Kentucky Tax Developments
The sections below highlight several prominent legislative, administrative, and procedural developments and their impact on Kentucky taxpayers.
I. 2018 Kentucky Tax Legislation
Kentucky Tax Reform
The 2018 Kentucky General Assembly enacted tax reform in two bills: House Bill 366 and House Bill 487. These include a number of important provisions that should be of great interest to many taxpayers. Among other things, the new laws:
Income Tax Changes (Generally effective for tax years beginning on or after 1/1/2018)
- Reduce the top marginal corporate income tax rate to a flat 5%. Reduce the top marginal personal income tax rate to a flat 5%.
- Update the Internal Revenue Code reference date within the Kentucky tax code to be December 31, 2018 to conform to the Tax Cuts and Jobs Act of 2017, with certain exceptions, g., 100% depreciation deduction, Section 179 expensing, and the 20% Qualified Business Income deduction.
- Disallow the deduction for domestic production activities, which the Tax Cuts and Jobs Act also does.
- Apply a single-factor apportionment formula with market-based sourcing of receipts. Proposed regulations are in the works on this.
- Effective for tax years beginning on or after 1/1/2019, require a corporate taxpayer doing business in the Commonwealth that is a member of a unitary group to determine its corporation income tax using the unitary combined reporting method, unless the corporate group makes an election to file consolidated with its affiliated group under the Internal Revenue Code of 1986, as amended. Watch for legislation in 2018 that would repeal unitary or the unitary mandate. Also, see detailed discussion in Section VI. Unitary Combined Required, Unless Consolidated Elected.
Sales Tax Changes (effective 7/1/18)
- Impose sales tax on certain types of labor and services associated with the repair, installation, and maintenance related to the sale of taxable tangible personal property (with an exemption for manufacturers and industrial processors).
- Impose sales tax on landscaping services, veterinarian services for small animals, janitorial services, fitness and recreational sports centers, industrial laundry services, dry cleaning and laundry services, linen supply, limousine services, and a variety of other services.
- Impose sales tax on admissions to events, including fundraisers or charity events put on by nonprofit organizations, unless there is an educational component. Several state representatives have already pre-filed bills for the 2019 legislative session to address this issue and apply some sort of sales tax exemption to nonprofits or fundraisers.
- Impose sales tax on initiation fees, membership dues, monthly or annual fees, or single-use fees charged to access golf courses, gymnasiums, spas, swimming clubs, and other venues.
- Position Kentucky’s tax code to address the U.S. Supreme Court’s decision to overturn Quill Corp. v. North Dakota by allowing remote sellers to elect to collect and remit tax to Kentucky or report information to the Department for use tax compliance (see discussion below).
- Impose tax on pollution control facilities.
The Kentucky Department of Revenue has created a website (TaxAnswers.ky.gov) to answer common taxpayer questions on the sales tax changes and provide guidance on Kentucky tax reform topics. The website will continue to be updated.
Other Tax Changes
- Establish a phased-in inventory tax credit in an amount equal to the property tax timely paid on business inventory.
- Increase the cigarette tax by $0.50 per pack, to $1.10 per pack.
- Extend the time to protest a tax assessment to 60 days, up from the current 45 days.
- Extend the time to report federal tax changes to 90 days, up from the current 30 days.
- Eliminate the “pay-to-play” bond required to appeal a tax assessment.
- Prohibit contingency fee contracts for tax collection between the Department and third parties.
Other Newly Enacted Tax-Related Laws
H.B. 136 was enacted in March. The bill amends KRS 243.157 to require microbreweries to report and pay taxes to KDOR on wholesale sales made directly to consumers. H.B. 259 was adopted the same month and it amends KRS 138.510, which relates to taxes on pari-mutuel, account, and intertrack wagering.
S.B. 151, although entitled as an act relating to the local provision of wastewater services, focuses on the state’s pension problem. Before its passage, it was amended to add pension provisions that would place future teachers in a hybrid “cash balance” plan, while another section prevents current teachers and workers from applying sick days toward retirement eligibility, among other changes.
Under H.B. 2, workers’ compensation medical benefits have to be paid to certain permanently partially disabled workers beyond 15 years if an administrative law judge deems the benefits medically necessary. Additionally, more injuries have been added for which benefits must be paid as long as there is a disability, and the period for all workers’ compensation income benefits has been extended to age 70 or four years after the date of the injury, whichever comes last.
Kentucky Responds to Wayfair with Economic Nexus Legislation
On June 21, 2018, the United States Supreme Court issued a landmark opinion impacting state sales and use tax regimes across the country in South Dakota v. Wayfair et. al., 138 S.Ct. 2080 (2018). The decision allows for states to constitutionally impose sales and use tax registration and collection requirements on remote retailers, even online retailers. Under prior law, states could not impose these requirements on a seller unless it had “physical presence” in the state. By overruling the physical presence requirement, the Supreme Court has effectively allowed for states to impose the collection and remission obligations on out of state retailers based on their economic nexus with, rather than physical presence in, the state.
The Court in Wayfair upheld the South Dakota economic nexus law at issue. This law required out of state retailers with no physical presence in the state to collect and remit sales tax if: the seller delivered more than $100,000 of goods or services into South Dakota or engaged
in 200 or more separate transactions for the delivery of goods or service. The Court also looked favorably on the fact that South Dakota was a member of the Streamlined Sales and Use Tax Agreement (“SSUTA”).
