What’s new in Kentucky for 2026: the rate falls to 3.5%, and tips and overtime stay taxed

Two things happened to the Kentucky income tax for 2026. The rate fell from 4% to 3.5%, the second half-point cut in three years, under House Bill 1 of 2025. Then, in April 2026, House Bill 757 moved Kentucky’s tie to the federal tax code forward to December 31, 2025, which pulls the One Big Beautiful Bill Act into Kentucky law with four exceptions: the federal deductions for tips, overtime pay and car-loan interest are not allowed, and several business provisions are kept on the old rules. Because Form 740 starts from federal adjusted gross income, and the new federal deductions for seniors, tips and overtime all come off after AGI, none of them would have reached the Kentucky return anyway. The standard deduction rose $90 to $3,360. The Family Size Tax Credit thresholds moved up with the poverty guidelines. And the rate will stay at 3.5% for 2027, because the state missed the revenue trigger for the next cut.

For most Kentucky households the 2026 return will look like the 2025 return with a smaller number on the tax line. A single filer with $50,000 of wages pays $1,632 of Kentucky tax for 2026 against $1,869 for 2025, a saving of $237. The city or county occupational tax taken out of the same paycheck did not change at all.

The rate: 3.5% for 2026, and 3.5% for 2027

House Bill 1, signed February 6, 2025, set the individual income tax rate at 3.5% of net income for taxable years beginning on or after January 1, 2026 (KRS 141.020(2)(d)). Employers have been withholding at 3.5% since the first paycheck of 2026; the Department of Revenue’s 2026 withholding formula is simply annual wages minus $3,360, times 3.5%.

The same bill set up the test for further cuts. Each year the Office of State Budget Director checks two conditions for the fiscal year just ended: the Budget Reserve Trust Fund must hold at least 10% of General Fund receipts, and receipts must cover appropriations plus the cost of a one-point rate cut. If both are met, the General Assembly may reduce the rate; the Act says plainly that the Department “shall not implement an income tax rate reduction without an action by the General Assembly.” For fiscal 2025 the state missed the second test by $7.5 million, as the budget director reported in August 2025. For fiscal 2026, reported September 4, 2026, it missed by more than $1 billion, and missed the lower threshold for a quarter-point cut as well. No cut was enacted in the 2026 session. The rate is 3.5% for 2026, 3.5% for 2027, and on the current numbers 3.5% for 2028.

HB 757: the 2025 federal law arrives, minus four pieces

Kentucky is a static-conformity state: it follows the Internal Revenue Code as of a fixed date, and the legislature moves the date when it chooses. Until this year the date was December 31, 2024, which left the whole 2025 federal law outside Kentucky law. House Bill 757, an omnibus revenue bill passed over the governor’s line-item vetoes on April 14, 2026 (Acts chapter 161), moves the date to December 31, 2025 for tax years beginning on or after January 1, 2026, and then names what Kentucky will not follow.

Kentucky also keeps its own rule that later federal amendments do not apply unless they merely extend an expiring provision. Whether the Department will add a line to Schedule M for tips and overtime, or simply rely on AGI already including them, will be clear when the 2026 Form 740 booklet is published.

The practical point for a wage earner: the “no tax on tips” and “no tax on overtime” headlines are federal only. A Kentucky server or nurse who sees a smaller federal bill in 2027 will see no corresponding change on the Kentucky line, and the local occupational tax never saw the deductions in the first place.

The standard deduction and the Family Size Tax Credit

The standard deduction is $3,360 for 2026, up from $3,270, as the Department announced on September 4, 2025. It is one deduction per return, not doubled for a joint return, which is why most two-income couples file separately on a combined return (filing status 2) and take it twice. The Department has already set the 2027 figure at $3,470.

The Family Size Tax Credit, which wipes out the Kentucky tax entirely at or below the federal poverty guideline and then phases down to 133% of it, uses these 2026 thresholds from the Department’s TY2026 e-file handbook: $15,960 for a family of one, $21,640 for two, $27,320 for three, $33,000 for four or more. A family of four gets some credit up to $43,890 of modified gross income, against $42,760 for 2025. The 2026 Form 740 booklet, with the full percentage table, is to come.

Estimated tax penalties on the federal pattern

The Department’s handbook says Kentucky “elected to mirror the federal rules for estimated tax penalty for tax year 2026.” Form 2210-K gains a section for the annualized income installment method, which helps anyone whose income arrives unevenly, such as a farmer, a seasonal business or someone with a large December capital gain. The safe harbor stays at 90% of the current year’s tax or 100% of last year’s, and no estimates are required if the tax after withholding is $500 or less. The penalty itself shows on Form 740, line 34(a).

New and changed forms

Form 461-K, excess business losses. The federal Form 461 was discontinued, so Kentucky built its own. The 2026 limit is $256,000, or $512,000 for joint filers and couples filing separately on a combined return; any excess becomes a Kentucky net operating loss carryover on Schedule KNOL. Kentucky never adopted the federal suspension of this limit during the pandemic years.

Form 8863-K, education tuition credit. Unused credit carried forward from the 2021 return has expired; the five-year carryforward has run out. The Department still recommends filing the form each year the credit is earned, to keep the carryforward record straight.

Business credits. HB 577 extends the Angel Investor credit to qualifying pass-through entities, and a new refundable Economic Development tax credit, capped at $4 million a year statewide, begins with tax years starting in 2026. Neither will appear on an ordinary wage earner’s return.

Beyond the income tax

Sales tax. HB 757 repealed the 200-transaction economic-nexus test for out-of-state sellers (the $100,000 receipts test remains) and made data-brokering services taxable. It also created excise taxes on prediction-market operators (14.25% of transaction fees) and fantasy-sports platforms (12% of entry fees net of winnings), both from January 1, 2027. The state rate stays 6%, with no local sales taxes anywhere in Kentucky.

Homestead exemption. Homeowners 65 or older, or totally disabled, take $49,100 off the assessed value of their home for the 2025 and 2026 property tax years, under KRS 132.810. The figure resets every two years; the 2027–2028 amount is to come, normally announced in November. Apply once with the county Property Valuation Administrator by December 31 of the year claimed.

No ballot measure. The only question on the November 3, 2026 ballot was Constitutional Amendment 1, on the governor’s pardon power near elections. Two proposed amendments that would have shielded homeowners 65 and older from assessment increases were filed in the 2026 session and did not make the ballot.

The 2026 return against the 2025 return