As Kentucky looks to grow its economy, the business community has successfully advocated for many priorities to create a more competitive tax system to help the state become more attractive for businesses and workers.
Dr. Charles Aull, Executive Director for the Kentucky Chamber Center for Policy and Research, and Kevin Fuqua, CPA, Regional Service Tax Line Lead for the Central Region for Cherry Bekaert Advisory, testified on Wednesday in front of the Interim Joint Committee on Appropriations and Revenue to discuss the positive impact of Kentucky’s pass-through entity tax since being enacted in 2023.
Understanding Pass-Through Entity Tax
A pass-through entity tax is a voluntary state tax option for business owners that allows them to reduce their federal income tax liability and supports parity between federal tax treatment of corporate businesses and non-corporate businesses. States throughout the country began implementing pass-through entity taxes after the 2017 Tax Cuts and Jobs Act capped the State and Local Tax deduction at $10,000. A sanctioned practice by the IRS, state-level pass-through entity taxes allow owners of pass-through businesses like partnerships and S-corps to pay state taxes at the entity level instead of at the individual level. The same amount of tax is paid to the state, but owners of a business can fully deduct their state income taxes on their federal returns. This has the effect of reducing their total federal income tax liability. The Kentucky Chamber successfully advocated for legislation to establish a Kentucky pass-through entity tax in the 2023 legislative session.
“Of the 41 states that levy a personal income tax, 36 of them have a pass-through entity tax on the books. I think that statistic is important to keep in mind as we think about this,” said Aull. “Think about the competitiveness impact if we didn’t have this but it was offered in states surrounding us; it’s an important part of our broader economic competitiveness landscape.”
Fuqua commended the Kentucky General Assembly for passing this legislation and called it a “very favorable tax law for the state of Kentucky and our residents and businesses.” Fuqua provided committee members with a history of pass-through entity taxes and offered an example of how the tax helps business owners.
Representatives of the Office of State Budget Director and Department of Revenue also presented during the meeting, sharing technical information on the pass-through entity tax.
Going forward, there are unknown factors that could cause this law to change as many elements of the Tax Cuts and Jobs Act are set to expire in 2025, including the $10,000 State and Local Tax deduction cap. Congress could extend the cap, repeal it, reduce it, raise it, or structurally change the deduction. When asked by lawmakers about the impact of a repeal of the cap on the State and Local Tax deduction, Fuqua explained that the pass-through entity tax could still help many Kentucky business owners. Stay tuned to The Bottom Line for more on tax legislation.
