Colorado enacts several revenue measures in special session

Corporate income tax haven / FDDEI addback⁴

Colorado is one of several states that historically has presumptively treated corporations as being engaged in tax avoidance if incorporated in one of more than 40 listed tax haven jurisdictions.

Corporations incorporated in a tax haven are required to add back income to the Colorado corporation income tax base that would otherwise have been excluded. The tax avoidance presumption may be overcome if it can be proven that incorporation in this jurisdiction is done for reasons that meet federal economic substance standards, as set forth in IRC Section 7701(o). The enacted legislation provides that for tax years beginning in 2026 and beyond, the tax haven jurisdiction list is expanded further to include Hong Kong, Ireland, Liechtenstein, the Netherlands and Singapore. The legislation also clarifies that the Colorado executive director may confirm that the economic substance standard is met.⁵

In addition, the legislation addresses the treatment of FDDEI, which replaces the foreign-derived intangible income (FDII) concept in previous federal legislation addressing international taxation for multinational companies. Under the OBBBA, the FDDEI inclusion is partially offset by a one-third deduction of the  amount from the federal tax base. Without any legislative action, Colorado’s rolling conformity to the IRC would have allowed taxpayers to include the FDDEI deduction in the corporation income tax base. In an effort to decouple from this result for the 2026 tax year and beyond, Colorado will require an addback to FDDEI of the amount eligible for deduction under IRC Section 250.⁶ The enacting legislation claims that the addback will provide incidental and de minimis revenue gain to the state.

Insurance premium tax rate adjustments⁷

Insurance companies that write business in Colorado are required to pay a 2% tax on the gross amount of premiums that cover certain property or risks in Colorado. However, a company that maintains a home office or regional home office in Colorado historically was offered a discounted 1% tax rate. The legislation eliminates this rate preference, raising the tax rate to 2% for these businesses for the 2026 tax year and beyond.⁸

Creation of tax credit sale program⁹

The legislation permits Colorado to create a tax credit sale program in which it is authorized to sell insurance premium tax and corporation income tax credits to taxpayers, subject to procedures to be established by the Colorado Department of the Treasury.¹⁰ Essentially, the credit sale program advances funds to the state that would be paid by businesses as these taxes become due. The program addresses insurance premium tax and corporation income tax credits in separate statutes that are very similar. For each tax, the state is authorized to issue credits, equal to the lesser of: (i) $125 million in face value; or (ii) $100 million in sales proceeds. With respect to the insurance premium tax credits, the legislation requires the state to offer credits to qualified home office or regional home offices prior to offering the credits to other insurance companies.

To obtain the credits under the program, taxpayers are required to apply, with a proposed tax credit purchase amount, which must be the greater of either 80% of the requested dollar amount of credits, or a higher percentage amount that the Colorado Department of Revenue and an independent third party determines to be consistent with market conditions on the offer date. If approved, the taxpayer receives a tax credit certificate as proof that the credit has been obtained. The tax credits cannot be carried forward past the 2033 tax year, and the overall tax credit sale program expires at the end of 2040.

Elimination of sales tax vendor fee¹¹

The sales tax vendor fee was designed to provide retailers with $1 million or less in taxable sales with an amount that would presumably cover some of the costs incurred to collect and remit the sales tax on taxable sales transactions to Colorado. Since 2020, eligible retailers could retain the lesser of 4% of the tax reported, or $1,000 in tax during each filing period.¹² Based on a desire to promote fairness and equality between all retailers, improve simplicity in the collection of state tax, and in order to increase revenue to the state, the ability to retain a vendor fee has been removed. Beginning in 2026, retailers no longer may retain funds to cover their sales tax collection and remittance expenses.¹³

Commentary

Through close collaboration between Gov. