Colorado creates CARES Act modifications

On Jan. 21, 2021, Colorado enacted legislation, H.B. 21-1002, to create a deduction for expenses disallowed by the state’s CARES Act decoupling legislation enacted last year.¹ For many taxpayers, the required state addbacks resulted in a permanent disallowance of certain deductions. The new legislation provides for a limited recapture of these disallowed deductions in tax years beginning on or after Jan. 1, 2021. Specifically, a deduction is allowed for the 2021 tax year, but the amount is limited to the lesser of the taxpayer’s Colorado taxable income or $300,000. Excess amounts may be deducted in future tax years until the entire deduction amount is exhausted. However, the deduction in the 2022 through 2025 tax years is limited to the lesser of Colorado taxable income or $150,000.² Also, the earned income tax credit (EITC) statute is amended.

Colorado decoupling provisions

In July 2020, Colorado enacted H.B. 20-1420 in response to the federal CARES Act. In addition, the Colorado Department of Revenue adopted a regulation in June 2020 to clarify that Colorado’s statutory conformity to the Internal Revenue Code (IRC) should be applied on a prospective basis.³ These two actions decoupled Colorado’s corporate and individual income tax regimes from several major provisions of the CARES Act (Secs. 2303 (net operating losses (NOLs)), 2304 (excess business loss deduction), 2306 (business interest expense deduction), and 2307 (qualified improvement property (QIP))). As a result, addition modifications were required on the Colorado income tax return for the following items: (i) the increase in the allowable interest expense deduction under IRC Sec. 163(j) from 30% to 50% of adjusted taxable income; (ii) the temporary suspension of the 80% of taxable income limitation on NOL deductions; (iii) the technical correction to the depreciable life of QIP and its eligibility for bonus depreciation; and (iv) the elimination of excess business loss limitations.

In contrast to other states which decouple from the federal acceleration of deductions, the Department published guidance providing that Colorado law does not allow for a future year subtraction of disallowed expenses.⁴ For many taxpayers, this resulted in the loss of future state income tax benefits that would otherwise have been available to them.

State income tax deduction for CARES Act provisions

In H.B. 21-1002, the Colorado legislature has created a mechanism for corporate and individual taxpayers to recover deductions disallowed by the state’s CARES Act decoupling provisions. The allowable deduction is calculated as the excess amount of federal taxable income from the originally filed return over the amount on the amended return after applying the income tax policy changes in Sections 2303, 2304, 2306, and 2307 of the CARES Act.⁵ For multistate corporate taxpayers apportioning income to Colorado, the available deduction is computed using the apportioned income for each year in which deductions were disallowed. In subsequent years, the deduction is applied against Colorado taxable income as computed using that year’s apportionment factor.⁶

The deduction only is available for the 2021 tax year, but unused amounts may be carried forward.⁷ For all taxpayers, the allowable deduction is limited to Colorado taxable income each year. For tax years beginning in 2021, the deduction also is capped at $300,000.⁸ For tax years beginning in 2022 through 2025, the cap is reduced to $150,000 for each year. No limitation beyond Colorado taxable income will be in place for tax years beginning on or after Jan. 1, 2026. If the total deduction available exceeds Colorado taxable income, or the statutory cap for a tax year, then the remaining amount is carried forward to offset taxable income in future tax years.⁹

State EITC eligibility

For Colorado resident individual taxpayers, H.B. 20-1420 also amended the state-level EITC.¹⁰ The allowable credit is 10% of the credit amount claimed on the federal income tax return for tax years prior to 2021 and 15% for 2021 onwards.¹¹ Under federal rules, the EITC requires that taxpayers and dependents have a Social Security Number (SSN) that is valid for employment and issued before the tax return is due. In H.B. 20-1420, eligibility for the Colorado EITC was expanded to allow those residential individuals, their spouses or their dependents who do not have valid SSNs to claim the credit. Originally, this expanded eligibility provision did not take effect until tax years beginning on or after Jan. 1, 2021. H.B. 21-1002 revises the effective date to tax years beginning on or after Jan. 1, 2020.¹²

Commentary

This legislation should provide some measure of relief to both individual and business taxpayers who otherwise would have permanently lost significant deductions as a result of the state’s CARES Act decoupling. The computation of the Colorado deduction is more complex than those in other states which have decoupled from federal accelerated deduction provisions, resulting in an added burden on taxpayers. This new deduction, as with last year’s decoupling additions, may require several Colorado-specific calculations and carryover tracking. It is possible that taxpayers with significant Colorado presence may not get the full state income tax benefit from these CARES Act provisions for several years given the relatively low levels at which the deductions are capped. This approach to conformity stands in contrast to other states which more clearly conform to or decouple from IRC changes.

The new deduction will have some interesting implications for ASC 740 calculations, as the future deduction is limited to Colorado taxable income, even after years in which a cap on the deduction is imposed. For purposes of ASC 740, corporate taxpayers may need to perform an additional valuation allowance analysis to resolve whether, and if so when, future income apportioned to Colorado will allow for expense carryovers to be deducted, especially if Colorado apportionment levels are volatile from year to year.

Taxpayers must also carefully analyze positions taken on originally filed federal and Colorado returns to determine the amount of the deduction actually available. This determination is complicated by the annual caps placed on the deduction amount for the 2021 through 2025 tax years. The state’s decoupling from bonus depreciation for QIP may have had retroactive impact for some taxpayers and required the filing of an amended return for 2017 or 2018. Others may have claimed bonus depreciation on this property on federal income tax returns before enactment of the CARES Act, in anticipation of the federal technical correction being made. If amended Colorado returns were not filed to properly add back disallowed deductions, no future deduction would be available for the same expense item. This issue creates an additional layer of complexity to tax years for which retroactive federal and state legislation may already have changed several times. As the state faces revenue shortages and increased expenses due to the impact of the COVID-19 pandemic, Colorado taxpayers can expect to see additional tax legislation introduced. With lessons learned from the enactment of H.B. 20-1420 and H.B. 21-1002, the hope is that future changes to the taxable income calculation will not require taxpayers to revisit the same tax years multiple times.

1 Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, March 27, 2020.
2 For tax years after 2025, the deduction only is limited to Colorado taxable income.
3 COLO. CODE REGS. § 39-22-103(5.3). This originally was adopted as an emergency regulation, effective June 2, 2020 through Sept. 30, 2020. On July 31, 2020, this regulation was permanently adopted with a Sept. 30, 2020 effective date. For further discussion of this regulation and H.B. 20-1420, see GT SALT Alert: Colorado decouples from some CARES Act provisions.
4 CARES Act Tax Law Changes & Colorado Impact, Colorado Department of Revenue, June 2020, revised Sept. 23, 2020.
5 COLO. REV. STAT. §§ 39-22-104(4)(z)(I); 39-22-304(3)(p)(I)(A).
6 COLO. REV. STAT. § 39-22-304(3)(p)(I)(B).
7 COLO. REV. STAT. §§ 39-22-104(4)(z); 39-22-304(3)(p).
8 COLO. REV. STAT. §§ 39-22-104(4)(z)(II)(A); 39-22-304(3)(p)(II)(A). The limitation is the lesser of Colorado taxable income or $300,000.
9 COLO. REV. STAT. §§ 39-22-104(4)(z)(II)(B); 39-22-304(3)(p)(II)(B).
10 COLO. REV. STAT. § 39-22-123.5.
11 COLO. REV. STAT. § 39-22-123.5(2).
12 COLO. REV. STAT. § 39-22-123.5(2.5)(a).

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