April 15, 2020
By
Timothy J. Eifler
Member, Stoll Keenon Ogden PLLC
(502) 560-4208
tim.eifler@skofirm.com
and
Stephen A. Sherman
Of Counsel, Stoll Keenon Ogden PLLC
(502) 568-5405
stephen.sherman@skofirm.com
The 2020 General Assembly has passed H.B. 351 , the “revenue package” accompanying the Executive Branch Budget bill for the 2020 – 2021 state fiscal year, making a number of changes to Kentucky’s state tax laws. The same legislature enacted S.B. 150 which ratified various actions taken by Governor Beshear to address the COVID-19 emergency and gives his administration additional flexibility to adjust tax payment and return filing deadlines. This outline provides an overview of the state tax changes enacted by H.B. 351 and S.B. 150.
Changes with special effective dates are noted below. All other changes take effect immediately upon H.B. 351’s enactment. (See H.B. 351, §81).
Electronic Filing of Returns
KRS 131.250 authorizes the KY Department of Revenue (“KDOR”) to require returns to be filed electronically. H.B. 351 amends KRS 131.250 to give the KDOR greater flexibility in determining which returns are to be so filed. The statute had mandated that certain returns be filed electronically. The bill removes these mandates, allowing the determination to be made within the KDOR’s discretion.
A. Postponement of Various KY Tax Filing and Payment Due Dates In Response to the COVID-19 Emergency
The obligation to file Kentucky income tax and LLET returns and remit payment for the 2019 calendar year have been extended to July 15, 2020. For filers who submit an automatic return filing extension, the due date for returns previously due April 15, 2020, but now due July 15, 2020, shall be October 15, 2020. For C corporations the extension due date shall be November 15, 2020. The obligation to file Kentucky tangible personal property tax returns (Form 62A500) for the January 1, 2020 assessment date similarly have been extended to July 15, 2020.
The U.S. Treasury issued IRS Notices 2020-17 and 2020-18 providing relief from federal income tax filing and payment deadlines to U.S. taxpayers who have been adversely affected by the COVID-19 emergency and have a federal income tax payment or federal income tax return due on April 15, 2020. These Notices postpone to July 15, 2020 the obligation to file income tax returns and pay income taxes (including estimated income taxes) otherwise due April 15, 2020. No interest, penalty, or addition to tax for failure to file a federal income tax return or to pay federal income taxes will accrue between April 15, 2020 and July 15, 2020, for any return postponed by the Notices.
These IRS Notices apply only to federal income tax return and payment due dates; they do not alter state tax return and payment liabilities. The KDOR initially announced it would adopt “most” of the income tax relief described in the Notice by agreeing to waive all penalties for “reasonable cause” for Kentucky taxpayers filing and paying late based on the federal guidance. However, the KDOR stated it lacked authority to waive interest and that interest would accrue on late payments.
S.B. 150 addressed this lack of authority by requiring the KDOR to adhere to any tax filing or tax payment relief authorized by the U.S. Treasury or Internal Revenue Service (“IRS”) during the state of emergency declared by Governor Beshear in response to COVID-19 on March 6, 2020 by Executive Order 2020-215, as follows:
The Department of Revenue shall adhere to any declarations or changes in tax filing and payment requirements provided by the U.S. Treasury Department or the Internal Revenue Service and provide the same to taxpayers for comparable tax filing and payment requirements under Kentucky law, including an extension of time to file a return or report and an extension of time to pay any tax due with that return or report, without the imposition of penalty under KRS 131.180, 141.044, 141.305, or 141.990 on that extended payment, and notwithstanding KRS 131.175 and 141.170, without the imposition of interest under KRS 131.183 or 141.985;
(S.B. 150, § 1(3)). S.B. 150 also authorized but did not require local governments to grant similar postponements of filing deadlines for local occupational license taxes:
Notwithstanding KRS 67.750 to 67.795, a tax district may suspend or otherwise extend the applicable deadline for the filing of returns for taxable net profits or taxable gross receipts of businesses within the tax district during the pendency of the state of emergency.
(S.B. 150, § 1(9)(d)).
B. Income Taxes and Limited Liability Entity Tax (“LLET”)
1. No Interest on Additions for Underpaid Estimated Income Taxes and LLET
H.B. 351 amends KRS 131.183, the tax interest statute, to clarify that additions to tax as a result of a taxpayer underpaying estimated income taxes and LLET are considered a penalty and interest does not accrue on such additions. The statute is further clarified to provide that no refund of estimated tax shall be made unless a return is filed. (H.B. 351, §§ 1 (amending KRS 131.183)) and 17 (amending KRS 141.985)). These changes are effective for taxable years beginning on or after January 1, 2019. (Id. at § 76).
2. Refund Interest on Overpaid Estimated Income Taxes and LLET
H.B. 351 amends KRS 141.044, the statute requiring estimated income tax and LLET payments, to provide that interest shall be paid on a refund of overpaid estimated taxes. Interest shall not begin to accrue until ninety (90) days after the latest of: (i) the due date of the return; (ii) the date the return was filed; (iii) the date the tax was paid; (iv) the last day prescribed by law for filing the return; or (v) the date an amended return claiming a refund is filed. (Id. at § 9 (amending KRS 141.044)). This change is effective for taxable years beginning on or after January 1, 2019. (Id. at § 76).
3. Allowance of Exclusion from Gross Income of Qualified Lessee Construction Allowances for Short-Term Leases
Section 110(a) of the Internal Revenue Code (the “Code”) enacted as part of the Taxpayer Relief Act of 1997 provides a safe harbor for excluding from gross income any amount received in cash (or treated as a rent reduction) by a lessee from a lessor under a short-term lease of retail space, for the purpose of the lessee’s constructing or improving qualified long-term real property for use in the lessee’s trade or business at the retail space, but only to the extent that the amount does not exceed the amount expended by the lessee for the construction or improvement (a “qualified lessee construction allowance”).
Kentucky de-couples from Section 110 for corporation income tax, requiring lessors to include the amount of any qualified lessee construction allowance in the lessor’s gross income and requiring lessees to exclude such amounts from their gross income. See KRS 141.039(1)€.
H.B. 351 amends the calculation of gross income for Kentucky corporation income tax purposes to allow lessees to exclude qualified lessee construction allowances from gross income pursuant to Section 1110 of the Code effective for taxable years beginning on or after January 1, 2019. (H.B. 351, §§ 7 (amending KRS 141.039) and 76)).
Note that H.B. 351 makes an identical change to KRS 141.900 which defines gross income for corporations for taxable years beginning prior to January 1, 2018. (H.B. 351, § 16). This change appears to have no effect because H.B. 351 makes the change effective only for taxable years beginning on or after January 1, 2019. (Id. at § 76).
4. Decouple from Phase-out of Federal Section 179 Deduction
Section 179 of the Code allows a taxpayer to elect to expense the cost of any “section 179 property” and deduct it in the year the property is placed in service (as opposed to capitalizing the cost and taking annual depreciation deductions). The federal Tax Cuts and Jobs Act increased the maximum deduction from $500,000 to $1 million. It also increased the phase-out threshold from $2 million to $2.5 million, providing that the maximum deduction shall be decreased (but not below zero) by the amount by which the cost of “section 179 property” placed in service during the taxable year exceeds $2.5 million (thus, no deduction is available if the cost of such property placed in service during the taxable year equals or exceeds $3.5 million).
KRS 141.0101(16) provides that for property placed in service on or after January 1, 2020, only the expense deduction ($100,000) allowed under Section 179 of the Code in effect on December 1, 2003, exclusive of any amendments made subsequent to that date, shall be allowed. On December 1, 2003, the phase-out threshold was $400,000. Thus, no Kentucky deduction is available if the cost of “section 179 property” placed in service during the taxable year equals or exceeds $500,000.
H.B. 351 amends KRS 141.0101(16) to remove the phase-out provisions of Section 179 of the for property placed in service on or after January 1, 2020. Kentucky taxpayers may deduct up $100,000 of cost of “section 179 property” placed in service on or after January 1, 2020, regardless of the total cost of “section 179 property placed in service during the taxable year. (H.B. 351, § 28 (amending KRS 141.0101)).
5. Partnership Level Audits
Federal legislation enacted in 2015 provides for a new centralized federal income tax audit regime for partnerships. Generally (absent some elections), the new federal rules allow the IRS to make adjustments and collect related underpayments at the partnership level, rather than separately from each of the partners. The new federal audit regime generally took effect for taxable years beginning after December 31, 2017. The resulting federal audits (or taxpayer amendments) may result in adjustments for state tax purposes.
Under the new federal audit regime, the default rule is that the partnership pays the imputed underpayment in its tax year during which the adjustment is finally made (the “adjustment year”) even though a partnership’s imputed underpayment relates to income, gain, loss, deduction, or credit of the partnership for a prior tax year (the year reviewed by the Internal Revenue Service under audit, referred to as the “reviewed year”). That potentially shifts the economic burden of an understatement of income in the reviewed year from the reviewed-year partners to the adjustment-year partners, not all of whom may have been partners during the reviewed year.
In lieu of paying the imputed underpayment at the partnership level, a partnership may elect to “push out” the audit adjustments to the reviewed-year partners, who compute tax on the underpayment and pay the relevant tax with their current tax year return (using a formula to determine the amount by which to increase their current-year tax). In this situation, the partnership provides the reviewed-year partners (and the IRS) with statements showing those partners’ shares of adjustments to the partnership’s items (adjusted schedules K-1). Each reviewed-year partner then increases its federal income tax liability for the year that includes the date on which that statement is furnished (the current year) by an amount that reflects the hypothetical increase in its federal income tax liability for each tax year between the reviewed year and the current tax year in a manner that takes into account the adjustment in the reviewed year.
Some smaller partnerships can elect out of the new federal audit provisions altogether. In that case, adjustments generally would be determined in separate proceedings for each partner using the current procedures applicable to audits of smaller partnerships and their partners.
H.B. 351 enacts the Multistate Tax Commission’s Model Uniform Reporting Statute which provides a process for taxpayers to report and pay Kentucky income taxes (or claim refunds) when federal adjustments occur due to the new federal rules regarding partnership audits. (H.B. 351, §§ 57 (enacting a new section of KRS Chapter 141) and 58 and 59 (making conforming amendments to KRS 141.210 and 141.235, respectively)). Also, within 180 days of receiving notification of final federal adjustments arising from a federal partnership-level audit or an administrative adjustment, partners must file the required supplemental Kentucky return and make Kentucky income tax payments.
The new process provides for the following:
• Allows an audited partnership the ability to make different elections under the partnership audit regime for Kentucky tax purposes than the partnership makes for federal tax purposes, notably for the “push-out” election (i.e., partnership audit adjustments pushed out to the partnership’s ultimate partners) or the decision to pay the imputed underpayment (i.e., partnership pays the tax on the partnership audit adjustments).
• Provides Kentucky should use the apportionment and allocation factors from the reviewed year to apply to the partnership audit adjustments flowing from the federal audit of the reviewed year.
• Provides that for an imputed underpayment, those apportionment factors should be applied at the partnership level for adjustments allocable to all partners except direct resident partners.
• For tiered structures, allows flexibility and options to each tier for reporting and payment elections that mirror the federal options.
