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Kentucky Income Tax Update

This year, the Kentucky General Assembly refrained from making any substantive changes to the Commonwealth’s income tax laws.  This is a welcome respite from the wholesale changes made just a few years ago (remember the Tax Modernization legislation of 2005 and 2006?).  That said, there are several legislative developments of potential significance to select businesses and individuals and to Kentucky’s tax system as a whole.  Plus, several interesting income tax-related cases have been winding their way through the courts of the Commonwealth.  

Abolishment of the Office of Kentucky’s Taxpayer Ombudsman

One significant development that would seem to be of interest to all Kentucky taxpayers is the abolishment of the Office of Taxpayer Ombudsman, which was created in 1990 when the General Assembly enacted the Kentucky Taxpayers’ Bill of Rights.  To its credit, the Department of Revenue has indicated that, “Taxpayer services will be provided by the Ombudsman through the Office of the Commissioner.”  But, these services will no longer be defined or required by statute.  This means that Taxpayer Ombudsman-type services can be altered, reduced or even eliminated unilaterally by Revenue.  

As originally envisioned, the Taxpayer Ombudsman’s Office was to be staffed with a taxpayers’ rights advocate and with other support personnel necessary to carry out the spirit and specific purposes of the Kentucky Taxpayers’ Bill of Rights, not unlike a similar program of Internal Revenue Service.  Some of the Ombudsman’s Office’s former statutorily provided-for duties included: coordinating taxpayer complaints and problems; providing recommendations to Revenue as to publications and educational programs needed to improve voluntary compliance by taxpayers; providing recommendations for simplification and improvements in tax laws, regulations, forms, systems and procedures to promote voluntary compliance; and, reporting to the Commissioner of Revenue as to the Taxpayer Ombudsman’s Offices’ activities, recommendations and Revenue’s progress in implementing these, and providing other information as to taxpayers’ rights.  These are very worthwhile operational and policy functions.  

As a point of comparison, Kentucky’s taxpayer advocate could be contrasted with the Taxpayer Advocate Service within the IRS.  Regarding its charge, the Taxpayer Advocate Service plainly states, “As an independent organization within the IRS we help taxpayers resolve problems with the IRS and recommend changes that will prevent the problems.”  

In this regard, the Taxpayer Advocate Service has assisted many of us in resolving problems with the IRS. And, National Taxpayer Advocate, Nina Olson, is well known for her frank recommendations for improvements to the IRS, tax laws, etc.  

Perhaps, the General Assembly should consider reestablishing the Office of Taxpayer Ombudsman and providing funding to the Office so that it can live up to its potential as exemplified by the National Taxpayer Advocate Service - as an agent of change for the betterment of Kentucky’s tax system.  

Restructuring Kentucky’s Tax Incentives for Businesses

During the June 2009 Special Session, the General Assembly enacted legislation (House Bill 3) to restructure Kentucky’s tax incentives programs, many of which provide credits to businesses against the income tax and limited liability entity tax (“LLET”); it also established several new tax incentive programs to be administered by the Kentucky Cabinet for Economic Development.  

A core policy element of this legislation was to create a new, more flexible program to replace several economic development programs:  Kentucky Rural Economic Development Act (“KREDA”); Kentucky Economic Opportunity Zone (“KEOZ”); Kentucky Jobs Development Act (“KJDA”); and Kentucky Industrial Development Act (“KIDA”).  Notably, outstanding projects and those with preliminary or final approval will remain in place.  

This new program provides for potentially very generous credits against the income tax and LLET – up to 100% of the tax resulting from the project.  To be eligible for the program, a new or existing business must be engaged in one or more of certain types of activities within Kentucky such as manufacturing, agribusiness, nonretail service, nonretail technology, or a regional or national headquarters operation.  And, to qualify for the tax incentives, the company must create at least 10 new jobs meeting statutorily established criteria and invest at least $100,000.

