FRANKFORT, Ky. — Owners of some Kentucky small businesses now have access to a new opportunity to reduce their federal income tax liability, thanks to legislation passed by the General Assembly earlier this year and championed by the Kentucky Chamber.
Under the new law, owners of pass-through businesses – such as partnerships, for example – can pay their state income taxes at the business level instead of at the individual level. In some instances, this option may allow these employers to reduce their overall federal individual income tax burden.
The Kentucky Department of Revenue recently released a new form for filing the tax as well as a Q&A and instructions.
The change relates to a cap on the amount of state taxes that small business owners can deduct from their federal income taxes. Under federal law, owners can only deduct up to $10,000 in state taxes paid as individuals. The new law in Kentucky, however, allows owners to pay state income tax at the business level, thereby creating a business expense that is fully deductible and not subject to the $10,000 cap.
Generally known as a pass-through entity tax or a SALT (state and local tax) cap workaround, this option is available in 30 other states and is recognized by the IRS as an allowable option for states to consider and utilize. All taxpayer savings are realized at the federal level. There is no impact on state revenues.
Kentucky’s new pass-through entity tax is optional and may not necessarily result in net savings for all business owners. Any decision to utilize the tax should be considered carefully and in consultation with a tax professional.
Passing legislation to allow for a pass-through entity tax was a top priority for the business community in the 2023 legislative session. Lawmakers passed House Bill 360, which included the initial framework for the pass-through entity tax. They later passed House Bill 5, which included key details and significantly improved the statutory basis of the tax. It has been estimated that a pass-through entity tax could save upwards of $40 million in reduced federal income tax liability for Kentucky taxpayers.
This legislation was in addition to the passage of House Bill 1, which will reduce Kentucky’s individual income tax rate from 4.5 percent to 4.0 percent in January 2024.
