Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states corporations are subject to a corporate income tax, while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
Currently, four states (Nevada, South Dakota, Washington, and Wyoming) do not have a corporate income tax, and the same four states, along with Alaska, Florida, and Texas, have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Kentucky has a “limited liability entity tax” (LLET) and a corporation income tax. Your business may be subject to one, both, or neither of these taxes depending on its legal form. Additionally, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.
Kentucky’s limited liability entity tax applies to traditional corporations, S corporations, LLCs, limited partnerships (LPs), and limited liability partnerships (LLPs). The tax is based on a business’s annual gross receipts. For businesses with gross receipts less than $3 million, there is a minimum LLET of $175. For businesses with $3 million or more in gross receipts, the LLET is the lesser of 9.5 ¢ per $100 of gross receipts or 75 ¢ per $100 of gross receipts. (Also, while not detailed here, there are several methods through which businesses with gross receipts greater than $3 million but less than $6 million may reduce their LLET.)
Kentucky’s corporation income tax is based on a series of marginal tax rates; the specific breakdown is as follows:
A corporation is also allowed a credit on its income tax equal to the amount by which its LLET exceeds the LLET minimum of $175.
Let’s briefly look at additional details for five of the most common forms of Kentucky business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Kentucky corporations are subject to Kentucky’s corporation income tax and LLET.
Example: For the latest tax year, your Kentucky corporation had taxable net income of $100,000 and gross receipts under $3 million. Your corporation will owe the minimum LLET of $175. Other things being equal, your corporation will also owe Kentucky corporation income tax in the amount of $4,500 (4% of first $50,000 plus 5% of remaining $50,000).
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation generally is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each shareholder is subject to federal tax on his or her share of that income; in other words, S corporations are “pass-through” entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.) Kentucky recognizes the federal S election, but nonetheless imposes the LLET on S corporations. In addition to the LLET, each individual S corporation shareholder will owe tax to the state on his or her share of the corporation’s income.
Example: For the latest tax year, your Kentucky S corporation had net income of $100,000 and gross receipts under $3 million. Your corporation will owe the minimum LLET of $175. In addition, the corporation’s net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your respective state tax returns. The rate for each shareholder will vary depending on his or her overall taxable income for the year.
Limited Liability Companies (LLCs). Like S corporations, standard LLCs are pass-through entities and are not required to pay federal income tax. However, in Kentucky, LLCs are required to pay the LLET. The LLET aside, income from the LLC is distributed to individual members, who then pay federal and state taxes on the amount distributed to them.
Note that while by default LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, “disregarded entities”), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject to Kentucky’s corporate income tax.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $100,000 and gross receipts under $3 million. The LLC will owe the minimum LLET of $175. In addition, the LLC’s net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your own portions on your respective state tax returns; the rate for each member will vary depending on his or her overall taxable income for the year.
Partnerships. In Kentucky, limited partnerships and limited liability partnerships, as limited liability entities, are subject to the LLET. General partnerships, however, are not. The LLET aside, income from partnerships is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns.
Example: For the latest tax year, your Kentucky partnership, which is not a limited partnership or limited liability partnership, had net income of $100,000. The $100,000 in net income will be divvied up between you and your fellow partners, and you will each pay tax on your respective portions on your respective state tax returns; the rate for each partner will vary depending on his or her overall taxable income for the year.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income. (A sole proprietorship is not a limited liability entity so there is no LLET.)
Example: For the latest tax year, your sole proprietorship had net income of $100,000. The $100,000 in net income is distributed to you personally, and you pay tax on that income on your individual state tax return; the rate will vary depending on your overall taxable income for the year.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Kentucky. However, if you’re doing business in several states, you should be aware that your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Kentucky, it may be subject to Kentucky taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Kentucky’s limited liability entity tax and corporation income tax, check the Department of Revenue website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Frederick Daily (Nolo).