jan. 1, 2019. The recent legislation contains a variety of “clean up” provisions and clarifies the existing statutes. Among other changes, the legislation somewhat restricts the scope of the definition of “tax haven” by excluding “treaty” countries, clarifies the use of NOLs among members and further explains what entities are included in the combined group. The legislation also provides some flexibility for taxpayers that elect to use consolidated tax reporting instead of combined reporting by reducing the consolidated return election period from eight years to four years.
Corporations required to file combined reports should consider the new deferred tax deduction that offsets the effects of the combined reporting changes for financial statement reporting purposes, and file the required statement with the Department by July 1, 2019, to be eligible for the deduction. It will be interesting to see whether Kentucky eventually defers the actual application of the deduction to a future date as other jurisdictions have done, as a means to retain the deduction for financial statement purposes while deferring the state budgetary impact of the deduction.
The legislation allows corporations to receive an extension of seven months to file their income tax returns. Due to the significant changes in federal income tax law, the preparation of corporate income tax returns has become increasingly complex. This is a welcome development that should benefit corporations by providing additional time to file their Kentucky corporate income tax returns.
The IRC Sec. 179 expensing limits are increased for property placed in service on or after January 1, 2020. However, the $100,000 limitation with a $400,000 phaseout remains substantially less than the corresponding $1 million limitation and $2.5 million phaseout currently provided by federal law for tax years beginning before 2023.
Kentucky is simplifying the estimated income tax payment requirements by generally conforming to federal law. Thus, taxpayers should now be able to file their Kentucky estimated tax payments at the same time that they file their federal estimated tax payments. Previously, Kentucky had estimated tax payment deadlines that differed from the federal deadlines.
Like many other states, Kentucky has enacted sales tax nexus legislation in response to the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc.50
Last year, Kentucky enacted remote seller legislation that was very similar to the South Dakota legislation at issue in Wayfair
. The legislation that Kentucky enacted last year included definitions relevant to online marketplaces, but did not impose a sales tax collection requirement on these entities. For transactions occurring on or after July 1, 2019, this year’s legislation imposes a collection requirement on marketplace providers and enacts new definitions to clarify the taxation of marketplaces. The marketplace provider definition, which resembles the definition used by New Jersey in its recent state-specific tax reform legislation,51
requires the provider to perform at least one operational activity and one financial activity in the marketplace.
The tax reform legislation that Kentucky enacted last year expanded the sales tax base by including a variety of services. The recent legislation should provide some relief by exempting small providers of the newly taxable services, and providing a resale exemption to cover transactions involving otherwise taxable services.
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