Colorado Gov. Jared Polis recently signed several tax-related bills into law making changes to the personal and corporate income tax code, providing for a pass-through entity tax workaround of the federal state and local tax (SALT) deduction limitation and providing other business tax changes. A summary of the newly enacted legislation follows below.
Personal and corporate income tax changes
House Bill 1311 makes a number of changes to Colorado’s personal and corporate income tax code. A summary of those changes includes the following:
- Effective for tax years beginning Jan. 1, 2022, Colorado will use the ‘Finnigan rule’ to determine how combined groups apportion corporate income to the state. For purposes of the Finnigan rule, a combined group is treated as a single taxpayer for purposes of determining whether the group has nexus with the state. Under current law, the ‘Joyce rule’ is followed which considers the nexus of each individual corporation in the group separately
- Effective for tax years beginning Jan. 1, 2022, combined groups must also include affiliated corporations within their combined return that are incorporated in a foreign jurisdiction for the purpose of tax avoidance. The bill lists a number of jurisdictions where incorporation is presumed for the purpose of tax avoidance
- Effective for tax years beginning Jan. 1, 2022, taxpayers with adjusted gross incomes of $400,000 or more are required to add back a portion of their federal itemized deductions when calculating Colorado taxable income. Single filers are required to add back itemized deductions that exceed $30,000, or $60,000 for joint filers
- Effective for tax years beginning Jan. 1, 2022 the state capital gains income tax deduction for certain federal capital gains is repealed, except for certain qualifying agricultural property
- Effective for tax years beginning on or after Jan. 1, 2022 and before Jan. 1, 2023, taxpayers must add back an amount equal to the enhanced federal deduction for business meals when calculating Colorado taxable income
- The add back for federal qualified business income deductions (section 199A) effective for tax years 2021 and 2022 is extended through 2025. The add back applies to single filing taxpayers with over $500,000 of adjusted gross income, or joint filers with over $1,000,000 of adjusted gross income
Elective pass-through entity tax
House Bill 1327 allows certain Colorado partnerships or S corporations to elect into an optional pass-through entity tax, effective for tax years beginning on or after Jan. 1, 2022. The tax is imposed at a rate of 4.55%, the same rate as the flat rate on individual taxpayers. Members of the electing entity are permitted a subtraction from their federal taxable income for determining their Colorado tax liability in the amount equal to the owner’s share of the pass-through entity’s income attributable to the state.
This provision is intended to be a so-called ‘workaround’ to the state and local tax deduction limitation. Colorado is at least the fourteenth state to adopt such a provision, with several other states expected to adopt similar provisions over the next few weeks. The election must be made annually and be made on the returned filed by the pass-through entity. Taxpayers considering the election should also consider that pass-through entity workarounds may not always be a tax saving strategy.
Miscellaneous business tax changes
House Bill 1312 makes several other tax changes to the insurance premium tax, property tax and sales and use tax. A highlighted summary of those changes follows:
- For purposes of insurance premium tax, insurance companies with a regional home office in the state and subject to the lower 1% rate must, in addition to existing requirements, maintain a specified percentage of their workforce in the state as follows: 2% in 2022, 2.25% in 2023, and 2.5% in 2024
- The personal property exemption threshold is increased from $7,900 to $50,000 for property tax years beginning on Jan. 1, 2021 and Jan. 1, 2022, and adjusted for inflation every two years after that
Sales and use taxes
- ‘Digital goods’ are included in the statutory definition of ‘tangible personal property’ and defined as any item of tangible personal property that is delivered or stored by digital means, including but not limited to video, music or electronic books
- Mainframe computer access, photocopying and packing and crating to property and services are now subject to the tax
- Effective January 2022, retailers with more than $1 million of taxable sales are no longer permitted to retain the vendor fee, currently 4% of state sales and use tax collections, up to $1,000 per filing period
Takeaways
Together, the three tax bills make significant changes to Colorado’s state tax laws and will likely impact most businesses or individual taxpayers in some regard. While there is no positive or negative impact to state revenues, the state estimates that up to 18% of pass-through businesses will elect into the pass-through entity tax workaround. Businesses should caution that the workaround may not be beneficial to every partner in the entity. Taxpayers with questions about the changes or other Colorado tax provisions should speak to their state and local tax adviser.
