The Kentucky CPA Journal

Feature

Kentucky vs. our neighbors: Part II - From education to research and development

Issue 3
November 3, 2025

By Jon Tennent, CPA

This article is a follow-up to our earlier piece comparing tax policy between Kentucky and four of our closest neighbors: Tennessee, West Virgina, Ohio, and Indiana. In this article, we will move beyond general tax rates and into specific tax policies in a few key areas: 529 plans, research and development incentives, and Federal tax conformity as it relates to depreciation.

529 plans

At the Federal level, contributions to education savings accounts via 529 plans are not tax-deductible. The primary benefit is the tax-free growth of these investments, which can also be distributed tax-free if used for qualified educational expenses.

Since these plans are organized and administered at the state level, many states have enacted policies that result in additional state tax benefits designed to promote savings for education. Tennessee is an exception as there is no state income tax.

Kentucky (www.kysaves.com) is not one of the states with specific benefits, as the Kentucky 529 plan tax treatment is essentially the same as Federal: no state deduction or credit, simply tax-free growth and distributions for qualified educational expenses.

In Indiana (www.myindiana529.com), taxpayers can claim a state tax credit equal to 20 percent of their 529 plan contributions, up to a maximum of $1,500 per year (or $750 per year if married filing separately). There are some circumstances that could lead to the recapture of this credit, such as rolling the funds over to another state’s 529 plan, non-qualified withdraws, paying K-12 (pre-college) expenses to a school outside Indiana with the funds, education loan repayments, or rollovers to a Roth IRA.

In West Virginia (www.smart529.com), families can deduct their entire 529 plan contribution against their state taxable income. Similarly to Indiana, this benefit (deduction in WV’s case) can be recaptured on non-qualified distributions.

In Ohio (www.collegeadvantage.com), taxpayers can deduct up to $4,000 per beneficiaries per year against their state taxable income. This deduction has an unlimited carryforward period, and the deduction is available to the contributor (not necessarily the account owner). The deduction is per contributor or married couple.

Research and Development (R&D) Tax Credit

The Federal Credit for Increasing Research Activities (IRC Section 41) has been in the news recently, largely due to the requirement to capitalize the larger category of all Section 174 R&D expenses. Some states have additional tax incentives aimed at encouraging research activities in their jurisdictions.

The sections below will focus on the R&D credit (Section 41), but note that while many states conform to the Federal requirement to capitalize all Section 174 expenses, Indiana and Tennessee still allow immediate expensing of these costs.

Kentucky has a Qualified Research Facility Tax Credit, which is more of a construction credit and differs from the requirements of the Federal R&D credit. This nonrefundable credit, claimed on Kentucky Schedule QR, is equal to 5 percent of the qualified costs of “construction of research facilities” for qualified research as defined in Internal Revenue Code Section 41.

The eligible construction, remodeling, and equipping costs must be in Kentucky and include only tangible, depreciable property. Amounts paid for replacement property are excluded. This credit may be taken against individual income tax, corporate income tax, or the LLET, and the unused portion can be carried forward up to 10 years.

Indiana’s Research Expense Credit is more similar to the Federal credit but provides an incentive for increasing research activities specifically in Indiana. The credit can be carried forward for up to 10 years, and there are two ways to calculate it:

1. The incremental method provides a credit of 15 percent for the first $1m of qualified expenses compared to a base amount, and then 10 percent on any excess above that $1m;
2. The alternative simplified credit provides a credit of 10 percent of the difference between current year qualified expenses and 50 percent of the average qualified expenses for the previous 3 tax years (if there are no prior year qualified expenses, the credit equals 5 percent of the current year qualified expenses).

Ohio also provides an R&D credit with similar qualifications to the Federal credit. It is a nonrefundable credit taken against the state’s Commercial Activity Tax (CAT), and it can be carried forward up to 7 years. The credit is equal to 7 percent of the total annual qualified expenses, after those expenses are reduced by the average of the prior three years’ qualified expenses.

West Virginia and Tennessee have no state-specific credit for R&D.

Federal conformity and depreciation

All five states either have rolling conformity or have passed relatively recent conformity bills to align themselves with the Federal Internal Revenue Code – with specific carve outs. The most common carve outs are oriented around depreciation, which we’ll address in this section.

Also, since all these states (with the exception of Tennessee) use Federal AGI as their starting point for individual income tax, both Federal credits and “below the line” deductions (such as QBI) will generally be irrelevant or subject to different treatment.

In Tennessee, tax years 2023 and 2024 conform to Federal bonus depreciation treatment; prior to 2023, however, Federal bonus depreciation was an add-back for Tennessee and depreciation had to be re-calculated at the state level.

Kentucky and Indiana do not conform to Federal bonus depreciation at all, meaning that bonus depreciation must be added back to income and MACRS depreciation calculated at the state level instead. The maximum Section 179 deduction is $100,000 for Kentucky and $25,000 for Indiana (as opposed to the Federal $1.22m limit in tax year 2024).

West Virginia conforms to Federal Section 179 and bonus depreciation rules.

Ohio has the gross receipts Commercial Activity Tax (CAT), which makes depreciation adjustments irrelevant for C corporations. For passthrough and other business entities, bonus depreciation is disallowed and recovered for Ohio purposes over a period of five years. The same add-back and expense over five years applies to any Section 179 taken in excess of $25,000.

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.