• For administrative ease, offers partnerships the ability to use alternative reporting and payment solutions subject to state approval.
• Provides a default rule that the federal partnership representative will serve as the state partnership representative regardless of the state of residence of the partnership or its partners and gives partnerships the option to instead designate a state-specific partnership representative for each state on a state-by-state basis.
6. Clarifications to the Selling Farmer Tax Credit Program
The 2019 General Assembly authorized the Kentucky Selling Farmer Tax Credit Program beginning January 1, 2020. (See S.B. 246 (2019), enacting KRS 154.60-040). H.B. 351 adds clarifying definitions and further statutory framework to the Selling Farmer Tax Credit Program. (H.B. 351, §§ 18 (amending KRS 154.60-040), 19 (enacting a new section of KRS Chapter 141), 20 (amending KRS 141.0205 to provide for the ordering of the credit)), 22 (amending KRS 154.60-005 (naming the subchapter) and 23 (amending KRS 154.60-020 to make conforming changes).
The Kentucky Selling Farmer Tax Credit program encourages continued use of agricultural land for farming by granting tax credits to selling farmers who agree to sell agricultural land and assets to beginning farmers. Farmers desiring to sell agricultural land and assets may be eligible for a Kentucky income tax credit up to five percent (5%) of the purchase price of qualifying agricultural assets, subject to a $25,000 calendar year cap and a $100,000 lifetime cap. The statutory cap of $3,000,000 in tax credits per state fiscal year is shared between the Kentucky Small Business Tax Credit program and the Kentucky Selling Farmer Tax Credit program and is to be prorated by the Kentucky Economic Development Finance Authority (“KEDFA”) between the two programs.
To be eligible to receive approval for the credit, a selling farmer must have, at a minimum, demonstrated the active use, management, and operation of real and personal property for the production of a farm product; executed and effectuated a purchase contract to sell agricultural land with a beginning farmer for an amount evidenced by an appraisal; and sold, conveyed, and transferred ownership of related agricultural land and assets to a beginning farmer. KRS 154.60-020(1).
A beginning farmer cannot have previously owned any agricultural land for a period exceeding 10 years. In addition, beginning farmers must commit to managing and operating a for-profit farming business for a minimum of 5 years after purchasing eligible agricultural land.
H.B. 351 clarifies that the purpose of the Selling Farmer Tax Credit program is to promote the continued use of agricultural land in Kentucky for farming purposes by granting a tax credit to a selling farmer who agrees to sell agricultural assets to a beginning farmer. H.B. 351 expands the program to “agricultural assets” (not just land) and adds the following statutory definitions for the program:
“Agricultural assets” means: (i) agricultural land which has been appraised by an individual certified by the Real Estate Appraisers Board created under KRS 324A.015; and (ii) buildings, facilities, machinery, equipment, agricultural products, or horticultural products, if: (a) owned by the same selling farmer owning the agricultural land sold to a beginning farmer; (b) purchased at the same time and in the same transaction with the agricultural land; and (c) purchased with the intent to be used on the purchased agricultural land. “Agricultural assets” does not mean: (i) a personal residence or any other residential structures; and (b) any agricultural assets that have been previously included in an approved application for the Kentucky selling farmer tax credit.
“Agricultural land” means: (i) any land located entirely in Kentucky that is zoned or permitted for farming, if the jurisdiction where the land is located has enacted an ordinance for zoning or permitting; and (ii) (a) is a tract of land of at least ten (10) contiguous acres in area for a farming operation for agricultural products; or (b) is a tract of land of at least five (5) contiguous acres in area for a farming operation for aquaculture or horticultural products; owned by the selling farmer prior to the sale. (Compare KRS 132.010(9)).
“Agricultural products” means: (i) livestock or livestock products; (ii) poultry or poultry products; (iii) milk or milk products; or (iv) field crops and other crops, including timber if approved by KEDFA.
“Aquaculture” means the farming of fish, crustaceans, mollusks, aquatic plants, algae, or other similar organisms (compare the definition used in KRS 260.690 and KRS 139.480(29)).
“Farm product” means aquaculture, agricultural products, or horticultural products.
“Farming operation” means the management and operation of agricultural assets for the purpose of pursuing a profitable commercial business venture to produce agricultural products, horticultural products, or both for sale. “Farming operation” does not mean any (i) hobby farm, as determined by the IRS; (ii) nonprofit venture; (iii) farm used primarily for storing agricultural products or horticultural products; or (iv) farm used to grow or raise agricultural products or horticultural products primarily for use by the immediate family members or owners of the agricultural assets.
“Horticultural products” means orchards, fruits, vegetables, nuts, flowers, or ornamental plants (compare KRS 132.010(10)).
“Immediate family member” means any of the following in relation to any owner or spouse of the owner of the agricultural assets: (i) parent or grandparent; (ii) children or their spouses; or (iii) siblings or their spouses.
H.B. 351 limits the credit to selling farmers that are a small business with 50 or fewer full-time employees and the sole legal owner of the agricultural assets sold to a beginning farmer. H.B. 351 excludes from eligibility for the credit any of the following: (i) (a) farm equipment dealer, (b) livestock dealer, or (c) similar entity primarily engaged in the business of selling agricultural assets for profit and not engaged in farming as a primary business activity; (ii) a bank or any other similar lending or financial institution; (iii) (a) an owner, partner, member, shareholder or trustee, (b) a spouse of an owner, partner, member, shareholder, or trustee, (c) an immediate family member of any of the owners, partners, members, shareholders, or trustees; of the beginning farmer to whom the selling farmer is seeking to sell agricultural assets.
Finally, H.B. 351 provides that any unused Selling Farmer Tax Credit may be carried forward for up to five taxable years.
7. Enactment of New Renewable Chemical Production Program
H.B. 351 authorizes the Kentucky Department of Agriculture (“KDOA”) to “create and administer” the Renewable Chemical Production Program by promulgating regulations and authorizing tax credits for that production. (H.B. 351, §§ 24 (creating a new statute in Chapter 246), 25 (creating a new statute in Chapter 141), 26 (amending KRS 141.422) and 27 (amending KRS 141.423). The KDOA is authorized to consult with the chemical engineering departments of any university to create and administer the program and with the KDOR related to awarding tax credits. The statutory cap of $10,000,000 in tax credits per state fiscal year is shared between the biodiesel, renewable diesel, and renewable chemical production tax credit programs. The program will sunset on December 31, 2024.
The credit shall be nonrefundable, nontransferable and allowed against income taxes and LLET for taxable years beginning on or after January 1, 2021. Any unused credit may be carried forward for a period not exceeding three taxable years.
To be eligible for the renewable chemical production tax credit, a business must: (i) be physically located in Kentucky; (ii) operate for profit; (iii) organize, expand, or locate in this state on or after July 1, 2020; (iv) (a) create new jobs and retain those jobs for at least four years or (b) invest a substantial amount of new capital in the Commonwealth and maintain that capital for at least four years. An eligible business cannot provide professional services, health care services, medical treatments or engage in retail operations and cannot relocate operations from another area of Kentucky or reduce operations in another are of the state while seeking this incentive.
H.B. 351 does not define what constitutes a “renewable chemical”, leaving that detail to be determined by regulations adopted by the KDOA. Similar credit programs in other states likely will provide guidance to the KDOA. For example, Iowa, Minnesota and Maine each has enacted a renewable chemical production tax credit. Iowa, the first state to enact such program, defines “renewable chemical” to mean a “building block chemical” with a biobased content percentage of at least 50%. (I.A.C. 261—81.2(15)). The regulation excludes a chemical sold or used for the production of food, feed, or fuel, but specifically includes cellulosic ethanol, starch ethanol, or other ethanol derived from biomass feedstock, fatty acid methyl esters, or butanol, but only to the extent that such molecules are produced and sold for uses other than food, feed, or fuel. (Id.)
8. LLET Calculation for Affiliated Groups
Kentucky imposes the LLET on corporations and limited liability pass-through entities in an amount equal to the lesser of a tax on gross receipts or gross profits. See KRS 141.0401. Each taxpayer owes a minimum annual LLET of $175.00. (H.B. 351, § 8 (amending KRS 141.0401)). The tax phases in for taxpayers with gross receipts or gross profits greater than $3,000,000 but less than $6,000,000. A taxpayer which is a member of a “combined group” would determine the applicable tax based on the total gross receipts and total gross profits of the entire combined group. For this purpose, “combined group” is defined to mean “affiliated group” as used in Section 1504(a) of the Code “and all limited liability pass-through entities that would be included in an affiliated group if organized as a corporation.” H.B. 351 amends KRS 141.0401 to limit this calculation solely to members of an “affiliated group.” Limited liability pass-through entities that would be included in an affiliated group if organized as a corporation are no longer included in the calculation.
C. Ad Valorem Property Taxes
1. New Website to Provide H.B. 44 Information
KRS 133.225 requires Sheriffs to include the KDOR’s explanation of H.B. 44 (the Rollback Law) with the annual property tax bills. H.B. 351 repeals this requirement and mandates instead that the KDOR provide similar information on a Web site that is accessible to the public the address of which must be included on every notice of assessment and property tax bill sent to taxpayers. The Web site shall include the following information:
An explanation of the process for assessing property values, which shall include but not be limited to:
(a) The duties and function of each state and local official involved in the property assessment process;
(b) The methods most commonly used to compute fair cash value;
(c) The types of property exempt from taxation;
(d) The types of property assessed at a lower value as required by Sections 170 and 172A of the Kentucky Constitution, including property with a homestead exemption, agricultural property, and horticultural property;
(e) The property tax calendar;
(f) How and when to report property to the Property Valuation Administrator;
(g) The process for examining real property for valuation purposes;
(h) How and when a taxpayer is notified of the assessed value of property;
(i) When and where the public can inspect the tax roll; and
(j) The process for appealing the assessed values of real and personal property, including motor vehicles;
An explanation of the process for setting the state tax rate and the county, city, school, and special taxing district tax rates, including but not limited to:
(a) The duties and function of each state and local official involved in the process for setting tax rates;
(b) The definitions of compensating tax rate and net assessment growth;
(c) The requirements set forth in KRS 68.245, 132.023, 132.027, and 160.470; and
(d) The recall provisions set forth in KRS 132.017;
An explanation of the process for property tax collection, including but not limited to:
(a) The duties and function of each state and local official involved in the tax collection process;
(b) How and when to remit payment of the tax;
(c) The due date for the tax;
(d) The early payment discount;
(e) The penalties assessed on delinquent taxes; and
(f) The delinquent tax collection process; and
(g) Direct links to the Web sites or guidance on how to access the Web sites of the local offices, such as the property valuation administrator’s office, the county clerk’s office, and the sheriff’s office, that provide taxpayers additional information on the property taxes within its jurisdiction.
(H.B. 351, § 3 (amending KRS 133.225).
2. Increase to City and County Fees to County Property Valuation Administrators (“PVAs”)
H.B. 351 increases the fees to be paid by certain cities and counties to the PVAs. H.B. 351 increases the fee for cities electing to use the PVA’s assessment and having an assessment subject to city ad valorem tax of $6 billion or more is increased from $60,000 to $100,000. (H.B. 351, § 44 (amending KRS 132.285)). H.B. 351 increases the cap on the county fees for counties with a total assessed value of property subject to county tax of $15 billion or more from $250,000 to $400,000 and removes any specific limit for urban-county governments (Fayette County) and consolidated local governments (Jefferson County). (H.B. 351, § 45 (amending KRS 132.590)).
3. Address Tax Treatment of Seniors Residing in Residential Communities Sponsored by the Grand Lodge of Kentucky, F. & A. M.
H.B. 351 amends KRS 132.195 to confirm that certain private leasehold interests in exempt property are exempt from state and local ad valorem tax. (H.B. 351, § 60 (amending KRS 132.195)). This change addresses an ongoing dispute over the ad valorem property tax treatment of residents’ interests in certain residential communities developed by Grand Lodge of Kentucky, Free and Accepted Masons.
The Grand Lodge developed several residential housing communities in Kentucky for seniors whereby the Lodge and/or affiliated nonprofit companies developed residential units and entered into certain “residential agreements” with tenants. Those agreements included the following provisions:
• There is a stated entrance fee varying between $151,000-$252,000 depending on the size of the unit.
• Monthly maintenance fees cover community services and maintenance of appliances and interior upkeep.
• The resident’s interests in the unit are not assignable or transferable.
• The resident does not obtain title.
• The resident cannot mortgage or encumber unit.
• Resident agreements can be terminated upon death, transfer to a nursing home, election of resident to terminate, a determination by the landlord that resident is incapable of continued occupancy, or resident’s refusal to cooperate.
• The resident receives back 82% of the entrance fee at termination.
The Grand Lodge and its affiliates are considered institutions of purely public charity and their property is exempt from ad valorem taxation. See Ky. Const. § 170; Com. Ex. Rel. Luckett v. Grand Lodge of Kentucky, Ancient Order of Free and Accepted Masons, 459 S.W.2d 601 (Ky. 1970)
KRS 132.195 provides that when real or personal property which is exempt from ad valorem taxation is leased to a private person in connection with a business conducted for profit, the leasehold interest or other interest in the property is subject to state and local ad valorem taxation. Citing this statute, the City of Taylor Mill and Kenton County in 2001 filed a declaratory judgment action in Kenton Circuit against the Kenton County PVA and KDOR seeking the assessment of the residential units at Springhill Retirement Community, a Grand Lodge-sponsored residential community. The parties ultimately entered an agreed order agreeing that the Grand Lodge and its affiliates were exempt but that residents’ leasehold interests in the units were to be assessed for taxation as omitted property City of Taylor Mill et al. v. Kenton County PVA, Kenton Cir. Ct. Case No. 2011-CI-949 (July 7, 2011). The Kenton County PVA then sought to assess the property, and the Grand Lodge appealed.
In Grand Lodge F. & A.M. et al. v. Kenton County PVA, Ky. Bd. Tax App. No. K12-S-69 (Nov. 19, 2014), the Kentucky Board of Tax Appeals held that tenants’ bare possession of their units at the Springhill Retirement Community, with no ability to sublet or transfer or encumber that property, “does not qualify as a taxable ‘interest in the property,’ within the meaning of the statute” [KRS 132.195] and the tenants do not have a taxable equitable or beneficial ownership interest in the units that they occupy. The Board also held that the residents have no rights to transfer the property and their bare right to occupy the premises has, therefore, no market value that could even be assessed.
H.B. 351 ends this dispute by amending KRS 132.195 to provide that it does not apply to interests in two categories of privately owned leasehold interests in residential property – Leasehold Categories 1 and 2, imposing a special low state-only property tax rate on Leasehold Category 1 and authorizing local governments to exempt that category from local ad valorem property taxation. These changes are effective for privately owned leasehold interests in residential property assessed on or after January 1, 2021. (H.B. 351, §§ 60 (amending KRS 132.195), 61 (amending KRS 132.020) and 79).
First, H.B. 351 amends KRS 132.195 to exclude Leasehold Category 1, being all privately owned leasehold interests in residential property when such property is owned in fee simple by an exempt purely public charity as of July 1, 2020: (i) when the real property includes a residential property unit that is (a) leased by the purely public charity for a period of at least one year to an individual person who is fifty-five years of age or older; (b) maintained as the individual person’s permanent residence under a lease agreement that prohibits the lessee from subleasing the unit and provides that the lessee’s possessory interest in the unit is terminable by the lessor upon the death of the lessee, the physical or mental inability of the lessee to continue to reside in the unit, or the lessee’s relocation to a nursing home or similar assisted living facility; and (c) constructed on or before July 1, 2020, or constructed after July 1, 2020, on land that was privately owned in fee simple by the purely public charity on or before July 1, 2020.
Second, H.B. 351 amends KRS 132.195 to exclude Leasehold Category 2, being all privately owned leasehold interests in residential property owned in fee simple by an exempt purely public charity, when the residential property unit is leased by the charity to an individual person who is: (i) receiving medical or educational supportive services from the charity; and (ii) is either a postsecondary educational participant; a minor; sick, disabled or impoverished; or over the age of sixty five.
H.B. 351 amends KRS 132.020 to impose a state rate of $0.015 per $100 of fair cash value of all Leasehold Category 1 privately owned leasehold interests. H.B. 351 also amends KRS 132.200 to provide that Leasehold Category 1 is exempt from local ad valorem property taxation provided an exemption is approved by the county, city, school or other taxing district where the residential property is located.
4. Changes to Industrial Revenue Bonds (“IRBs”) Authorizing Statutes
a. Clarification that IRBs may be Issued to Finance Solar Generating Facilities
IRBs may be issued by the state and local governments in Kentucky to help finance “industrial buildings” as defined by KRS 103.200. Bond funds may be used to finance the total project costs, including engineering, site preparation, land, buildings, machinery and equipment, and bond issuance costs. See KRS 103.200 to 103.285.
For IRBs the interest on which qualifies as tax-exempt for federal income tax purposes, the issuer serves as a conduit to provide a lower interest rate to the borrower. The issuer is not obligated for debt repayment; bondholders look to the “revenue” arising from the project to cover debt service. Bond proceeds from bond issues can be lent directly by the issuer.
KRS Chapter 103 also permits the issuer to hold title to the project financed with IRB proceeds and to lease the project to the private user/conduit borrower. In this instance, the project may be exempt from local property taxes during the term of the bond issue. KRS 103.285 and 132.200(7). The private user’s/conduit borrower’s leasehold interest in the project may also be eligible to be taxed at a reduced state rate of $0.015 per $100 of leasehold value, if such reduction receives the prior written approval by KEDFA as required by KRS 103.210 and KRS 132.020(1)(f)1.
H.B. 351 amends the definition” of “industrial buildings” to clarify that “solar-generated electricity constitutes the manufacturing, processing or assembly of a commercial product” which qualifies for IRB financing. (H.B. 351, § 47 (amending KRS 103.200)). This is simply a clarifying amendment; the Kentucky Attorney General opined in 2001 the generation of electricity constitutes manufacturing and electricity is a commercial product for purposes of the IRB statutes. Ky. Atty. Gen’l Op. No. 01-2, 2001 Ky. AG LEXIS 5 (March 2, 2001).
b. Increase Maximum Term of IRBs to Forty Years
The 2019 General Assembly amended KRS Chapter 103 and attempted to increase the maximum maturity date of any IRBs from 30 years to 40 years. See S.B. 192 (2019), 2019 Ky. Acts ch. 35, § 6 (eff. July 12, 2019). The 2019 Act amended the term reference in KRS 103.2101(7) but failed to amend the references KRS 103.220(1) and 103.246(6).
H.B. 491 (2020) corrects these deficiencies, allowing IRBs to be issued with a maximum term of up to 40 years. (H.B. 491, §§ 5 (amending KRS 132.220) and 6 (amending KRS 103.246)). H.B. 491 was signed by the Governor on April 2, 2020 and will take effect 90 days after the legislature adjourns sine die. See Ky. Const. § 55.
D. Sales and Use Taxes
1. Extension of Manufacturing Exemptions to Certain Retail Locations of Alcohol Manufacturers
H.B. 351 provides that effective August 1, 2020 the various sales and use tax exemptions provided to manufacturers – the exemptions for machinery for new and expanded industry, raw materials, industrial tools and industrial supplies – apply to the manufacturing or processing of distilled spirits, wine, or malt beverages at a premises that includes a retail establishment.
a. Machinery for New and Expanded Industry
H.B. 351 expands the sales and use tax exemption for machinery for new expanded industry to qualifying machinery located at a retail establishment of a distillery, winery and/or brewer. (See H.B. 351, §§ 34 (amending KRS 139.010), 35 (amending KRS 139.470) and 77). The exemption is provided by KRS 139.470(10)).
To qualify as machinery for new and expanded industry, the property must satisfy four requirements: (i) it must be machinery; (ii) it must be directly used in the manufacturing or industrial processing process; (iii) it must be incorporated for the first time into “plant facilities” in Kentucky; and (iv) it must not replace other machinery (the “Four Requirements”). (See KRS 139.010(19) and 103 KAR 30:120).
In Camera Center, Inc. v. Revenue Cabinet, 34 S.W.3d 39 (Ky. 2000), the Kentucky Supreme Court addressed whether on-site photo processing laboratory equipment used at primarily retail locations qualified as machinery for new and expanded industry. The Kentucky Board of Tax Appeals, Jefferson Circuit Court and the Kentucky Court of Appeals each had held the purchases did not qualify because, as primarily retail locations, the equipment was not incorporated into “plant facilities.” The Kentucky Supreme Court reversed, holding the term “plant facilities” included more than just factories or industrial manufacturing establishments and the exemption was based on the type of machinery or equipment and not the extent of the industrial manufacturing occurring at a particular location.
The 2001 General Assembly legislatively overruled Camera Center by defining “plant facility” to exclude primarily retail locations as follows:
“Plant facility” means a single location that is exclusively dedicated to manufacturing or industrial processing activities. A location shall be deemed to be exclusively dedicated to manufacturing or industrial processing activities even if retail sales are made there, provided that the retail sales are incidental to the manufacturing or industrial processing activities occurring at the location. The term “plant facility” shall not include any restaurant, grocery store, shopping center, or other retail establishment.
KRS 139.010(28)(emphasis added).
H.B. 351 amends the definitions for the second and third of the Four Requirements for the machinery for new and expended industry exemption. As amended, qualifying machinery must be directly used in the manufacturing or industrial processing process of: (i) tangible personal property at a plant facility; (ii) distilled spirits or wine at a plant facility or on the premises of a distiller, rectifier, winery, or small farm winery licensed under KRS 243.030 that includes a retail establishment on the premises; or (iii) malt beverages at a plant facility or on the premises of a brewer or microbrewery licensed under KRS 243.040 that includes a retail establishment. Qualifying machinery must be incorporated for the first time into: (i) a plant facility established in Kentucky; or (2) licensed premises located in Kentucky.
b. Raw Materials, Industrial Tools and Industrial Supplies
H.B. 351 makes similar changes to the sales and use tax exemptions for raw materials, industrial tools and industrial supplies, expanding these exemptions to qualifying purchases of tangible personal property to be used in manufacturing or processing alcoholic beverages at a retail establishment of a distillery, winery and/or brewer. (See H.B. 351, §§ 35 (amending KRS 139.470) and 77). The exemptions are provided by KRS 139.470(9)).
c. Installation and Repair Labor
H.B. 351 similarly expands the exemption for labor or services to apply, install, repair, or maintain tangible personal property directly used in manufacturing or industrial processing process to include such process of alcoholic beverages at the retail establishment of a distillery, winery, and/or brewer. (See H.B. 351, § 35 (amending KRS 139.470) and 77). The exemption is provided by KRS 139.470(22)).
2. Educational, Charitable and Religious Exemption
KRS 139.495 exempts charitable, educational and religious institutions exempted from federal income taxation under Section 501(c)(3) of the Code (collectively, “Charities”) from Kentucky sales and use taxes on their purchases of tangible personal property to be used in their charitable, educational or religious function. That statute has never exempted Charities from the obligation to collect and remit tax on their sales. Nevertheless, the KDOR after the recent decision of the Kentucky Supreme Court in Commonwealth v. Interstate Gas Supply, Inc., 554 S.W.3d 831 (Ky. 2018) began stating publicly that the decision changed the law such that Charities must now, for the first time, begin collecting and remitting sales and use tax on their sales.
The 2018 General Assembly enacted two bills that, inter alia, amended some of the existing categories of taxable services and added ten new categories of services subject to sales tax. See H.B. 366 (2018) and H.B. 487 (2018) (collectively, the “ 2018 Acts”). Kentucky’s sales tax has been imposed on admissions since the tax was enacted in 1960. The Acts added a definition of “admissions” that substantially expanded the scope of the existing sales tax on admissions to include fees paid for “the privilege of using facilities or participating in an event or activity.” See KRS 139.010(1). These changes were effective July 1, 2018.
The combination of newly expanded taxable admissions and KDOR-threatened enforcement against Charities led to lobbying for a legislative fix. The 2019 General Assembly responded by exemptinh Charities and other nonprofit organizations from sales tax on the following: (i) sales of admissions; or (ii) fundraising event sales. (H.B. 354 (2019), §§ 28 and 29, amending KRS 139.495 and creating a new statute, respectively). “Fundraising event sales” are not defined, but they do not include sales related to the operation of a retail business, such as thrift stores, bookstores, surplus property auctions, recycle and reuse stores, or any ongoing operations in competition with for-profit retailers. All other sales by Charities and other nonprofit organizations remain taxable. For purposes of these new exemptions, exempt Charities are “resident, nonprofit educational, charitable, or religious institutions which have qualified for exemption from income taxation under Section 501(c)(3) of the Internal Revenue Code.” See KRS 139.495, as amended. Other nonprofit organizations are “nonprofit civic, governmental, or other nonprofit organizations.” (Id., § 29.)
H.B. 351 further clarifies the exemptions enacted in 2019 to provide that effective August 1, 2020 exempted sales of admissions by Charities and other nonprofit organizations include “sales of admissions to a golf course when the admission is the result of a fundraising event” but “all other sales of admissions to a golf course by these institutions are not exempt from tax.” (H.B. 351, §§ 40 (amending KRS 139.495), 41 (amending KRS 139.498), 42 (amending KRS 139.200) and 77).
E. Miscellaneous Excise Taxes
1. Notification of “Average Wholesale Price” for Fuel Taxes
Kentucky imposes an excise tax on gasoline and special fuel received in the state at the rate of nine percent (9%) of the “average wholesale price” rounded to the nearest one-tenth of one cent ($0.001), which tax is paid by the dealer who receives the gasoline or special fuel. See KRS 138.220. H.B. 351 amends KRS 138.220 to provide that the KDOR will notify dealers of the average wholesale price at least twenty days prior to July 1 of each calendar year. (H.B. 351, § 4 (amending KRS 138.220)). Prior to this change, the KDOR was required to provide such notification quarterly.
2. Renewal and Extension of the Motor Vehicle Tire Fee Program
Kentucky imposes a motor vehicle tire “fee” at the rate of $2.00 on each new tire sold in Kentucky at retail for use on “motor vehicles”. The “fee” is administered by the KDOR. A “motor vehicle” is one not powered by human propulsion and is used to transport people or property over public highways, including automobiles, trucks, farm and construction equipment, trailers and motorcycles (but not mopeds). Tires sold for vehicles not used on public highways, recapped tires, used tires and tires placed on motor vehicles prior to the original sale of that vehicle are exempt from the fee. See KRS 224.50. The current fee is set to expire July 1, 2020.
H.B. 351 renews and extends the program for an additional two years. Beginning July 1, 2020 but prior to July 1, 2024, a $2.00 fee is imposed upon a retailer not only for each new “motor vehicle” tire sold in Kentucky but also each new “trailer” or “semitrailer” tire sold in Kentucky. The fee is subject to the Kentucky sales tax. (H.B. 351, § 29 (amending KRS 224.50-868), 30 (amending KRS 224.50-855) and §§ 31-33 (conforming amendments to KRS 224.60-130, -142 and -145). H.B. 351 provides the following new definitions:
“Motor vehicle” means every vehicle intended primarily for use and operation on the public highways that is self-propelled, including a low-speed motor vehicle defined in KRS 186.010 (compare to prior definition in KRS 138.450).
“Semitrailer” means any vehicle: (i) designed (a) as temporary living quarters for recreation, camping, or travel, or (b) for carrying persons or property; (ii) designed for being drawn by a motor vehicle; and (iii) constructed that: (a) some part of its weight, or (b) some part of its load; rests upon or is carried by another vehicle (compare KRS 139.470(20) and KRS 189.010(12)).
