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Note: This alert has been updated to add a reference to subsequent law changes made by House Bill 5 (HB 5) that clarify the pass-through entity tax provisions enacted in HB 360 and modify changes to the definition of taxable “telemarking services” made by HB 360.

On March 24, 2023, Kentucky Governor Andy Beshear signed into law House Bill 360 (HB 360), which includes a number of tax-related changes. Key tax changes in HB 360:

• Create an elective passthrough entity (PTE) tax
• Update Kentucky's Internal Revenue Code (IRC) conformity date
• Make technical corrections to sales tax legislation enacted in 2022 by HB 8 (see Tax Alert 2022-0564)
• Expand the definition of taxable telemarking services to include the use of text messages and social media
• Allow a deduction for expenses covered by Restaurant Revitalization Funds received between January 1, 2020 and March 11, 2023

HB 360 is designated as emergency legislation and, therefore, it took effect upon the governor's signature.

Internal Revenue Code conformity

HB 360 updates Kentucky's IRC conformity date to December 31, 2022, including amendments extending provisions that would otherwise have terminated on December 31, 2022, but excluding amendments made after that date. This change is effective for tax years beginning on or after January 1, 2023.

Elective PTE Tax

HB 360 allows partnerships and other PTEs to elect to pay Kentucky income tax at the entity level (i.e., the PTE tax). The PTE tax is intended to enable Kentucky taxpayers who are PTE owners to deduct, for federal income tax purposes, state and local taxes exceeding the annual $10,000 deduction limitation imposed by IRC Section 164(b)(6) (the SALT Cap), consistent with IRS Notice 2020-75 (see Tax Alert 2020-2690).

The election is available for tax years beginning on or after January 1, 2022. The election must be made by the 15th day of the 4th month after the close of the tax year, or the 15th day of the 10th month after the close of the tax year if filing under an extension. The election can be made only upon consent of all partners, members or shareholders (collectively, investors) holding more than 50% ownership in the PTE. If made, the election is binding on all investors. PTEs must make the election on a form to be prescribed by the Kentucky Department of Revenue (KY DOR).

Individual investors in an electing PTE will be allowed a nonrefundable PTE tax credit equal to 100% of the tax paid by the PTE "on behalf of" the investor and based on the pro rata share of the investor's income from the PTE. Conforming changes were made to Ky. Rev. Stat. 141.070(4) and 141.206(3)(c) to allow the individual credit and to specify that an electing PTE is subject to income tax at the entity level.

Note: HB 5, signed into law on March 31, 2023, supplements the PTE tax adopted in HB 360. HB 5 makes a number of clarifying changes, which are discussed in Tax Alert 2023-0649.

Sales/use tax changes

Legislation enacted in 2022 (HB 8) imposed sales and use tax on an additional 34 services. (See Tax Alert 2022-0564.) Many of these services were not defined in HB 8, requiring the KY DOR to issue guidance on many of these services through frequently updated FAQs.

HB 360, applicable retroactively to January 1, 2023, clarifies the definitions of the following services made taxable in HB 8:

• Cosmetic surgery services: Amends Ky. Rev. Stat. 139.010(5)(b) to provide that otherwise taxable "cosmetic surgery services" do not include services "medically necessary to reconstruct or correct dysfunctional areas of the face" due to birth disorders, trauma, burns or disease.
• Executive employee recruitment services: Adds Ky. Rev. Stat. 139.010(14)(a) and (b) to define taxable "executive employee recruitment services" to mean services provided by a person to locate potential candidates to fill open senior-level management positions, including making a detailed list of client requirements, researching and identifying potential candidates, performing pre-screening interviews, and providing contract and salary negotiations.
• Extended warranty services: Renumbers as Ky. Rev. Stat. 139.010(15)(a) (formerly (14)(a)) and expands "extended warranty services" to include contracts to repair, replace, support or maintain prewritten computer software access services.
• Lobbying services: Adds Ky. Rev. Stat. 139.010(21) to define "taxable lobbying services" as the act of promoting or securing passage of legislation or an attempt to influence or sway a public official or other public servant to a desired action, including the support of or opposition to a project or the passage, amendment, defeat, approval or veto of any legislation, regulation, rule or ordinance.
• Storage: Amends Ky. Rev. Stat. 139.010(45) (formerly (44)) to expand the definition of "storage" to include the keeping or retention in Kentucky of prewritten computer access services.
• Telemarketing services: Amends Ky. Rev. Stat. 139.010(48) (formerly (47)) to expand the definition of "telemarketing services" to include the use of text messages to (1) promote products or services, take orders, or provide information or assistance regarding the products or services or (2) solicit contributions. (Note: HB 5 deleted the reference to social media that had been added by HB 360.)
• Use: Renumbers as Ky. Rev. Stat. 139.010(50) (formerly (49)) and adds new subsection (b)(2) to specify that a "use" does not include the keeping, retaining or exercise of any right/power over prewritten computer services purchased for use outside of Kentucky and transferred electronically outside Kentucky for use solely outside Kentucky.

