Colorado enacts major tax changes

On June 23, 2021, Colorado Governor Jared Polis signed three sweeping tax bills (the “Acts”) into law:

• House Bill 21-1311 — Income Tax Act
• House Bill 21-1327 — SALT Parity Act
• House Bill 21-1312 — Sales, Insurance Premium, Property, & Severance Tax Act

Most businesses and individuals residing or doing business in Colorado will be impacted by one or more of the Acts. The key provisions of each act are discussed below.

House Bill 21-1311 — Income Tax Act

The Act contains several unrelated provisions with varying effective and sunset dates for the following classes of taxpayers:

C corporations

Except where noted, the following provisions of the Act are effective for tax years beginning on or after Jan. 1, 2022, and don’t expire unless repealed by legislative action or as otherwise noted:

• The Act adopts the Finnegan rule for combined group apportionment. As a result, the apportionment numerator must include sales from all members of the combined group regardless of each member’s nexus in Colorado.
  • Colorado continues to apply its “3 of 6” unitary relationship test to determine the members of a combined group.
• The Act stipulates a combined group must include the income of affiliated C corporations incorporated in a “foreign jurisdiction” for the purpose of tax avoidance. The Act includes a list of foreign jurisdictions in which incorporation for the purpose of tax avoidance is presumed unless a taxpayer provides a sufficient explanation for economic substance under IRC Section 7701(o).
  • Such foreign corporations must determine “federal taxable income” in accordance with Generally Accepted Accounting Principles, be subject to an independent audit, and convert all foreign currency to the U.S. dollar on a reasonable and consistent basis.
• The Act creates a subtraction modification for IRC Sec. 951(a) and Sec. 951A(a) income included in federal taxable income attributable to a controlled foreign corporation incorporated in a foreign jurisdiction for the purpose of tax avoidance.
  • The Act repeals the subtraction for IRC Sec. 78 dividends received from a C corporation incorporated in a foreign jurisdiction for the purpose of tax avoidance.
• For the 2022 tax year only, the Act requires an addition to federal taxable income for the deduction claimed for food and beverage expenses in excess of the 50% allowed under IRC Sec.  274(n)(2)(D).
• The Act amends the definition of a “qualified taxpayer” for the purpose of claiming the subtraction for net capital gains to exclude taxpayers not required to file Schedule F, Profit or Loss From Farming, with the federal tax return.

Individuals, estates, and trusts

Except where noted, the following provisions of the Act are effective for tax years beginning on or after Jan. 1, 2022, and don’t expire unless repealed by legislative action or as otherwise noted:

• The Act requires taxpayers reporting federal adjusted gross income (AGI) of $400,000 or more to add to federal taxable income itemized deductions claimed in excess of $30,000 for single filers and $60,000 for joint filers.
• For the 2022 tax year only, the Act requires an addition to federal taxable income for the deduction claimed for food and beverage expenses in excess of the 50% allowed under IRC Sec. 274(n)(2)(D).
• The Act extends the addition to federal taxable income of the IRC Sec. 199A deduction for single filers with AGI greater than $500,000 or joint filers with AGI greater than $1,000,000 through 2025.
  • The Act clarifies there is no limitation for taxpayers required to file Schedule F, Profit or Loss From Farming, for the tax year in which the taxpayer claims the deduction.
• The Act increases the subtraction allowed for social security benefits received by individuals age 65 or older to equal the amount included in federal taxable income. 
• The Act imposes a limit on the annual subtraction from federal taxable income related to Section 529 plan contributions.
  • The limit is $20,000 per taxpayer per beneficiary for single filers, and $30,000 per taxpayer per beneficiary for joint filers.
    • For tax years beginning on or after Jan. 1, 2023, the limits are adjusted annually by the percentage change in the combined average annual costs of tuition and room and board for all state institutions of higher education.
• The Act codifies an explicit requirement that any change in designated beneficiaries must involve a new beneficiary that is a member of the old beneficiary’s family to avoid treatment as an unqualified distribution.
• The Act requires CollegeInvest to furnish data to the Colorado Department of Revenue to determine unqualified distributions unreported by taxpayers in tax years 2017 through 2020. Routine examinations of data will be conducted beyond 2021.
  • Taxpayers will be assessed for deficiencies in the substantiation of the qualified use of distributions.
• The Act amends the definition of a “qualified taxpayer” for the purpose of claiming the subtraction for net capital gains to exclude taxpayers not required to file Schedule F, Profit or Loss From Farming, with the federal tax return.
  • Qualifying real property must be classified as agricultural land by the county tax assessor immediately preceding the sale.
• The Act expands the Colorado Earned Income Tax Credit (EITC) to 20% of the federal EITC in tax year 2022 and tax years beginning on or after Jan. 1, 2026. The EITC is increased to 25% for tax years 2023 through 2025.
  • Colorado’s EITC doesn’t require verification of the taxpayer’s or dependent’s social security number.
• The Act increases the eligibility of the Colorado Child Tax Credit (CTC) to include dependents without a valid social security number who otherwise meet the definition of a qualifying child under IRC Sec. 24.
  • If the applicable CTC provisions of the “American Rescue Plan Act of 2021” are no longer in effect, the allowable portion of the Colorado CTC is increased.

Business conversion costs

To provide an incentive for small businesses to establish employee stock ownership plans or employee ownership trusts, or to convert to a worker-owned cooperative, the Act authorizes  temporary income tax credits for tax years beginning on or after Jan. 1, 2022, but prior to Jan. 1, 2027:

• Up to 50% of the conversion costs, not to exceed $25,000, incurred by a qualified business converting to a worker-owned cooperative or an employee ownership trust.
• Up to 50% of the conversion costs, not to exceed $100,000, incurred by a qualified business converting to an employee stock ownership plan.

Captive insurance companies

• Effective upon enactment of the Act, a disqualified insurance company is statutorily excluded from the income tax exemption applicable to insurance companies taxed on gross premiums. A “disqualified insurance company” is a company licensed as a captive insurance company with gross receipts for the taxable year consisting of 50% or less of premiums from arrangements that constitute insurance for federal income tax purposes.

House Bill 21-1327 — SALT Parity Act

The SALT Parity Act was signed in response to the limitation on deductibility of state and local taxes imposed by IRC Sec. 164, pursuant to the Tax Cuts and Jobs Act of 2017. As a consequence of the federal law, Colorado taxpayers who are owners of pass-through entities are disadvantaged under current state law relative to businesses structured as C corporations, since the limitation didn’t apply to C corporations. The Act seeks to address this discrepancy by aligning the deductibility of state expenses for all business owners by instituting a pass-through entity tax election, subject to eligibility requirements and computational adjustments as described in further detail below.

• The Act provides an annual election for income tax years beginning on or after Jan. 1, 2022, and is binding on all electing pass-through entity owners.
  • An electing pass-through entity owner doesn’t include a partner that is a unitary C corporation.
  • The election is automatically disallowed by statute if IRC Sec. 164 is amended to remove the $10,000 SALT deduction limitation.
• The amount subject to the 4.55% tax on an electing pass-through entity consists of each nonresident owner’s distributive share of income sourced to Colorado and each resident owner’s distributive share of income regardless of source. 
• Income tax credits attributable to the activities of an electing pass-through entity must be claimed by the entity against the tax imposed directly upon the entity and may not be passed through or claimed by the electing pass-through entity owner.
  • Excess credits may be carried forward, but may only be claimed by the entity, and only in a tax year in which the election is made.
• Resident electing pass-through entity owners aren’t entitled to a credit for taxes paid in other states with respect to income attributable to an electing pass-through entity.
  • However, the electing pass-through entity is entitled to a credit for taxes paid to other states regardless of whether tax was paid by the electing pass-through entity or by the electing pass-through entity owners.
• Nonresident individuals aren’t required to file a tax return if the only source of income from Colorado is from the electing pass-through entity. Electing pass-through entity owners will not be subject to alternative minimum tax on income attributable to an electing pass-through entity.

House Bill 21-1312 — Sales, Insurance Premium, Property, & Severance Tax Act

The Act predominantly purports to codify the Department of Revenue’s (DOR) position on the classification of digital goods as tangible personal property for sales tax and the DOR’s determination of “gross income” for severance tax purposes. The legislature indicated that existing rules reflect such treatment and the statutory codification is an alignment of existing law rather than repeal of a sales tax exclusion that would be subject to voter approval pursuant to the Taxpayer Bill of Rights (TABOR). Specific statutory amendments include:

Sales tax

• The Act codifies the definition of tangible personal property to include digital goods regardless of method of delivery. Examples include CDs, electronic download, and internet streaming.
  • A “digital good” includes any item of tangible personal property delivered or stored by digital means, including content such as videos, music, or electronic books.
• The Act clarifies that charges related to mainframe computer access, photocopying, and packing and crating are subject to sales tax.
• The Act repeals the vendor allowance for retailers with total taxable sales greater than $1,000,000 in a filing period.

Insurance premium tax

• The Act imposes limitations on the eligibility of the reduced insurance premium tax rate for companies with a home office or regional home office in the state by requiring a percentage of the company’s domestic workforce in Colorado.
  • The percentage is 2% in 2022 and increases through 2024 to a fixed percentage of 2.5%. 

Property tax

• The Act increases the exemption for business personal property tax from $7,700 to $50,000 for tax years beginning Jan. 1, 2021 and Jan. 1, 2022. The exemption is adjusted for inflation thereafter. The state is required to reimburse local governments for the lost revenue as a result of the increased exemption.
• The Act requires the actual value of real and personal property to reflect the value of the fee simple estate and the personal property’s actual value in use, as determined by the property tax administrator.

Severance tax

• The Act provides that only direct costs for transportation, manufacturing, and processing of the product, including depreciation, paid by the taxpayer can be used to reduce gross lease revenue in determining “gross income.”
  • Deductions for indirect expenses and the cost of capital are no longer allowed.
• The Act phases out the exemption of tax on the severance of coal for the first 300,000 tons of coal produced in each quarter of the taxable year. The exemption is reduced annually beginning in the 2022 tax year and phased out completely in 2026.
• The Act phases out the 50% tax credit for coal produced from underground mines and lignite coal. The credit is reduced annually beginning in the 2022 tax year and phased out completely in 2026.

If you have questions on these tax changes, please give us a call.