Current law
Colorado requires an affiliated group of corporations to file a combined report if they are 1) under common ownership and 2) engaged in a unitary business. The common ownership prong requires that at least 50% of the stock of each corporation in the group be owned by another includible corporation and that the common parent corporation of the group own more than 50% of the stock of at least one other includible corporation.
For tax years beginning prior to Jan. 1, 2026, Colorado employs six tests of unity for determining whether entities are engaged in a unitary business under the second prong. A corporation and its affiliates are engaged in a unitary business only to the extent the entities satisfy at least three of the six statutory factors in the current year as well as the two preceding tax years. The six factors include: 1) inter-corporate sales or leases; 2) certain enumerated inter-corporate services; 3) significant inter-corporate debts; 4) inter-corporate use of proprietary materials; 5) directors in common; and 6) interlocking corporate officers. In practice, the rule has meant that the Colorado combined group of a taxpayer may differ from their federal consolidated group or the state combined group in other mandatory combined reporting jurisdictions.
New unitary business standard
For tax years beginning on or after Jan. 1, 2026, Colorado repeals the six tests of unity and adopts the MTC model rule for determining the existence of a unitary business required to use combined reporting. This rule provides that a ‘unitary business’ is a single economic enterprise made up either of separate parts of a single C corporation or an affiliated group of C corporations that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts. The definition also applies to a taxpayer’s business conducted through a partnership, whether held directly or indirectly.
The new law revises other rules related to combined reporting, such that:
- The net income of each member of the Colorado combined return is determined by excluding intercompany transactions among members of the combined group, applying the consolidated return regulations under the Internal Revenue Code.
- The combined group sales factor numerator is determined by applying the Finnigan rule, meaning that receipts sourced to Colorado from any member of the Colorado combined group are included in the sales factor numerator, regardless of whether the member generating the Colorado receipts has nexus in Colorado.
Takeaways
No other state uses a six-part test for unity considerations; taxpayers were required to perform additional analysis for Colorado purposes. As noted in the bill’s declarations, the six tests of unity are arbitrary and difficult for taxpayers and the Colorado Department of Revenue to apply. The new approach brings the state’s corporate income tax reporting regime into line with most other states that require corporate taxpayers to file combined returns for affiliated members that are engaged in a unitary business.
Taxpayers doing business in Colorado should review the composition of their combined group to determine if any affiliated entities that were excluded under the prior law should be included in the Colorado combined reporting group beginning in 2026. Moreover, taxpayers should evaluate whether any recently acquired entities may be includable in the Colorado combined reporting group beginning in 2026. Such entities may not be includable under the current test because they were not members of the group in the current year as well as the two preceding tax years.
Taxpayers with questions about the contents of this alert should consult with their state and local tax advisers.