Kentucky responded to the Wayfair decision by enacting economic nexus legislation, mirroring the South Dakota law approved by the Supreme Court. Kentucky H.B. 487, enacted April 2018, requires remote retailers to collect sales and use tax if, in the previous or current calendar year, their gross receipts from Kentucky sales exceeded $100,000 or they had 200 or more separate in-state sales transactions. The effective date of this changes, which was a part of the larger Kentucky tax reform, was July 1, 2018, though the Kentucky Department of Revenue has indicated that registrations should be completed with sales and use tax collections beginning by October 1, 2018.
Thus, retailers, especially online retailers, meeting these sales thresholds in Kentucky are required to register and collect Kentucky sales and use tax. Kentucky is also a full member of the SSUTA, which allows remote sellers to register through the central registration system in all twenty-four SSUTA member states in one process.
Those with concerns about complying with the October 1, 2018 timeframe should consider a strategy to address this. The Kentucky Department of Revenue has directed taxpayers with concerns about complying with this timeframe to contact the Department directly for further assistance at KRS.WebResponseSalesTax@ky.gov. Obviously, another option may be for taxpayers’ tax advisors to contact the Department. The October 1, 2018 compliance date is aggressive for many reasons, e.g., time needed for implementation, complexity of operations, availability of collection solutions, etc. There are 1,000’s of other jurisdictions simultaneously trying to compel compliance with their sales tax collection laws.
II. Administrative Developments, including Regulations and Guidance
Kentucky Department of Revenue Issues TAM (KY-TAM-18-02) on GILTI
KDOR issued a Technical Advice Memorandum (“TAM”) regarding the treatment of Global Intangible Low-Taxed Income (“GILTI”) for Kentucky income tax purposes. As part of the Tax Cuts and Jobs Act of 2017, GILTI was enacted under IRC § 951A. Under IRC § 951A, a U.S. shareholder of a controlled foreign corporation (“CFC”) must include in its gross income its pro rata share of the CFC’s GILTI. GILTI is a deemed distribution from a CFC, similar to Subpart F income. Federally, there is a corresponding GILTI deduction that brings the effective U.S. corporate tax rate on GILTI to 10.5%.
The TAM addressed three issues related to Kentucky’s treatment of GILTI. First, due to GILTI’s similarity with Subpart F income, GILTI will be considered nontaxable income in Kentucky. Second, because GILTI will not be considered taxable income, the associated GILTI deduction will not be allowed. Any expenses allocated against GILTI must also be added back per KRS 141.039(2)(c)(4). Lastly, GILTI must not be included in the computation of the sales factor for corporate income tax purposes, or in the KRS 141.0401(1)(a) calculation of gross receipts for the limited liability entity tax.
New Kentucky Revenue Procedure for Tax Guidance
Kentucky Revenue Procedure KY-RP-17-01 issued by KDOR on November 22, 2017 provides that KDOR will begin to issue guidance in the form of (1) Technical Advice Memorandums; (2) Revenue Procedures; (3) Private Letter Rulings; and (4) General Information Letters. KDOR’s issuance of this Revenue Procedure appears to be setting the stage for KDOR to implement H.B. 245.
KDOR says that it is issuing these guidance documents (TAMs, RPs, PLRs, and GILs) to provide the public with reliable information regarding the position KDOR may take when confronted with a question concerning the applicability of a tax law or regulation, to help taxpayers understand KDOR’s opinions concerning tax matters, and to help insure consistent application of Kentucky tax laws and regulations.
Because KDOR will issue TAMs to provide guidance in the form of the application of Kentucky tax laws to a set of facts or general category of taxpayers, it can be reasonably anticipated that KDOR will issue many of these, similar to when KDOR used to issue Revenue Circulars. Likewise, KDOR will issue PLRs and GILs in response to written requests for guidance; this formalizes KDOR’s practice of issuing such guidance. Currently, there is no cost for PLRs which will be issued in the order in which each request for guidance is received.
Notably, KDOR will continue to promulgate regulations in accordance with KRS Chapter 13A. The guidance issued pursuant to Revenue Procedure KY-RP-17-01 does not have the force or effect of law, according to its terms.
H.B. 50 (2017) was enacted into law and provides that administrative regulations will automatically expire every seven years without further action by the issuing agency. Effectively, this legislation requires an agency to review regulations at least once every seven years. Many tax regulations have not been updated since the mid-2000s or before. The Department has been updating some of its regulations. More are anticipated, but below is a summary of some recent changes:
- Ethanol Tax Credit: 103 KAR 15:110 (ethanol tax credit), 15:120 (cellulosic ethanol tax credit), 15:140 (biodiesel tax credit) and 16:352 (corporation income taxes policies and circulars) were amended in order to update statutory citations to conform to recent statutory revisions. 103 KAR 16:352 also was amended to add Revenue Policy 41P150 to the list of rescinded policies as it was replaced and updated guidance is now provided in 103 KAR 16:060.
- Income Tax Reciprocity for Individuals: 103 KAR 17:140 (individual income tax - reciprocity – nonresidents) incorporates reciprocity agreements with Indiana and Wisconsin by reference that were previously missing and corrects the Department’s zip code.
- Economic Development Acts Wage Assessment: 103 KAR 18:180 (retitled Kentucky economic development acts wage assessment) has been updated to conform to new consolidated report 42A900. It also consolidates filing requirements for all seven “K” credits in one regulation (see 18:191 below). Prior guidance did not cover Kentucky Jobs Retention Agreement (“KJRA”) and Kentucky Business Investment Program (“KBI”) credits.
