Tax reform has been on Kentucky lawmakers’ minds for years, and while significant progress has been made recently, substantial work remains to be done. In 2018, the General Assembly made important strides in creating a more neutral, pro-growth tax structure even while generating a net increase in revenue. With its reduction in income tax rates, consolidation of brackets, and modest sales tax base broadening, Kentucky put itself on the map as a state that is serious about reorienting its tax structure to enhance productivity and promote economic growth.
Much has changed in the world since 2018, with taxpayers and governments everywhere confronting new challenges on top of the old ones. There’s more motivation than ever to remove barriers that for too long have stood in the way of individuals’ and communities’ ability to thrive.
Kentucky’s challenges are many—the state continues to lag the national average in terms of personal income growth, gross state product growth, and state inbound migration—but the Commonwealth’s opportunities are greater. In this new era of increased workplace flexibility, where many people are leaving high-tax, high-cost-of-living states in favor of more affordable alternatives, Kentucky holds a competitive advantage.
Many similarly situated states are seizing opportunities to make their states more attractive to individuals and businesses alike, and pro-growth tax reforms have been central to those efforts, with 11 states enacting laws to reduce their income tax rates in 2021 alone and more expected to come in 2022.
Kentucky is projected to experience robust revenue growth over the next few years, presenting a valuable opportunity for policymakers to pursue reforms. Ultimately, the goal of tax reform should be to enable the state and local governments to raise sufficient revenue to fund government services in a manner that avoids hindering business productivity, job growth, and personal wage growth.
Menu of Kentucky Tax Reform Solutions
Kentucky has relatively well-structured and competitive corporate and individual income taxes at the state level but is held back by substantial taxes on business and personal productivity at the local level, as well as a complex state gross receipts tax on limited liability businesses. Kentucky also has room for improvement in its treatment of business investments and in its heavy reliance on incentives that add complexity to the tax code. The following recommendations would create a more competitive environment for businesses that would encourage long-term investment in Kentucky.
- Repeal the Limited Liability Entity Tax (LLET), imposed on C corporations and limited liability pass-through entities based on gross receipts, thus burdening startups, low-margin businesses, and companies experiencing losses.
- Reduce the corporate income tax rate, particularly given the continued existence of local net profit taxes which raise the overall burden of this harmful tax well above the 5 percent state rate.
- Improve treatment of business capital investments, raising the Section 179 expensing allowance for small businesses and offering permanent full expensing like that available under IRC Section 168(k) to reduce the tax code’s bias against investments in machinery and equipment.
- Evaluate and streamline incentives, empowering the Legislative Research Commission to evaluate the economic impact of these incentives and convening a commission or committee to study the LRC’s findings.
- Use revenue triggers to phase in reforms, ensuring revenue stability and reducing uncertainty while phasing in rate relief or pro-growth structural reforms.
Property and Inheritance Taxes
Kentucky is one of a few states that use property taxes as both a local and state revenue source, but the Commonwealth’s real property tax collections are quite modest, due in large part to rate and levy limits that have been in place for decades. However, taxes on business inventory, machinery, and equipment, as well as inheritance taxes on individuals, introduce complexity and economic distortions into the property tax code. Kentucky has an opportunity to rebalance its revenue sources away from economically distortive taxes on tangible property and toward far less economically harmful taxes on real property.
- Repeal the inventory tax or improve the inventory tax credit, ensuring that a 2018 policy intended to blunt the impact of the inventory tax actually provides relief for business taxpayers.
- Create a de minimis exemption for tangible personal property (TPP) taxes, eliminating compliance costs for businesses with minimal liability.
- Modify the local property tax recall provision, replacing it with a more straightforward system of voter ratification of increases above the cap.
- Permit one-time property tax rate adjustment in excess of limits to rebalance local tax bases, should an effort be made to shift local governments away from municipal income taxation.
- Raise the state real property tax rate to offset income tax rate reductions, providing a stable source of revenue that could be used to yield highly competitive income tax rates even as combined property tax burdens remain at or below national averages.
- Repeal the inheritance tax, an outlier tax (only six states tax inheritances) which drives people out of Kentucky while generating only $48 million in revenue in FY 2020.
You can read the full report here.
For help evaluating how tax credits, incentives, and reform affect your business, reach out to the experts at Ashmore Consulting
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ashmore Consulting LLC to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact Ashmore Consulting LLC or other tax professional prior to taking any action based upon this information. Ashmore Consulting LLC assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.