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HB 458 was signed into law by Governor Matthew Bevin on April 9, 2019.

On March 26, 2019, Governor Matthew Bevin signed House Bill 354 (HB 354), which enacts tax-related provisions designed to "fix" some of the tax provisions of House Bill 487 (HB 487), which was enacted in 2018 (See Tax Alert 2018-0911).¹

Before adjourning on March 28, 2019, the legislature approved House Bill 458 (HB 458), which provides additional "fixes" to supplement those enacted in HB 354. Governor Bevin has 10 days to sign or veto the legislation. If he vetoes HB 458, the legislature cannot revisit the bill, as the legislative session has concluded. Alternatively, the Governor could just allow HB 458 to become law without his signature as was the case with HB 487 in 2018.

Some of the provisions adopted in HB 354 and HB 458 are discussed separately in this Alert since HB 354 has been signed into law and HB 458 awaits the Governor's action.

HB 354

Estimated payments — immediate action required

HB 354 changed the corporate income tax (CIT), limited liability entity tax (LLET), and individual income tax estimated payment procedures. Under prior law, estimated payments of CIT and LLET, for calendar-year taxpayers, were due on June 15 (50%), September 15 (25%), and December 15 (25%). For 2019 and forward, HB 354 aligns Kentucky's estimated payment procedures with those in the Internal Revenue Code of 1986, as amended (IRC); as such, 2019 estimated payments, for calendar-year taxpayers, are now due April 15 (25%), June 15 (25%), September 15 (25%), and December 15 (25%). The Kentucky Department of Revenue (Department) is expected to issue additional guidance on these requirements in the coming days.

IRC conformity

For tax years beginning on or after January 1, 2018, but before January 1, 2019, Kentucky conforms to the IRC as of December 31, 2017. For tax years beginning on or after January 1, 2019, HB 354 updates Kentucky's conformity to the IRC as of December 31, 2018 (including amendments that extend provisions in effect on December 31, 2018, that would otherwise terminate). Regarding IRC Section 179 expensing, HB 354 conforms to the IRC as of December 31, 2003, for property placed in service after January 1, 2020.

Corporation income tax

HB 487 enacted mandatory unitary combined reporting starting with tax years beginning on or after January 1, 2019. HB 354 addresses concerns with the legislation as enacted in 2018. The combined reporting "fixes" enacted by HB 354 include the following:

• Requiring a "combined report" be filed on a "water's-edge basis"
• Amending the definition of a "combined group" to include only corporations whose voting stock is more than 50% owned, directly or indirectly, by common owners
• Amending the definition of "tax haven" to exclude a jurisdiction that has entered into a comprehensive tax treaty with the United States, which the Secretary of the Treasury has determined is satisfactory for purposes of IRC Section 1(h)(11)(C)(i)(II)
• Eliminating intercompany transactions from the computation of "combined income"
• Excluding from the computation of "combined income," a domestic (US)² corporation that earns 80% or more of its income from sources outside the US, the District of Columbia, or any US territory or possession

In addition to mandatory unitary combined reporting, HB 487 also permits elective consolidated filing starting in tax years beginning on or after January 1, 2019. As originally enacted, a consolidated election was binding for 96 months; HB 354 reduces this period to 48 months.

(HB 458, if enacted, would make additional changes, see later discussion.)

LLET

HB 354 establishes a minimum $175 LLET for certain smaller businesses (e.g., those with less than $6 million in gross receipts). In addition, the LLET statute of limitations is modified for assessments of the tax against pass-through entities. In those cases, the individual partners, members, etc. in the limited liability entity will have 180 days from the date of the assessment to file amended returns to allow for flow-through items stemming from the assessment.

(HB 458, if enacted, would make additional changes, see later discussion.)

Sunset of bank franchise tax

Beginning January 1, 2022, the Kentucky bank franchise tax (BFT) will no longer apply to financial institutions. As a result, beginning January 1, 2021, financial institutions will be subject to the CIT or the LLET. For the 2021 tax year, financial institutions will pay BFT and CIT³ or LLET but will be allowed a refundable credit on the CIT or LLET for BFT timely paid for the 2021 tax year.

HB 354 calls for the Department to promulgate administrative guidance regarding the apportionment-sourcing rules for receipts associated with financial institutions that were previously subject to the BFT. Kentucky generally sources receipts based upon market-based sourcing principles under the CIT and the BFT, so it seems likely that the Department will promulgate regulations adopting sourcing rules similar to what are now used under the BFT, although the Department has not yet issued any guidance to that effect. Also unclear is how affiliated unitary groups, including both financial institutions and non-financial institutions, will be represented on combined returns. That may need to be the subject of additional legislative "fixes" and/or rulemaking by the Department.

(HB 458, if enacted, would make additional changes, see later discussion.)

Multichannel video programming and communication services tax

Kentucky imposes a 3% excise tax on all retail purchases of multichannel video programming services. HB 354 amends the definitional sections of the statute to include video streaming services within the definition of a multichannel video programming service.

Recycling credits

Kentucky law provides for a credit against the CIT or individual income tax for 50% of the installed costs of machinery and equipment purchased by the taxpayer and used to recycle industrial wastes and postconsumer wastes (except for demolition wastes). Qualifying machinery and equipment must be used exclusively to process waste materials or manufacture finished products composed substantially of recycled waste materials. The amount of the credit that can be taken for the tax year in which the equipment is bought is limited to 10% of the total allowable credits and 25% of the taxpayer's income tax liability. Unused credit can be carried forward until used. HB 354 limits the amount of recycling credit claimed in a tax year after the year of purchase to 25% of the tax liability for that tax year.

Kentucky law also provides a credit for a "major recycling project," which is a project in which the taxpayer invests more than $10 million in recycling or composting equipment, has 750 or more full-time employees who are paid more than 300% of the federal minimum wage, and has total plant and equipment costs of over $500 million. A taxpayer with a major recycling project may claim a credit for up to 10 years and up to 50% of the installed costs of the equipment. In each tax year, the amount of credits claimed for all major recycling projects is limited to the lesser of 50% of the excess of the total of each tax liability over the baseline tax liability of the taxpayer or $2.5 million.

HB 354 modifies the credit associated with a major recycling project for tax years beginning after December 31, 2019. These changes include the following:

• Specifies that the credit applies to CIT and LLET
• Amends the definition of a "major recycling project" to mean a "project location" (it was defined only as a "project" under prior law)
• Reduces the required employment associated with a project from 750 full-time employees to 400 employees (the existing prevailing wage requirements remain unchanged)
• Reduces the credit from 50% to 25% of installed costs
• Increases the term of the credit from a maximum of 10 years to 30 years
• Caps the amount of credit claimed in the year of purchase to no more than 75% of the tax otherwise due for that tax year
• Caps the amount of credit claimed in subsequent tax years to no more than 75% of the tax otherwise due for that tax year
• Limits the credit for taxpayers with more than one major recycling project to 75% of the total tax liability otherwise due for that tax year.

HB 354 also requires that the Department provide information to the legislature about each major recycling project on an annual basis so that the legislature can evaluate the efficacy of the credit in achieving its goal of encouraging more recycling within Kentucky.

Other changes

HB 354 adopts marketplace provider nexus provisions for sales/use tax purposes. A marketplace provider is deemed to have nexus with Kentucky if the provider makes retail sales on its own behalf or facilitates retail sales of tangible personal property, digital property, or services that are delivered or transferred electronically to a purchaser in the state in any sales combination that exceeds $100,000 or reaches 200 or more separate transactions in the preceding or current calendar year. This provision applies to transactions occurring on or after July 1, 2019.

HB 354 also: (1) provides a sales and use tax exemption from otherwise taxable admissions charged by certain non-profit organizations; (2) modifies, as of July 1, 2018, the exemption application for energy manufacturers;⁴ (3) modifies certain incentive programs; and (4) provides that certain Department guidance, including private letter rulings, will not be made public.

HB 458

The legislature passed HB 458 to address ongoing concerns that some felt were not fully addressed in either HB 487 (enacted in 2018) or in HB 354. These provisions are not yet final, as HB 458 awaits the Governor's action (or inaction, as the case may be) as previously noted.

Some changes contemplated by HB 458 are summarized next.

LLET

As previously noted, HB 354 modified the LLET statute of limitations for assessments of the tax against pass-through entities to allow investors up to 180 days from the date of the assessment to file amended returns to allow for flow-through items stemming from the assessment. HB 458 would modify this statute of limitations to the greater of the normal 4-year statute of limitations or 180 days from the date the assessment is final.

CIT deduction for deferred taxes

HB 458 would provide a deduction for deferred taxes. This deduction appears to be designed to mitigate the effect on certain tax attributes from the transition from the prior nexus consolidated filing regime to combined reporting. This deduction would be limited to publicly traded corporations and their affiliates that participate, as of January 1, 2019, in a publicly traded corporation's financial statements.

For 10 years, starting with the combined group's first tax year beginning on or after January 1, 2024, a combined group could deduct equal to 10% of the amount necessary to offset the increase in net deferred tax liability, the decrease in net deferred tax asset, or the aggregate change from a net deferred tax asset to a net deferred tax liability. The foregoing items would be computed based on the change resulting from the imposition of combined reporting as of the effective date of HB 458.

The deferred tax impacts previously described would be converted to an annual deferred tax deduction amount, which is the deferred tax impact divided by the apportionment factor used to compute the deferred tax assets and deferred tax liabilities that were considered in computing the deferred tax impact. The result of this complicated calculation would be the total net deferred tax deduction available over 10 years. The deduction would not be adjusted because of any events occurring after the calculation and would be made without regard to federal tax effect. Excess deduction would be carried forward until fully utilized. A combined group intending to claim the deduction would be required to file a statement with the Department by July 1, 2019, showing the deduction claimed, along with detailed support for its computation. Untimely claimed deductions would not be allowed.

This deduction, while a welcome development, presents several challenges. First, the computation is very complicated. Second, there is little time to file the request. This presents challenges to both taxpayers (e.g., gathering information, making complex computations) and the Department (e.g., generating the necessary forms and instructions). Finally, the computation must be made as of the effective date of HB 458, assuming it is enacted. Most publicly-traded corporations do not measure their deferred tax attributes until quarter-end.

Combined reporting — sharing of certain tax attributes

Kentucky's combined reporting statute, as enacted in HB 487, provided that certain tax attributes, such as net operating losses (NOLs) and credits remained with the member that generated them and were not shareable among members of the combined group. HB 458 would allow for sharing of such attributes among the combined group members, subject to certain conditions.

For tax credits, a credit earned by a combined group member in a tax year beginning on or after the first day of the initial combined reporting tax year would be sharable with other group members. Any credit utilized by another member would reduce the amount of credit carryover for the member that earned the credit. Similar sharing would be allowed for tax credit carryovers in subsequent tax years and even a member's pre-combined reporting tax credit carryovers. The tax credit ordering rules would apply when multiple credits are involved. Finally, the Department would be authorized to promulgate regulations providing further guidance.

HB 458 also would allow sharing of Kentucky NOLs among combined group members so long as the member belonged to the combined group that generated the NOLs. HB 458 also would allow for sharing of NOL carryforwards from pre-combined reporting years but limited to 50% of the post-apportioned income of the corporation with which the NOL is being shared (no such limitation applies for the member that brings the NOL into the combined group).

Language in HB 458 appears to reference limitations on Kentucky NOL utilization consistent with the new IRC Section 172 80% limitation on NOLs generated in 2018 and forward. The provision, however, appears to be silent as to how the 80% limitation would be applied for combined reporting. For example, would it apply to pre- or post-apportioned income? Would it apply in the aggregate of the combined group's Kentucky taxable income or to each taxpayer member's Kentucky taxable income? These provisions will likely require further "fixes," either through future legislation or the Department's promulgation of administrative rules or other guidance.

Bank franchise tax

As noted, HB 354 sunsets the BFT beginning January 1, 2022, and subjects financial institutions to the CIT or the LLET beginning January 1, 2021, with a refundable credit for BFT timely paid for the 2021 tax year. HB 458 would eliminate this one-year period of overlapping taxes and simply subject financial institutions to the CIT or LLET beginning January 1, 2021, and phase out the BFT after 2020. HB 458 would likewise subject savings and loan associations to the CIT starting January 1, 2021, and sunset the thrift tax after 2020. HB 458 would clarify that local deposit taxes are not affected by the foregoing changes and remain in place.

Implications

The changes in HB 354 are final, as the legislation was signed by Governor Bevin. Taxpayers will need to turn their immediate attention to the changes in estimated payment requirements as well as digesting the other changes wrought by the legislature.

HB 458 is not yet final. If the Governor vetoes the legislation, the legislature will have no opportunity to respond and, accordingly, none of the bill's provisions would go into effect. If the Governor signs HB 458, or allows it be enacted without his signature, then taxpayers will need to consider the changes made to combined reporting, particularly the effect of sharing available tax attributes. Taxpayers will also need to consider the availability of the deferred tax deduction previously described to meet the short-fuse filing deadline of July 1, 2019.

EY will continue to monitor development in this area.

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ENDNOTES

¹ HB 487 adopted a single sales factor and market-based sourcing for services starting as of January 1, 2018. After 2018, the mandatory nexus-consolidated regime for corporate income taxes was replaced with mandatory unitary combined reporting with an elective consolidated election available. HB 487 also enacted sales and use tax changes, including expanding the tax base to services that had not been previously taxed.

² Including corporations formed under the laws of the District of Columbia or any US territory or possession.

³ The CIT is imposed on a unitary basis and allows taxpayers to elect into a consolidated return filing with tax imposed at a 5% tax rate.

⁴ The exemption applies to the extent that energy costs exceed 3% of the manufacturer's cost of production. HB 487 required a toller to include the costs of its own tangible personal property in its computation of costs of production. HB 354 provides that, as of July 1, 2018, a toller may exclude such costs from its computation of its costs of production if certain requirements are met.