Colorado tax legislation restores the state benefit of the CARES Act’s retroactive provisions

On January 21, 2021, Colorado Governor Jared Polis signed into law House Bill 21-1002, which effectively restores (on a prospective basis) the Colorado individual and corporate income tax benefit of the federal CARES Act’s retroactive provisions.

This law change will be welcome news to many Colorado taxpayers, including those who had previously decided to forego amending their prior-year federal income tax returns to take advantage of these retroactive provisions due to the significant Colorado tax detriment that would have resulted.

It started with the Tax Fairness Act

On July 11, 2020, Colorado enacted H.B. 20-1420, known as the “Tax Fairness Act.” It made the single most significant change to Colorado’s income tax regime in over a decade, and here’s why: Automatically incorporating the CARES Act’s retroactive provisions meant that Colorado’s “rolling conformity” method of adopting the Internal Revenue Code (the “Code”) would have produced significant revenue loss. In response, the Tax Fairness Act created an addback on taxpayers’ Colorado income tax returns to reverse the impact of those provisions on their Colorado taxable income. This addback was required for tax years beginning or ending on and after March 27, 2020, but before January 1, 2021 (i.e., the calendar 2020 tax year):

• For individuals, the addback applied to the impact of the CARES Act’s retroactive changes to Code Sec. 172 (NOLs), Code Sec. 461(l) (excess business losses), Code Sec. 163(j) (business interest deductions) and qualified improvement property (QIP).
• For corporations, the addback applied to CARES Act’s retroactive changes to Code Sec. 163(j) (business interest deductions) and QIP only. This is because Sec. 461(l) doesn’t apply to C corporations, and because corporate NOLs in Colorado are calculated independently of the federal NOL.¹

On July 31, 2020, the Colorado Department of Revenue permanently adopted Colo. Code Regs. 39-22-103(5.3), interpreting Colorado’s “rolling conformity” statute in a way that caused it to adopt changes to the Code on a prospective basis only, meaning that Colorado only conformed to the CARES Act for tax years ending on or after March 27, 2020.

As a result, for tax years ending before March 27, 2020 (i.e., calendar tax years 2017, 2018, and 2019), both individual and corporate taxpayers were prohibited from applying the retroactive changes in the CARES Act when computing their Colorado taxable income for those years — most notably the treatment of QIP as being 15-year property eligible for 100% bonus depreciation. Because the Department also interpreted state law to prohibit taxpayers from recapturing those lost benefits on a prospective basis, Colorado taxpayers who amended their 2017, 2018 or 2019 federal returns for these retroactive CARES Act benefits generally became worse off from a Colorado income tax standpoint than they would have been before the CARES Act was enacted.

On January 21, 2021, Gov. Polis signed into law House Bill 21-1002 — a bill that passed through the Colorado legislature in a three-day special session, with the goal of restoring the Colorado individual and corporate income tax benefit of these retroactive CARES Act provisions. This new subtraction applies to tax years beginning on or after January 1, 2021, but before January 1, 2022 (i.e., calendar tax year 2021).

How the 2021 subtraction works

For both individuals² and corporations,³ the subtraction equals the sum of the amount by which a taxpayer’s Colorado “taxable income for the specified tax years” exceeds the Colorado “taxable income for the modified specified tax years” computed separately for each income tax year, plus the amounts added back (typically, on a calendar 2020 tax return) as a result of the Tax Fairness Act.

“Taxable income for the specified tax years" means an individual’s or corporation’s Colorado taxable income for tax years ending before March 27, 2020, as calculated under Colorado law applicable to the taxpayer's return as of the date the return was due (i.e., without application of the CARES Act’s retroactive provisions).

"Taxable income for the modified specified tax years" means:

• For individuals, the Colorado taxable income as computed under the Code and Colorado law applicable to each return at the time it was due, but as modified by the CARES Act’s retroactive provisions (specifically, those affecting Code Sec. 172 (NOLs), Code Sec. 461(l) (excess business losses), Code Sec. 163(j) (business interest deductions) and QIP).
• For corporations, the Colorado taxable income as computed under the Code and Colorado law applicable to each return at the time it was due at the time, but as modified by the CARES Act’s retroactive provisions (specifically, those affecting Code Sec. 163(j) (business interest expense) and QIP).

Taxpayers who use this subtraction with respect to QIP must compute gain/loss upon the sale of such QIP for purposes of that subtraction using the basis reported on the taxpayer’s federal income tax return at the time of the sale.

To summarize, the 2021 subtraction is calculated by adding the following amounts: 1) the reduction in a taxpayer’s Colorado taxable income that retroactive CARES Act conformity would have produced for each tax year ending before March 27, 2020, and 2) the amount the taxpayer was required to add back (typically, on their calendar 2020 tax return) due to the Tax Fairness Act’s decoupling from the CARES Act’s retroactive provisions.⁴

For C corporations, the portion of the subtraction arising from each of the “specified tax years” must be multiplied by its Colorado apportionment percentage from that tax year, and the product must be subtracted from its income after allocation and apportionment. For both individuals and C corporations, the subtraction must be claimed after all other Colorado addition and subtraction modifications (including the NOL deduction for C corporations).

Timing and amount

This new subtraction must be claimed by individual and corporate taxpayers for income tax years beginning on or after January 1, 2021, but before January 1, 2022 (e.g., calendar 2021), and its utilization is capped according to the following schedule:

• Tax year 2021: lesser of Colorado taxable income or $300,000
• Tax years 2022-2025: lesser of Colorado taxable income or $125,000
• Tax years 2026 and later: Colorado taxable income (no other cap)

If any subtraction is left over after applying the above cap, the excess may be carried forward indefinitely, but each year’s subtraction must be applied first to the earliest income tax year possible.

What’s next?

If you have any questions about this new law, reach out to the tax advisors at Wipfli. You can also visit our COVID-19 resource center for more information on how to respond, recover and revitalize in the wake of the pandemic.

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