There is an ongoing trend in sales and use taxes of states attempting to broaden the sales tax base, often by extending the sales tax to services. It is also common to see such measures coupled with reductions in income or sales tax rates. Whether or not this is a proper solution to states’ fiscal concerns is a point of no small amount of contention in the literature. Irrespective of that relatively esoteric discussion, sales tax base expansions—particularly those aimed at services in general and digital services especially—are a trend that can be expected to continue.
States are looking for new sources of revenue
During the COVID-19 pandemic, we witnessed a brief reversal of a nearly century-old trend of goods purchases declining as a percentage of total personal consumption. In 1947, purchases of goods accounted for a little over 60% of personal consumption. By 2007, that number had shrunk to around 35%. U.S. Bureau of Economic Analysis. While Wayfair helped ease the crunch on state coffers caused by the relatively rapid rise of eCommerce, many states remain affected by the sales tax implications of this longer-term trend of services dominating goods as a proportion of personal consumption. Though it isn’t an immediate concern, this trend does represent a long-term risk for states.
Therefore, it should come as little surprise that proposals to expand the sales tax base to include services crop up with some regularity in state legislatures. In the last session alone, there were no fewer than three such proposals. In Nebraska, LB 422 (died pursuant to adjournment) would have created the presumption that all services other than business inputs are taxable while lowering the sales tax rate to 5%. Likewise, North Carolina’s HB 823 (died pursuant to adjournment) would have extended the sales tax to sales of services. In Kentucky, however, HB 8 was enacted over a gubernatorial veto and will extend Kentucky’s sales and use taxes to a slew of new services.
It is worth noting that this is not the first time Kentucky has done this. There was similar legislation in 2018 that expanded the sales tax to several new services. HB 8, however, is much more expansive and includes, among other provisions, a scheduled individual income tax reduction, an extension of the use tax, and a new amnesty period—in addition to the sales tax expansion.
What is happening with Kentucky sales and use tax?
One of the most notable provisions of the bill is the expansion of the sales and use taxes to 38 additional services. For example, there are marketing and telemarketing services, respectively, defined to mean “developing marketing objectives and policies, sales forecasting, new product developing and pricing, licensing, and franchise planning” and ”services provided via telephone, facsimile, electronic mail, or other modes of communications to another person, which are unsolicited by that person, for the purposes of: (a) (i) promoting products or services; (ii) taking orders; or (iii) Providing information or assistance regarding the products or services; or (b) soliciting contributions.”
The bill also extends sales and use taxes to website design, development, and hosting services, as well as prewritten computer software access services (I.e., SaaS, PaaS, and IaaS). The latter of which is defined to mean “the right of access to prewritten computer software where the object of the transaction is to use the prewritten computer software while possession of the prewritten computer software is maintained by the seller or a third party, wherever located, regardless of whether the charge for the access or use is on a per use, per user, per license, subscription, or some other basis.” Both website services and software access are also part of a separate but similar trend of states extending their sales taxes to digital products and services.
Additionally, unlike the bill passed in 2018, HB 8 also extends the use tax to these newly taxable services, as well as to the services that were subjected to the sales tax previously. At the same time, it will exempt limo services, which were taxed in 2018, and provide a new exemption for “farm medications.”
The bill also provides for an incremental decrease of the individual income tax of 0.5% per year, beginning in 2023. However, there are certain criteria that must be met for the reduction to occur. First, the balance in the Budget Reserve Trust Fund at the end of the fiscal year must be greater than or equal to the General Fund monies for that fiscal year. Second, the General Fund monies must be greater than or equal to the General Fund appropriations plus the Individual Income Tax equivalent, which is the amount of reduction in General Fund monies resulting from a one percentage point reduction to the individual income tax rate.
What does this mean going forward?
Provided these criteria were met for this fiscal year, the individual income tax reduction will occur automatically on January 1, 2023, reducing the individual income tax from 5% to 4.5%. In future years, however, the reductions will require reaffirmation by the general assembly. Given Kentucky’s fiscal situation, as well as the current political climate, it seems likely that there will be reductions in 2023 and 2024, at least.
HB 8 also provides for a new amnesty period from October 1 to November 29, 2022. During this period, amnesty is available for sales that took place between October 1, 2011, to December 21, 2021, and will apply to most tax types, as well as associated penalties, fees, and interest collected by the Department of Revenue. The amnesty period will not be applicable to taxes and fees not collected by the Department of Revenue. Additionally, enhanced penalties are imposed for failure to participate in the amnesty period on any taxes later found to be due.
Some other notable provisions include a new excise tax on electric vehicle power distribution and new electric vehicle ownership fees. Such taxes and fees are another trend all their own, which is becoming more common as the growing electric vehicle market takes an ever-larger toll on fuel tax revenues. The bill also levies a new state excise tax on motor vehicle renting/sharing services while simultaneously authorizing local jurisdictions to impose a license fee on such services. Additionally, HB 8 authorizes state and local transient room license taxes on online travel companies.
These are only some of the numerous provisions found in HB 8. The bill is certainly worth a good read for any businesses operating in Kentucky, but particularly for those businesses selling services in the Commonwealth.
Even for those with no direct connection to Kentucky, this is a trend to keep an eye out for. It’s critical for accountants to know the details of each district in which their clients operate – or are planning to operate. Additionally, understand how sales tax regulations are evolving in other areas and how they could potentially impact your clients.
Consumer spending on services as a proportion of total personal consumption is already back to where it was pre-pandemic. If Kentucky’s move here is perceived as a success, it can only serve to increase the propensity of state legislatures to propose similar sales tax base expansions. Whether this comes to pass and whether or not such base expansions are the right way for states to address revenue issues, only time will tell.
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