A manufacturer can also qualify for an expanded program for a reinvestment project that requires an investment of at least $2.5 million in eligible equipment and skills training.  To qualify, a manufacturer must also agree to maintain at least 85% of its full-time employment base and cannot have received incentives for existing industry development in the past 5 years.  A manufacturer approved for such a project can qualify for income tax and LLET credits of up to 50% of the equipment costs and 100% of the skills training costs.  

House Bill 3 also established a small business economic development tax incentive program for a business with fifty employees or less that creates one new job (or more) and spends $5,000 (or more) on qualifying equipment or technology.  Like its “big brother,” the small business credit provides for a credit against the income tax and LLET of up to 100% of the tax resulting from the project.  

Sounds almost too good to be true.  Yes, there is a “BUT.”  But, the credit is limited to $25,000.  Yes, there is an “AND” too.  And, the small business program has an annual cap of $3,000,000 total for all businesses.  

There are lots of other “goodies” in House Bill 3. For example, it increases the income tax credit for qualified rehabilitation expenses of a historic structure and makes that credit refundable.  It also provides for a new railroad maintenance and improvement tax credit, and a $5,000 tax credit for qualifying new home buyers.  

Judicial Challenge to Legislation That Eliminates Refund Interest 

During their 2009 Regular Session, the General Assembly enacted House Bill 216 which repealed and reenacted the provisions of 2008 House Bill 704.  Among other things, the Bills decoupled the interest rate accruing on tax assessments and refunds from the adjusted “prime” rate for both – to prime plus 2% for assessments and prime minus 2% for refunds.  This created a 4% differential to the detriment of taxpayers.  The Bills also effectively changed the relevant date for the accrual of interest on a refund to the amended return filing date.  The result of this is a retroactive loss of refund interest to any taxpayer with an outstanding refund claim.  

In Revenue Cabinet v. Asworth – a case concerning whether under pre-2005 Kentucky corporation income tax laws a nonresident corporate partner was subject to tax on its distributive share of partnership income and if so, how – the Court of Appeals is considering arguments as to the unconstitutionality of these two Bills and the changes they purport to effect.   Yet another reason to watch this important case.

Other Income Tax-Related Case Developments

In another case involving refunds, the Kentucky Supreme Court heard oral arguments back in December in Johnson Controls, Inc. v. Rudolph.  That case concerned 2000 H.B. 541, which retroactively prohibited corporation income tax refund claims based on the unitary filing method that were advanced subsequent to the date of the decision in GTE v. Revenue Cabinet, 889 S.W.2d 788 (Ky. 1994).  The Court of Appeals held that 2000 H.B. 541 was unconstitutional on Due Process grounds.   Comments at oral argument went far beyond the narrow issue, and included whether unitary was in fact appropriately the law.

The Court of Appeals has scheduled oral arguments in Department of Revenue v. AT&T Corporation and Subsidiaries, which concerns the composition of the companies’ elective Kentucky consolidated corporation income tax return group as in effect for tax years and elections made prior to Tax Modernization – 2005.  In AT&T’s appeal from the Kentucky Board of Tax Appeals, the Jefferson Circuit Court essentially held that the consolidated return statute did not trump the nexus provisions of the corporation income tax imposition statute.  

In Department of Revenue v. Marquette Transportation Co., Inc., the Court of Appeals held (as to the substantive tax issue) that the wages of Marquette’s Mississippi and Illinois River towboat employees should have been excluded from the Kentucky numerator of its corporation income tax payroll factor because they did not perform “some” services in Kentucky.  Revenue has requested that the Kentucky Supreme Court review this case. 

It is also my understanding that more income tax cases are pending at the KBTA.  At least one involves a question regarding whether a corporate taxpayer’s gain resulting from a transaction that was the subject of an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended, should be classified as nonbusiness income, and thus, treated as allocable income.  This has the potential to be the first nonbusiness income case to be litigated in Kentucky in almost a quarter of a century.



About the author: Mark A Loyd, Esq., CPA, is a member of Greenebaum Doll & McDonald in Louisville and chairs its State and Local Tax Team. He is a member of the KyCPA board of directors; chair of the editorial board; member of the industry task force; and former chair of the taxation committee. He can reached at mal@gdm.com; 502.587.3552.

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