- Statute of Limitations: 103 KAR 15:041 repealed 103 KAR 15:040 (statute of limitations; assessments and refunds) since the relevant information covered by the regulation is clearly set forth in the KRS, as well as 103 KAR 15:090 (computing the amortization deduction for intangible assets) because it is obsolete.
- Coal Royalty: 103 KAR 16:011 repealed 103 KAR 16:010 (taxable income; coal royalty) since it restates information contained in federal and Kentucky statutes, and the six-month holding period referenced in it is not permitted by federal or Kentucky statute; 103 KAR 16:210 (calculation of gross income for corporations that are pass-through entities) since it is obsolete; 103 KAR 16:310 (Domestic Production Activity Deduction (DPAD)) since DPAD has been repealed by the Tax Cuts and Jobs Act; and 103 KAR 16:360 (deductibility of income taxes in New York, Massachusetts, and West Virginia) since the guidance it provided will now be provided in a new TAM.
- Consolidation of Regulations: 103 KAR 18.191 repealed 103 KAR 18:190 through 103 KAR 18:220 since the guidance for these regulations has been consolidated into 103 KAR 18:180 (see above) now that they all share the same form and instructions for reporting.
Kentucky Governor’s Red Tape Reduction Initiative
Kentucky Governor Bevin previously announced the Red Tape Reduction Initiative, the details of which can be found at www.RedTapeReduction.com. The website allows anyone to report a regulation, stating, “If you are aware of a regulation that you believe to be outdated, unnecessary or overly complex, let us know by filling out this form. All suggestions will be reviewed and evaluated.” Tax practitioners do not necessarily want tax regulations eliminated. However, they may want outdated, unnecessary or overly complex tax regulations replaced with updated, necessary and appropriately tailored regulations, which include examples to make them easier to understand. Often in the tax area, more regulations are needed, not less.
This Initiative has been endorsed by business leaders and organizations throughout the Commonwealth. The Kentucky Chamber of Commerce and the Kentucky Society of CPAs have encouraged their members to participate. The website states that “[t]he end goal is to allow businesses to operate in a modernized regulatory system that provides them with the flexibility they need to serve their customers.” Updated tax regulations come within this goal. While this Initiative is going on, Kentucky taxpayers should review regulations that are important to them and, if appropriate, request a review of those regulations.
Kentucky Department of Revenue Now Requires Power of Attorney Form for Taxpayer Representatives
In August of 2017, KDOR issued Form 20A100, Power of Attorney, which authorizes an individual to represent a taxpayer before KDOR. Kentucky joins a long list of states that require taxpayer representatives to obtain a power of attorney before corresponding with the state’s tax department on a taxpayer’s behalf, including Indiana and Ohio. Form 20A100 authorizes representatives to communicate and receive confidential tax information from KDOR regarding the taxpayer. Taxpayers may also authorize additional specific acts that a representative could perform on their behalf. These include signing a statute of limitations waiver, executing a protest, or representing a taxpayer in conferences before KDOR, among other things. Additionally, taxpayers may submit Internal Revenue Service Form 2848 (Power of Attorney and Declaration of Representative). The new form is 2 pages long, and KDOR has also issued instructions for its proper completion.
Kentucky’s form requests standard information such as the taxpayer’s name, address, phone number, and social security number or employer identification number. It also requests information regarding the taxpayer representative, including names, addresses, and telephone numbers. If the representative is a certified public accountant or enrolled agent, his or her identification number must be provided as well. If the taxpayer is a consolidated tax return filer, the taxpayer should list any subsidiary that will be excluded from the authorization, if any. Otherwise, the form extends to all includible corporations in the consolidated return. Taxpayers may designate specific tax types and tax periods for which the authorized representative may act on their behalf. Taxpayers may also leave that section of the form blank, which will authorize the representative to work with KDOR for all tax types until the form is revoked. The form must be signed and dated by both the taxpayer and the authorized representative. If the taxpayer is a business entity, the form must be signed by an individual with the authority to delegate a representative on the entity’s behalf. The form automatically revokes any prior power of attorney or authorization letter submitted to KDOR unless a copy of the prior authorization is attached to the form.
Form 20A100 is an important step toward protecting confidential taxpayer information. By requiring a properly-executed form, KDOR ensures that they will not give out confidential taxpayer information to those who may not be authorized to receive it. Taxpayers should take the necessary steps to review their records, gather any prior authorization letters they may have provided to KDOR, and then complete Form 20A100 with their designated and current tax representatives. Taxpayers should take care to include all tax periods and types for which they believe they may need assistance, as leaving out a period may require them to fill out another form. Taxpayers in the midst of ongoing matters with KDOR should complete and file the new form as soon as possible, as failure to do so could result in their representatives being unable to communicate with KDOR or receive important updates regarding the taxpayers’ cases.
III. Other Tax Updates and Trends
Kentucky’s Unclaimed Property
Kentucky’s Unclaimed Property Fund is managed through Missing Money, a national database of unclaimed property. The database is a partnership between the Kentucky State Treasury, the National Association of Unclaimed Property Administrators, and Xerox. Using the latest technology, the database is able to provide nationwide search services so that Kentuckians can determine if they or a loved one has property to claim. This is vital since the Kentucky State Treasurer has estimated that only about 20 percent of unclaimed cash or property actually gets claimed. The database can be found at www.missingmoney.com.