Applicable retroactively to January 1, 2023, HB 360 also amends the following taxability and exemption provisions:

• Security system monitoring services: Amends Ky. Rev. Stat. 139.200(2)(aa) (formerly (aa)) to specify that otherwise taxable residential and nonresidential security system monitoring services do not include separately stated onsite security guard services.
• Laboratory services: Amends Ky. Rev. Stat. 139.200(2)(aq) (formerly (ar)) to specify that otherwise taxable laboratory services do not include services required by (1) a federal, state, or local statute, (2) a regulation, (3) a court order, or (4) another government-related rule.
• Sewer services, water and fuel: Amends Ky. Rev. Stat. 139.470(7)(d) to specify that an exemption from otherwise taxable sewer services, water and fuel shall apply to those items billed to an owner or operator of a multi-unit residential facility or mobile home and recreational vehicle park if the owner or operator declares that the sewer services, water and fuel are purchased for Kentucky residents for such residents' use.
• Building materials, fixtures, or supplies: Adds Ky. Rev. Stat. 139.480(34) to provide an exemption for building materials, fixtures or supplies purchased by a construction contractor if fulfilled by a construction contract for a sewer or water project with specified governmental agencies.
• Short-term rental space: Adds Ky. Rev. Stat. 139.480(35) to provide an exemption for the rental of space for meetings, conventions, short-term business uses, entertainment events, weddings, banquets, parties or other short-term social events, if the tax otherwise imposed is paid by the primary lessee to the lessor. This exemption applies to such rentals made on or after February 25, 2022.
• Prewritten computer software access services: Adds Ky. Rev. Stat. 139.480(36) to provide an exemption for prewritten computer software access services sold to, or purchased by, a retailer that develops prewritten computer software for print technology and uses and sells prewritten computer software access services for print technology.
• Concessions: Adds Ky. Rev. Stat. 139.498(1)(b) to provide that Kentucky sales and use taxes do not apply to (1) concessions for leisure, recreational or athletic fundraising events or (2) the sale of leisure, recreational or athletic services made by nonprofit civic or other nonprofit organizations that operate fundraising events solely with volunteers.

Finally, HB 360 strikes former KRS 139.200(2)(r) and 139.010(22), which imposed tax on, and defined, "marketing services," making such services nontaxable.

Restaurant Revitalization Grants — individuals and corporations

Under HB 360, Restaurant Revitalization Grants, as well as related deductions and tax attributes, will receive the same treatment for state income tax purposes as they do for federal individual and corporate income tax purposes. This change applies retroactively to January 1, 2020 but before March 11, 2023.

Individual income tax — conditions for future rate reductions

The legislature recently enacted HB 1, which lowered the state individual income tax rate to 4.5%, retroactive to January 1, 2023, and to 4.0%, effective January 1, 2024. (See Tax Alert 2023-0341.) HB 360 amends Ky. Rev. Stat. 141.020 to adopt a process requiring the Office of State Budget Director to evaluate whether additional rate reductions may be adopted for tax years beginning on or after January 1, 2025.

Implications

HB 360 makes Kentucky the 32nd jurisdiction to adopt an elective PTE tax. While intended to comply with IRS Notice 2020-75, the new statutory language indicates that the tax is being paid "on behalf of" investors. However, language in amended Ky. Rev. Stat. 141.206(3)(c) removes an elective PTE from the prohibition of taxing certain PTEs at the entity level. These provisions may be ripe for technical corrections before the end of the legislative session.

The sales and use tax changes provide welcome clarity to the definitions of the services recently made taxable in HB 8. However, the addition of text messages and social media to the definition of taxable telemarketing services seems to make Kentucky unique among the states.

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Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor