Colorado Amends its Pass-Through Entity Tax to Expand Potential Benefits

By: Betsy Goldstein, SALT Manager

At a glance

• The main takeaway: Colorado amended its pass-through entity (PTE) tax to make it retroactive to 2018 and to provide PTE owners with a tax credit instead of an incomeexclusion.
• Impact on your business: These changes are likely to provide PTE owners with increased tax benefits going forward.
• Next steps: Aprio’s State and Local Tax (SALT) team can model out the impact of PTE elections on a multistate basis to help identify the relative benefits of any election.

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The full story on the Colorado PTE Tax:

On June 23, 2021, Colorado Governor Jared Polis signed HB21-1327, also known as the State and Local Tax Parity Act for Businesses. The legislation established Colorado’s pass-through entity (PTE) tax for tax years beginning on or after January 1, 2022, as a workaround to the federal $10,000 deduction limitation for state taxes under Internal Revenue Code Section 164. 

Less than a year later, on May 16, 2022, Governor Polis signed SB22-124, which made several notable changes to the original Colorado PTE tax and should have the effect of expanding the potential tax benefits available to PTE owners. I have summarized several of the key changes below:

Retroactivity

The original legislation applied to tax years beginning on or after January 1, 2022. The new legislation permits PTEs to make an election for tax years beginning on or after January 1, 2018.

For tax years beginning on or after January 1, 2018, but before January 1, 2022, the election must be made on or after September 1, 2023, but before July 1, 2024. This election will be made on a composite amended return for each year that the PTE chooses to elect. The Colorado Department of Revenue will establish this return, and the amendment shall only include changes directly related to the election. PTEs and their owners that follow this procedure will not incur any interest or penalty, and the Department of Revenue will not be required to pay interest on any refunds.

For tax years beginning on or after January 1, 2022, pursuant to the original legislation, the election will continue to be made on the annual return filed by the PTE for the tax year.

Income tax rates

The PTE taxable income is computed as the sum of (i) each PTE owner’s share of PTE income attributable (i.e., allocated and apportioned) to the state, plus (ii) each resident PTE owner’s share of PTE income not attributable to the state. In other words, PTE income is all income in respect of resident owners plus Colorado-source income in respect of non-resident owners. Under the original legislation, this income was multiplied by 4.55% to calculate the PTE tax.

Under the amended legislation, the rate of tax was changed to the corporate income tax rate in effect for the applicable tax year. This was done to account for changes in the corporate income tax rate for tax years beginning on or after January 1, 2018, under prior legislation that authorized the state to lower the income tax rate based on certain budget levels.[1] For 2018–2021, the applicable tax rates are 4.63%, 4.5%, 4.55% and 4.5%, respectively.[2]

From exclusion to credit

Under the original legislation, PTE owners, on their individual income tax returns, excluded any income from the PTE that was taken into account by the PTE to determine its PTE tax liability. In addition, the PTE was authorized to claim any income tax credits attributable to its activities as well as the credit for income taxes paid to other states.

Under the new legislation, the PTE owners will now include income flowing from the PTE and receive a refundable credit, including any credits for income taxes paid to other states, instead of excluding that income. In addition, any credits allowed by the PTE attributable to its activities are required to pass through to and must be claimed by the PTE owners.

The bottom line

Overall, these changes should increase the potential federal income tax benefits and provide tax neutrality at the state level. When thinking about whether to make a retroactive election, taxpayers should consider any administrative costs (e.g., amending returns) and whether any PTE owners could be negatively impacted by the election. Aprio’s SALT team has experience with PTE taxes and can assist your business with modeling out the impact of PTE elections on a multistate basis to help identify the relative benefits of any election. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Betsy Goldstein, SALT Manager at betsy.goldstein@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the June 2022 SALT Newsletter. 

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[1] Colo. Rev. Stat. § 39-22-627.

[2] See Colorado Corporate Income Tax Guide.

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.