The Kentucky CPA Journal

Feature

State Taxes: Kentucky vs. our neighbors

Issue 1
March 10, 2025

By Jon Tennent, CPA

State tax has become a hotter-than-usual topic recently as states have competed on tax policy and debated its economic effects. This article will juxtapose Kentucky with four comparable states that border us – Tennessee, West Virginia, Ohio and Indiana. We will cover income tax, sales tax and property tax.

Our goal is to provide a concise general overview. As with all things tax, there are nuances and exceptions to every rule. The numbers below are intended to be high-level averages, any specific tax scenario would naturally require a deeper analysis.

Income tax

Tennessee has no individual income tax, and the “Hall Tax” on investment income has been repealed since 2021. However, there are two other forms of tax that business owners need to consider:

1. The “Business Tax,” essentially a gross receipts tax, applies to businesses with at least $100,000 of annual receipts. Rates vary by the business classification. Notably, it can be enacted at both the state and local level. Market-based sourcing rules make this tax applicable even to businesses with no physical presence in Tennessee.
2. The “Franchise & Excise Tax,” applies to most corporations and limited-liability entities in the state. Both taxes are calculated on the same return, however, the Excise Tax is 6.5 percent of net taxable income derived in Tennessee, and the Franchise Tax is 0.25 percent of the greater net worth or the real and tangible property in Tennessee, with a minimum tax of $100.

The Kentucky state legislature is attempting to phase down the individual income tax and largely replace those revenues by expanding the sales tax base. The individual income tax rate dropped from a flat 5 percent to 4.5 percent in 2023, 4 percent for 2024 and 2025, and has recently been approved for 3.5 percent in 2026. The Kentucky corporate income tax remains at a flat 5 percent, and all limited liability entities are also subject to the LLET, which is a tax on gross receipts or gross profits. Lastly, Kentucky has also empowered local municipalities to enact their net profits or gross receipts tax regimes which operate separately from any state tax program.

West Virginia is also attempting to phase down its individual income tax. Rates are graduated, but the top rate dropped from 5.12 percent to 4.82 percent for 2025. West Virginia is also the only state on this list (besides Tennessee, which has no individual income tax) to have no local payroll tax on individual employees, although some cities have flat “user fees” for workers in their jurisdiction. The West Virginia corporate income tax rate is 6.5 percent. Some municipalities have enacted a business gross receipts tax, the Business and Occupation tax, at the local level.

Indiana is also reducing its flat individual income tax to reach 2.9 percent by 2027. For 2025, the rate dropped from 3.05 percent to 3 percent. The corporate income tax rate is 4.9 percent. Indiana does have a local income tax system, but local taxes are remitted on the state income tax forms (such as the IT-40 for individuals or the IT-20 for corporations) and then distributed to the municipalities.

Ohio has a graduated bracket system for individual income tax with the top rate at 3.5 percent. Since 2020, there has been no corporate income tax. However, there are several additional considerations for business taxation:

1. On individual income tax returns with business income, such as from a sole proprietorship or a passthrough entity, Ohio allows a state deduction of $250,000 against Ohio business income. Any remaining business income is taxed separately from individual income at a flat 3 percent.
2. The Commercial Activity Tax (CAT) is a tax on Ohio gross receipts levied on entities doing business in the state. In 2024, the annual minimum tax of the CAT was eliminated, and the exclusion amount increased from $1 to $3 million. Starting in 2025, the exclusion amount is $6 million.
3. Local municipalities are also empowered to levy their taxes. Most Ohio cities participate in the state’s RITA (Regional Income Tax Agency) program, which allows standardized filing for local taxes.

Sales tax

All five states impose a sales tax at the state level, while three of the states (Ohio, Tennessee, and West Virginia) allow local sales tax in addition. The state rate is 6 percent for Kentucky, Ohio and West Virginia, while the state rate is 7 percent for Indiana and Tennessee.

The max rate for Tennessee localities is 3 percent; Ohio localities are 2 percent; and West Virginia localities are 1 percent. However, the average local rate imposed by localities in Ohio is only 1 percent as well.

When we combine the state and local rates to get the average combined rate, Kentucky comes out the lowest at 6 percent. Indiana, Ohio and West Virginia all average 7 percent, and Tennessee averages 10 percent.

It is important to note that sales and use taxes are not uniformly applied, and different states subject different types of goods and services to tax. Therefore, the percentage alone does not tell the entire story.

Property tax

Property taxes vary widely by municipality, but the Tax Foundation has collected and made available the effective average residential property tax rates by state. The percentages are calculated on the total real estate taxes paid divided by the total home value. The data are a few years old, but the percentages are useful as a baseline:

• Kentucky – 0.83 percent
• Indiana – 0.84 percent
• West Virginia – 0.57 percent
• Ohio – 1.59 percent
• Tennessee – 0.67 percent

The full data set is available here.

Putting it together

Although numerous other taxes are assessed at various levels – excise taxes, lodging taxes, gasoline taxes, financial institution taxes, etc. – the three categories above are the ones that individual taxpayers tend to think about most often. Let’s look at some round numbers to see how an example taxpayer’s situation might vary from state to state.

In this example, our taxpayer makes $100,000 per year on a W-2, spends $20,000 on items subject to sales tax, and owns a home worth $250,000. Only state income taxes (not Federal or local) are considered here. Business and corporate taxes, along with a host of other economic factors, would naturally also have an indirect impact on any individual taxpayer’s situation.

As state tax policy evolves, KyCPA will continue to monitor and advocate for our priorities here in Kentucky.

About the author: Jon Tennent, CPA, is a partner at Besten & Dieruf, PLLC in Lexington. Tennent serves on the Society’s Editorial Board and Tax Committee. He can be reached at jon@ebdcpa.com.