Kentucky Issues First-of-Its-Kind Guidance on AI and Software Taxation

The Kentucky Department of Revenue has recently issued guidance clarifying the taxability of AI components in software. The guidance states that sales and use tax applies to prewritten computer software and to prewritten computer software access, regardless of the presence of an AI component.

Because prewritten computer software is categorized as tangible personal property, it is taxable in Kentucky. Similarly, online access to this software is considered a taxable service.

The confusion surrounding AI components arises from the distinction between prewritten and custom software. Custom software is exempt from tax in Kentucky. Although AI programming adapts to individual user data, it does not qualify as custom software. To be considered custom, software must include separately stated modifications or enhancements made exclusively for a single customer.

Kentucky is one of the first states to formally address this issue, and additional guidance from other states is expected as AI-driven software continues to evolve.