Sports-Betting Tax Rates Up in the Air
States continue to move on legislation to legalize sports betting while hoping the U.S. Supreme Court soon will ax a federal law prohibiting such gambling. Kentucky’s two pending bills propose a 20 percent excise tax on the total amount wagered (2018 S.B. 22) and a 31 percent gaming tax, plus $3 per person per day admission tax (2018 B.R. 149).
IV. Select Case Updates
Income and Franchise Taxes
World Acceptance Corp. & World Fin. Corp. of Kentucky v. Kentucky Dep’t of Rev., 14-CI-01193, (Ky. Cir. Ct. Aug. 12, 2015), on appeal, 2015-CA-001852 (Ky. App. Dec. 3, 2015).
In World Acceptance Corp. & World Fin. Corp. of Kentucky v. Kentucky Dep’t of Rev., the Franklin Circuit Court of Kentucky reversed a Final Order of the Kentucky Board of Tax Appeals (“KBTA”) (Order No. K-24682) and held that certain factors were present that would require the taxpayer, World Acceptance Corp. (“WAC”) & World Fin. Corp. of Kentucky (“WFCKY”), a South Carolina corporation, to file a consolidated return together with its subsidiary. The three factors taken into consideration under KRS 141.120 are the payroll factor, the property factor, and a double-weighted sales factor. There was a single employee at issue whose payroll was assigned to Tennessee. Additionally, the property in issue was a vehicle and a laptop used in Kentucky, with the vehicle being titled in Tennessee. Further, the Court determined that the sales factor was sourced to South Carolina, rather than Kentucky. The Court concluded that “WAC was not an ‘includable corporation’ because WAC’s payroll, property, and sales factors were either de minimis or zero.” World Acceptance is on appeal at the Court of Appeals.
Sales & Use Tax
Dep’t of Revenue v. Interstate Gas Supply, Inc., 2016-SC-000281-DG (March 22, 2018).
The Kentucky Supreme Court recently held in Dep’t of Revenue v. Interstate Gas Supply, Inc. that the exemption applies only to property taxes. Section 170 exempts from taxation all institutions of “purely public charity.” Interstate Gas Supply, Inc. (“IGS”) applied for a refund of certain use taxes it collected and remitted on behalf of Tri-State Healthcare Laundry, Inc. (“Tri-State”), an entity which serves the laundry needs of three charitable hospitals. Tri-State is not a 501(c)(3) tax exempt organization, so it does not qualify for the charitable exemption from sales and use taxes afforded to those entities under KRS 139.495. Tri-State is, however, recognized by the Kentucky Department of Revenue (“Department”) as an institution of purely public charity, entitled to the Section 170 exemption. IGS requested a refund of Kentucky use tax collected from Tri-State, arguing that Tri-State’s status as a purely public charity exempted it from all revenue-raising taxes pursuant to Section 170 and that as stated in Commonwealth rel. Luckett v. City of Elizabethtown, 435 S.W.2d 78 (Ky. 1968), the use tax was in effect a property tax, thus bringing it within the scope of Section 170, even if that section was deemed to apply only to property tax.
The Kentucky Supreme Court first analyzed the scope of Section 170 and held that the exemption was intended only to apply to Kentucky property tax. Undertaking a review of both the plain language of Section 170 and its many references to property as well as a number of cases that had taken up the issue, the Court held that the Section 170 exemption for institutions of purely public charity applied only to ad valorem taxation. As to IGS’s argument that the use tax operated so similarly to a property tax that it should fall within the scope of Section 170, the Court ultimately held that the use tax was intended as a complement to the sales tax and arose out of a transaction, not the ownership or valuation of such property. The Court stated that nowhere else in the country had a use tax been treated as akin to a property tax, and in the Court’s words, such a conclusion “is simply wrong.” Accordingly, the Court overturned City of Elizabethtown and declined to extend the scope of Section 170 beyond property taxes.
Dep’t of Revenue v. Revelation Energy, LLC, 14-CI-00799 (Pike Cir. Ct. May 20, 2015), rev’d and remanded, 2015-CA-000930 (Ky. App. Mar. 9, 2018).
In Dep't of Revenue v. Revelation Energy, LLC, the Kentucky Court of Appeals reversed the Circuit Court, which had reversed the Kentucky Board of Tax Appeals’ decision granting Taxpayer’s excise tax refund. Taxpayer purchased substantial amounts of special fuel as part of its mining operations in Kentucky. The sales price included the special fuel tax imposed under KRS 138.220 and the petroleum environmental assurance fee imposed under KRS 224.60-145. Taxpayer learned that its non-highway use of the special fuel made the purchases exempt from the tax and fee and subsequently obtained a motor fuels tax refund permit and filed for a refund. KDOR partly denied the refund since Taxpayer was required to obtain the refund permit prior to any purchases. The Circuit Court held the pre-purchase requirement unconstitutional under the Due Process Clause since it leaves unwary taxpayers no avenue for recovery. The Court of Appeals reversed, holding that, since tax refunds arise solely from statute, the requirements of the refund statute must be strictly followed.
Rent-A-Center East, Inc. et al. v. Dep’t of Revenue, Finance & Admin. Cabinet, 16-CI-01075 (Franklin Cir. Ct. Sept. 11, 2017), on appeal, 2017-CA-001653 (Ky. App. Oct. 10, 2017).