“Trailer” means any vehicle: (i) designed (a) as temporary living quarters for recreation, campaign, or travel, or (b) for carrying persons or property; (ii) designed for being drawn by a motor vehicle, and (iii) constructed that (a) no part of its weight, and (b) no part of its load; rests upon or is carried by another vehicle (compare KRS 139.470(20) and KRS 189.010(17)).
3. Refund Authorized for Coal Severance Tax Paid on Coal Exported Outside of North America
H.B. 351 enacts a new statute that authorizes taxpayers engaged in severing or processing coal in Kentucky a refund of coal severance tax they paid with respect to coal that “is transported directly to a market outside of North America.” (H.B. 351, § 46 (creating a new statute in KRS Chapter 143)). Qualifying taxpayers must file an application for refund with the KDOR with supporting documentation. Refund applications can be filed on or after August 1, 2020 and before July 1, 2022. Refunds are limited during any calendar year to the export of a combined total of 10,000,000 tons of coal subject to the coal severance tax “and exported through United States Coal export terminals to markets outside of North America.”
4. Time for Remitting Payment for Cigarette Excise Tax Stamps
H.B. 351 adjusts the time for payment of the cigarette excise tax, a stamp tax. The general rule is that payment for stamps must be made at the time the stamps are sold to wholesalers. If the licensed wholesaler has filed a qualifying bond with the KDOR and registered and agreed to pay the tax electronically, the license wholesaler shall have 10 days from the date of purchase of the stamps to remit payment of cigarette tax. (H.B. 351, § 39 (amending KRS 138.146)).
5. Extend Tobacco Excise Tax to Vaping Products
H.B. 351 enacts a new vaping products tax on closed vapor cartridges and open vaping systems effective August 1, 2020.
Prior to the 2005 Kentucky Tax Modernization Act, Kentucky imposed an excise tax only on cigarettes; no other tobacco products were taxed. The Tax Modernization Act expanded the excise tax to “snuff” and “other tobacco products”, the latter category being defined to include “cigars, cheroots, stogies, periques, granulated, plug cut, crimp cut, ready dubbed, and other smoking tobacco, cavendish, plus and twist tobacco, fine-cut, and other chewing tobacco, shorts, refuse scraps, clippings, cuttings and sweepings of tobacco, and other kinds and forms of tobacco prepared in a manner to be suitable for chewing or smoking in a pipe or otherwise, or both for chewing or smoking” but excluding cigarettes and snuff. The General Assembly in 2006 attempted to expand the excise tax to “cigarette paper”, defined as paper or a similar product suitable for use and likely to be offered to, or purchased by, consumers of roll-your-own tobacco. That expansion was invalidated on procedural grounds because the tax was included in the Executive Branch Budget Bill. See Ky. Dep’t. of Revenue v. North Atlantic Operating Company, Inc., Ky. Ct. App. Case No. 2008-CA-000304 (March 27, 2009)(unpublished).
Effective August 1, 2020, H.B. 351 imposes a new “vapor products tax” on “closed vapor cartridges” and “open vaping systems”. (H.B. 351, §§ 50 – 56 (amending KRS 138.130, 138.132, 138.135, KRS 138.140, 138.183, 138.195 and 138.197) and 77). The excise tax on closed vapor cartridges is $1.50 per cartridge. The excise tax on open vaping systems is 15% of the actual price for which the distributor sells the open vaping system. The tax is imposed on the licensed retail distributors of tobacco products that first possesses “vapor products” for sale to a retailer in Kentucky when they purchase “untax-paid” closed vapor cartridges and open vaping systems.
“Vapor products” is defined to mean a “closed vapor cartridge” or an “open vaping system.”
“Closed vapor cartridge” is defined to mean a pre-filled disposable cartridge that: (i) is intended to be used with or in a noncombustible product that employs a heating element, battery, power source, electronic circuit, or other electronic, chemical, or mechanical means, regardless of shape or size, to deliver vaporized or aerosolized nicotine, non-nicotine substances, or other materials to users that may be inhaling from the product such as any electronic cigarette, electronic cigar, electronic cigarillo, electronic pipe, or other similar product or device and every variation thereof, regardless of whether marketed as such; and (ii) contains nicotine or non-nicotine substances or other material consumed during the process of vaporization or aerosolization. “Closed vapor cartridge” does not include any product regulated as a drug or device by the United States Food and Drug Administration under Chapter V of the Food, Drug, and Cosmetic Act.
“Open vaping system” is defined to mean: (i) any noncombustible product that employs a heating element, battery, power source, electronic circuit, or other electronic, chemical, or mechanical means, regardless of shape or size and including the component parts and accessories thereto, that uses a refillable liquid solution to deliver vaporized or aerosolized nicotine, non-nicotine substances, or other materials to users that may be inhaling from the product such as any electronic cigarette, electronic cigar, electronic cigarillo, electronic pipe, or similar product or device and every variation thereof, regardless of whether marketed as such; and (ii) any liquid solution that is intended to be used with the product described in subparagraph (i). “Open vaping system” does not include any product regulated as a drug or device by the United States Food and Drug Administration under Chapter V of the Food, Drug, and Cosmetic Act.
F. Cleanup Changes
H.B. 351 makes a number of nonsubstantive technical corrections to various Kentucky tax statutes. See H.B. 351, §§ 5, 6, 10-13 and 15 (technical corrections to KRS 138.450 relating to the motor vehicle usage tax, KRS 139.620 relating to sales and use tax resale certificates for services purchased for resale, KRS 141.121 governing apportionment of business income, KRS 141.201 governing the filing of mandatory combined and elective consolidated returns, KRS 141.202 governing the mandatory filing of unitary combined returns, KRS 141.205 governing the addback of certain expenses, and KRS 141.383 governing refundable motion picture or entertainment production tax incentives).
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