Kentucky banks seek tax changes ahead of legislative session

FRANKFORT, Ky. (AP) — Kentucky Farmers Bank, founded in 1931, is the only bank with headquarters in Boyd County, an eastern Kentucky community that borders West Virginia and Ohio. In 2017, the bank had $486,000 in taxable income. Kentucky's top corporate tax rate was then 6 percent, but the bank paid $454,000 in taxes.

That's because Kentucky taxes banks differently than other businesses, something the banking industry wants to change in 2019. They have found a receptive audience in the Kentucky legislature, where the Kentucky Bankers Association's political action committee spent more than $100,000 during the midterm elections, donating to more than half of the of the 100 House members who were elected.

Taxing the banks like every other business in Kentucky would cost taxpayers at least $50 million in annual revenue, money the state needs as it struggles to pay off a massive public pension debt. But the banking industry says the state has options to recover that money, including new revenue from taxing internet sales.

The issue is one lawmakers are likely to consider when they return to Frankfort in January for a "short session" when they will have 30 legislative days to pass bills.

Kentucky's bank franchise tax has been in place since the mid-1990s. The legislature came up with it after a court ruling said the way Kentucky taxed banks was unconstitutional. The formula is complex, but essentially the more capital a bank has, the more in taxes it must pay. In 2010, responding to the Great Recession that crippled the economy, Congress passed a law requiring banks to have more capital on hand. That meant more taxes from Kentucky banks.

Since then, the state legislature has lowered the corporate tax rate to 5 percent. But that change did not apply to Kentucky banks. It's difficult to compare the tax rates of banks and other businesses because one rate is based on capital while the other rate is based on revenue. But the Kentucky Bankers Association hired three accounting firms to give it a try. They surveyed 59 banks, determining their average tax rate was 13.3 percent compared to the 5 percent paid by other corporations.

In some cases, like Kentucky Farmers Bank, the discrepancy is even larger.

"It's becoming much more difficult to be a community bank," CEO April Russell Perry said.

Since 2000, Kentucky has lost at least 56 state-chartered banks, leaving 124 still operating, according to the Kentucky Department of Financial Institutions' annual reports. Ballard Cassady, president of the Kentucky Bankers Association, said many have been sold or merged with other banks that then move the capital out-of-state to avoid the state's taxes. In the past five years, Cassady said state-chartered banks have lost control of more than $600 million of capital, which has cost the state $7.5 million in tax revenue.

"This is not just a problem for banks," he said. "This is a problem for the entire state."

Glen Waldrop, spokesman for the Kentucky Department of Revenue, said the agency could not verify Cassady's assertion that Kentucky has lost $7.5 million in tax revenue. He noted the agency has not made an official projection of how much money the state would lose should the state change how it taxes banks, but said "$50 million appears to be a reasonable estimate."

But even with some banks being sold to out-of-state owners, the bank franchise tax has been a growing source of revenue for the state. The tax brought in $115 million in the 2018 fiscal year, up from $102 million in 2014. Still, the bank's argument appears to have won over Republican Senate President Robert Stivers, who says he is worried about the jobs and tax revenue that are leaving the state.

"It will be portrayed as nothing but a big break, a tax break for the banks. It's not," Stivers said. "It's so we can have locally owned banks here in Kentucky."

Filling a $50 million hole in the state budget could be difficult. But lawmakers have some options. For one thing, the state is expecting an extra $30 million a year from the taxing of purchases made on the internet following a U.S. Supreme Court decision. That was money the state did not plan to receive.

Chris McDaniel, chairman of the Senate's budget committee, said he does not want to use that money to offset a tax change for banks. He said he is open to the tax change, but noted the legislature passed a bill earlier this year that raised sales taxes on some industries while cutting corporate and individual income tax rates.

"We did a good solid overhaul this last time and I don't know how much appetite there is for doing all these little one-offs," he said.