In Rent-A-Center East, Inc. et al. v. Finance & Admin. Cabinet, Dep’t of Revenue, the Kentucky Board of Tax Appeals (“KBTA”) found that rent-to-own companies were not required to collect sales tax on separate liability waiver contracts they offered to their customers to protect against property damage. Rent-A-Center and Rent-Way, Inc. (“Rent-A-Center”) are rent-to-own companies that rent and sell household goods to Kentucky and out-of-state customers. A customer who wishes to rent or purchase an item signs a Rental Purchase Agreement and pays a rental purchase fee. They also have the option of purchasing an extra damage waiver that protects against the customer’s potential liability for damage or loss, which is covered by a waiver fee. While Rent-A-Center collected and remitted sales tax on the rental purchase fee, it did not collect and remit sales tax on the waiver fee. The KBTA found that the waiver fees were related to the waiver agreement, which is not tangible personal property and thus not subject to Kentucky sales tax. The Franklin Circuit Court affirmed, and KDOR has appealed.
CSX Transp., Inc. v. Finance & Admin. Cabinet, Dep’t of Revenue, 14-CI-00532 (Greenup Cir. Ct. Aug. 31, 2015), aff’d, 2015-CA-001415 (Ky. App. Mar. 9, 2018).
In CSX Transp., Inc. v. Finance & Admin. Cabinet, Dep’t of Revenue, the Kentucky Court of Appeals denied the taxpayer’s refund claim for sales and use tax paid on certain railroad items. The taxpayer claimed it overpaid the tax, claiming certain items it purchased were exempt as supplies used in the direct operation of locomotives pursuant to KRS 139.480(1). KDOR determined that some of the items were materials, not supplies, and that others were supplies but were not used in the direct operation of locomotives. The circuit court upheld KDOR’s findings and the Kentucky Court of Appeals affirmed.
LaRue County Geriatric Center, Inc. v. LaRue County PVA, et al., K16-S-76, Order No. K-25354 (KBTA Oct. 4, 2017), on appeal, 17-CI-00159 (Larue Cir. Ct. Oct. 30, 2017), dismissed June 4, 2018.
LaRue County Geriatric Center, Inc. v. LaRue County PVA, et al. concerned a nursing home facility owned by LaRue County Geriatric Center (“LCGC”), a tax exempt entity, which leased the real estate to Signature Healthcare. The fee interest, not the leasehold interest, was assessed by the LaRue County Property Valuation Administrator (“PVA”). The PVA assessed the property at $15,750,000. LCGC contested the assessment and asserted the property should have been valued at $9,200,000. The LaRue County Board of Assessment Appeals valued the property at an even higher value of $18,500,000. On appeal from the local board, the Kentucky Claims Commission (“KCC”) noted that Section 172 of the Kentucky Constitution states that “[a]ll property, not exempted from taxation by this Constitution, shall be assessed for taxation at its fair cash value, estimated at the price it would bring at a fair voluntary sale.” According to the KCC, LCGC was tax exempt under Section 170 of the Kentucky Constitution, and “the PVA assessed the fee interest owned by…LCGC, but made no assessment of the leasehold interest in the Property owned by the tenant, Signature Healthcare. LCGC is a tax exempt entity that should not have been assessed.” Thus, only the leasehold interest of Signature Healthcare was found to be subject to taxation. However, the PVA did not make an assessment on the leasehold interest. Thus, the KCC reversed the local board of appeal and ordered that the fee interest of LCGC was exempt from taxation, and the PVA assessment was improperly made. The authors’ law firm represented the taxpayer before the Kentucky Claims Commission.
Grand Lodge of Kentucky Free and Accepted Masons, et al. v. City of Taylor Mill et al., 14-CI-02367 (Kenton Cir. Ct. Oct. 9, 2015), aff’d in part, rev’d in part, and remanded, 2015-CA-001617-MR (Ky. App. Feb. 10, 2017), motion for discretionary review denied, 2017-SC-000122 (Ky. June 6, 2018).
In Grand Lodge of Kentucky Free and Accepted Masons, et al. v. City of Taylor Mill et al., the Kentucky Court of Appeals held that the real property owned by a non-profit organization but occupied by senior citizens as their residence is subject to ad valorem taxation and not subject to the charitable exemption found in Section 170 of the Kentucky Constitution. Grand Lodge of Kentucky Free and Accepted Masons (“Grand Lodge”) is a recognized public charity and generally receives the constitutional exemption from property taxes on real property it owns and occupies. The property at issue in this case is a 24-acre tract of real property that Grand Lodge leases to Masonic Retirement Village of Taylor Mill, Inc. (“MRV”), a nonprofit organization with a purpose of providing and maintaining affordable housing to senior citizens. It established a retirement community in the city of Taylor Mill, Springhill Village, which is located on the real property MRV leases from Grand Lodge. The Court of Appeals first held that the residents, not Grand Lodge or MRV, were the occupants of the property for purposes of the constitutional tax exemption, explaining that the Resident Agreements gave the residents exclusive rights to occupy the property during the term of the agreement in exchange for consideration. The Court further held that there is no “occupancy” interest in real property, and that occupancy was instead a result of possession of real property. Thus, this possessory interest was enough to subject the residents to property tax under Section 170 and KRS 132.195. However, the Court of Appeals went on to hold that the individual units should be considered as leaseholds for purposes of valuation, explaining that “[t]he law is well-settled that a leasehold’s fair market value for taxation purposes is obtained by subtracting the fair market value of the real property with the leasehold from the fair market value of the real property without the leasehold.” The Kentucky Supreme Court denied discretionary review.
Kroger Limited Partnership I v. Boyle County PVA, File No. K16-S-25, Order No. 25353 (KBTA Sept. 26, 2017), remanded, 17-CI-00385 (Boyle Cir. Ct. May 14, 2018).
In Kroger Limited Partnership I v. Boyle County PVA, the Kentucky Claims Commission (“KCC”) upheld a $5.5 million assessment made by the Boyle County Property Valuation Administrator of a Kroger with a gas station using the Marshall & Swift cost approach recommended by KDOR. The KCC held that, to prevail, a taxpayer must establish that the finding adverse to the taxpayer is clearly erroneous, rather than merely conflicting with the taxpayer’s acceptable appraisal approaches. However, on appeal, the Boyle Circuit Court set aside the Final Order and remanded the case to the KCC in May of 2018 because the Court held that the Final Order did not provide justification for reaching a different result than the hearing officer’s recommended order.
Buffalo School Apartments, LLLP v. LaRue County Board of Assessment Appeals, et al., K16-S-30, K16-S-77 (KCC July 7, 2017) (final).
In Buffalo School Apartments, LLLP v. LaRue County Board of Assessment Appeals, et al., the Kentucky Claims Commission (“KCC”) found that tax credits awarded under Section 42 of the Internal Revenue Code must be excluded from the value of low-income housing. In the case, the property at issue was a low-income apartment complex used for senior citizens, and the LaRue County Property Valuation Administrator (“PVA”) assessed the property at $2,671,454, which included the value of the tax credits. The local Board of Assessment Appeals reduced the assessment to $1,323,936. The taxpayer appealed to the KCC, and the PVA filed a cross-appeal. In finding for the taxpayer and valuing the property at $230,000, the KCC relied upon an appraisal presented by the taxpayer, as well as Kentucky case law that held that the value of tax credits for low-income housing are to be excluded from the value of the real property. Furthermore, the KCC found that the tax credits were intangible property that were not subject to state and local property tax pursuant to KRS 132.208.
Willow Woods Apartments, LLLP v. Anderson County Property Valuation Administrator, K16-S-03, K-25375 (KBTA Oct. 25, 2017) (final).
Willow Woods Apartments, LLLP owned real property that provided housing to low income people in the community and was thus subject to a Land Use Restrictive Covenant for Low Income Housing Tax Credits (“LIHTC”). Since the covenant is placed on the deed to the property, any prospective purchaser is subject to its restrictions. The Anderson County Property Valuation Administrator took the tax credits into consideration when assessing the property. Willow Woods appealed, and the Kentucky Claims Commission held that, when valuing LIHTC properties, “the value of the tax credits should not be included in the value of the real property,” since they are intangible and such intangible property is not subject to taxation pursuant to KRS 132.208.
International Paper Co. v. Dep’t of Revenue, K17-R-51, K-25390 (KCC Nov. 29, 2017) (final).
In International Paper Co. v. DOR, No. K17-R-51, International Paper failed to comply with SCR 3.020 and subsequently failed to show adequate cause for the noncompliance when requested to do so by the Kentucky Claims Commission (“KCC”). Regarding hearing procedures, 802 KAR 1:01 § 3(3) provides that, “[i]n accordance with Supreme Court Rule [SCR] 3.020, if the appealing party is a corporation, joint venture, partnership, LLC, estate, or any entity other than an individual . . ., the entity shall be represented by an attorney on all matters before the board, including the filing of the Petition of Appeal.” The purpose of SCR 3.020 is to protect people and entities from the unauthorized practice of law by unqualified individuals. In the Kentucky Bar Association’s Unauthorized Practice of Law Opinion KBA U-64 (2012), Question 1 asked: “Can a non-lawyer request that a board or agency initiate an administrative action and grant a hearing or file an answer on behalf of an otherwise unrepresented corporation or other artificial entity in an administrative hearing?” The answer was “No.” Here, the KCC found no cause for the appeal because it was filed by a non-attorney and because there was sufficient time for an attorney to enter an appearance on behalf of the company but none did so. Thus, the KCC dismissed the appeal with prejudice.
Coleman v. Campbell Cty. Library Bd. of Trustees, 12-CI-00089 (Campbell Cir. Ct. Oct. 21, 2016), motion for discretionary review denied, 2018-SC-000048 (Ky. June 6, 2018).
Coleman v. Campbell Cty. Library Bd. of Trustees addressed whether Kentucky public libraries created pursuant to KRS 173.710 et seq. should assess the library's ad valorem tax rate in accordance with KRS 132.023 or KRS 173.790. The Court of Appeals found that both statutes are applicable to ad valorem taxing rates of a library taxing district formed under KRS 173.720 and can be interpreted to complement each other. On remand, the circuit court solely briefed the issue of whether the opinion should be applied retroactively or prospectively. The court applied the three-factor test for retroactivity set forth in Chevron Oil Co. v. Huson, 404 U.S. 97, 106, 92 S. Ct. 349, 355, 30 L. Ed. 2d 296 (1971) and held that the opinion was intended to be applied prospectively only. The taxpayers appealed but the Kentucky Court of Appeals affirmed, and the Kentucky Supreme Court denied discretionary review.
West v. Commonwealth of Kentucky, K17-R-47, K-25406 (KCC Jan. 23, 2018), on appeal, 18-CI-00178 (Franklin Cir. Ct. Feb. 22, 2018).
In West v. Commonwealth of Kentucky, the Kentucky Claims Commission dismissed the taxpayer’s appeal of a KDOR final ruling because the taxpayer failed to include five copies of the final ruling with the appeal as required by 802 KAR 1:010 §2(3)(b).
Charter Group, LLC v. Hancock, K17-R-03, K-25401 (KCC Dec. 20, 2017) (final).
In Charter Group, LLC v. Hancock, Franklin County sold Appellant three delinquency certificates for real property that was involved in a foreclosure complaint at the time. When Appellant learned of the ongoing case, he sent a certified letter to Hancock, the county clerk, requesting a refund of the certificates on the grounds that they should have been put on a protected list and not sold pursuant to KRS 134.504. The Kentucky Claims Commission found that by filing an answer in the foreclosure case, the Franklin County Attorney had actual knowledge of the filing of an action concerning the real property at issue here and thus had a statutorily-imposed duty under KRS 134.504 to place any delinquency certificates concerning the property on the protected property list. Appellant was thus found to be entitled to a refund.
Tuan et al. v. Jefferson County PVA, K17-S-314, K-25403 (KCC Dec. 20, 2017) (final).
In Tuan et al. v. Jefferson County PVA, the Kentucky Claims Commission (“KCC”) dismissed the taxpayers’ untimely appeal. The taxpayers had thirty 30 days from the date the local board’s ruling was mailed to file an appeal, but failed to do so. The KCC didn't have the authority to extend the filing deadline and therefore dismissed the appeal.
Finance & Administration Cabinet v. Sommer, 13-CI-00029 (Franklin Cir. Ct. June 25, 2015), aff’d, 2015-CA-001128 (Ky. Ct. App. Jan. 13, 2017), discretionary review granted, 2017-SC-000071 (Ky. Aug. 16, 2017).
In Finance & Administration Cabinet v. Sommer, the Kentucky Court of Appeals held that KDOR must publish its final rulings after redacting them for confidential taxpayer information. The decision, which will greatly increase the transparency of KDOR policies, procedures, and positions, directs KDOR to join the ranks of other states like Indiana, who already publish rulings on taxpayer appeals. The Court of Appeals held that KDOR had to publish all the final rulings, explaining that the rulings “contain great bodies of information related to the reasoning and analysis of [KDOR] with respect to its task in administration of court tax laws.” The Court noted that in its view, the information could be made public while protecting taxpayer privacy interests through redaction.
V. Kentucky Unitary and Consolidated Returns
Is it true that there are no new ideas, only rediscoveries? The 2018 Kentucky General Assembly rediscovered both unitary combined reporting and elective consolidated reporting.
Going back to basics for a moment, what state consolidated reporting is would seem to be relatively straightforward, i.e., computing income on the same basis as the federal consolidated income tax return and apportioning and allocating the income thereof as though it were a single corporation. Unitary reporting is computing income by combining the income of the businesses that make up an economic business unit and then apportioning and allocating the income of the unitary group in accordance with the state’s rules.
From a historical perspective, this new methodology is curious. From the mid-1990s until 2005, when the General Assembly put the mandatory nexus consolidated return provisions into place, corporations could elect to file a consolidated return. And, prior to that the Kentucky Department of Revenue could require or corporations could attempt to compute their income using unitary combined reporting. For a history of unitary combined reporting in Kentucky, read GTE v. Revenue Cabinet, 889 S.W.2d 788 (Ky. 1994). Notably, the General Assembly outlawed unitary combined reporting and refunds using that methodology, which was discussed in Miller v. Johnson Controls, Inc., 296 S.W.3d 392 (Ky. 2009). While elective consolidated has been previously embraced and mandatory nexus consolidated reporting is somewhat unique to Kentucky, it is somewhat surprising that the 2018 General Assembly embraced the unitary method given the history.
No Guidance Yet
Obviously, the Kentucky Department of Revenue has not had enough time to promulgate proposed regulations or issue other guidance. So, we do not know how the Department will interpret the mechanics of these filing methods. The following are simply prognostications.
Unitary Combined Required, Unless Consolidated Elected
Corporate Income Tax Focus:
A corporate taxpayer doing business in Kentucky that is engaged in a unitary business with one or more other corporations is required to file a unitary combined report. See 2018 Ky. Acts c. 207, § 120(3)(a). However, such a corporation which is included in an affiliated group for federal income tax purposes that has elected to file a consolidated return for Kentucky income tax purposes does not have to report its income under the unitary method. See 2018 Ky. Acts c. 207, § 119(3). A consolidated return election is binding for 96 months, roughly 8 years. See 2018 Ky. Acts c. 207, § 119(4). Other corporate taxpayers may file a separate company return. See 2018 Ky. Acts c. 207, § 119(3)(c).
As a logical consequence, the mandatory nexus consolidated reporting will no longer be a filing methodology. One could wonder whether or not a corporate taxpayer could make the argument that it could continue using the mandatory nexus consolidated reporting under the alternative apportionment rules?
Single Return, Whether Unitary or Consolidated
One commonality between unitary combined and elective consolidated methods is that in either case, only a single tax return is filed. See 2018 Ky. Acts c. 207, §§ 119 & 120. At least both methods cut down on the number of the returns.
Composition of Unitary and Consolidated Groups
A unitary group, i.e., a unitary business, may be comprised of parts of a single corporation or commonly controlled corporations that are sufficiently interdependent, integrated, and interrelated through their activities providing a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts. See 2018 Ky. Acts c. 207, § 120(2)(f)&(3). This is essentially the same definition of a unitary business found in Multistate Tax Commission (“MTC”) Regulation IV.1.(b)(1).
A unitary group, in addition to U.S. domestic corporations, also includes: any member that earns more than twenty percent (20%) of its income, directly or indirectly, from intangible property or service related activities that are deductible against the apportionable income of other members of the combined group; any member doing business in a tax haven; income from a pass through entity. See 2018 Ky. Acts c. 207, § 120(8).
The classically unitary business is a vertically integrated business, such as a business in which a manufacturer produces an item that it sells (or transfers) to a distributor which in turn sells (or transfers) the item to a retailer. See also, e.g., Container Corp. of America v. Franchise Tax Bd., 463 US 159 (1983). However, a unitary business may also be a horizontally integrated business which could be, for example, a group of retail stores, although being in the same line of business does not necessarily mean that corporations are unitary. See, e.g., F. W. Woolworth Co. v. Taxation & Revenue Dep’t of State of N. M., 458 U.S. 354 (1982).
Obviously, determining the composition of a unitary group of corporations can be difficult, since it is a determination based on the particular facts and circumstances of corporations under common control. Different states may come to different conclusions. Doesn’t it seem like unitary can be in the eye of the beholder? There may be multiple unitary groups within a federal consolidated return group, and a unitary group could conceivably include corporations outside of the group.
The composition of the consolidated group is the same as the federal affiliated group that files or would file a consolidated return for federal income tax purposes. See 2018 Ky. Acts c. 207, § 119(2)&(4). This is pretty straightforward by comparison to determining the composition of a unitary group.
Consolidated versus Unitary Taxable Income
A consolidated group is treated for all purposes as a single corporation. See 2018 Ky. Acts c. 207, § 119(4)(a). So, the computation of the consolidated group’s Kentucky taxable income is relatively straightforward: the consolidated group’s federal taxable income adjusted for Kentucky differences less any allocable income is multiplied by the consolidated group’s apportionment factor, and then any allocable income (or loss) is added (or subtracted) therefrom. See 2018 Ky. Acts c. 207, §§ 53, 56 & 60.
A unitary group is not treated like a single corporation; rather, the Kentucky taxable income of each corporation in a unitary group is computed on a by-taxpayer basis: the unitary group’s federal taxable income adjusted for Kentucky differences less any allocable income is multiplied by the single sales factor apportionment factor, the number of which is each taxpayer’s sales and the denominator of which is the unitary group’s total sales. See 2018 Ky. Acts c. 207, § 120(6)&(7). Each taxpayer’s income is comprised of: the income from each unitary group of which it is a member (which assumes that a corporation – or presumably a part thereof – may be a member of more than one unitary group); income from distinct business activities; income from a business wholly in Kentucky; income from the certain capital asset sales and involuntary conversions; nonapportionable income allocated to Kentucky; and net operating loss carryovers. See 2018 Ky. Acts c. 207, § 120(5)(a). There is particular treatment prescribed for charitable expenses as well. See 2018 Ky. Acts c. 207, § 120(8)(f).
Several questions arise in the context of computing the taxable income of unitary groups. For example, there are statutory provisions for the deferral of intercompany expenses. 2018 Ky. Acts c. 207, § 120(8)(e). So, would it seem that intercompany expenses are eliminated? What about the exceptions to the disallowance provided for by KRS 141.205 of certain deductions for certain intangible expenses, management fees, and certain other expenses paid to related parties? Another issue is how the protections of P.L. 86-272 will be applied.
Since a consolidated group is treated like a single taxpayer for all purposes, these same issues would not appear to similarly manifest themselves.
Net Operating Losses
Under mandatory nexus consolidated reporting, net operating losses and carryovers are computed on a pre-apportionment basis. See generally 2018 Ky. Acts c. 207, § 79 (KRS 141.200). In switching from mandatory nexus consolidated reporting to either consolidated reporting or unitary reporting, issues can be anticipated to arise with regard to net operating loss carryforwards. Does Section 120(5)(a) require the computation of net operating losses under unitary reporting to be made on a post-apportionment basis? Does Section 119 require the computation of net operating losses under consolidated reporting to be made on a post-apportionment basis? Will the Department use the same logic as in the net operating loss regulation, 103 KAR 16:250, that applied to the prior iteration of elective consolidated returns?
The tax credits of one unitary group member cannot offset the tax of another member. See 2018 Ky. Acts c. 207, § 120(5)(b). But, since, a consolidated group is treated for all purposes as a single corporation, tax credits from one corporation may offset the liability of the consolidated group. See 2018 Ky. Acts c. 207, § 119(4)(a). Corporate groups with tax credits residing in corporations different from the corporations generating Kentucky taxable income may be well incentivized to elect to file a consolidated return.
Criticisms of Unitary Reporting
A group of taxpayers and organizations representing businesses have criticized mandatory unitary combined reporting. They argue: most of Kentucky’s neighboring states do not have mandatory unitary reporting which puts Kentucky at a competitive disadvantage; the determination of what companies constitute a unitary group has been the subject of prolonged litigation in several states; and, mandatory unitary reporting does not necessarily result in increased revenue. They seek to make unitary reporting elective.
That the approach to unitary reporting chosen by Kentucky has received criticism is not surprising. There was no study done, and the methodology was not vetted.
Assuming that Kentucky is going to continue down the path of becoming a unitary reporting state, should not the General Assembly consider some suggestions to ensure that Kentucky is not an outlier? If kept, shouldn’t Kentucky’s unitary reporting scheme be tweaked to make it more mainstream? What about making unitary reporting elective? What about allowing a phase-out of mandatory nexus consolidated reporting? Maybe as a 96 month election?
Unitary combined reporting? Elective consolidated reporting? They are coming back, unless the General Assembly changes its mind and repeals them or tweaks them. Shouldn’t we start evaluating the options and start planning?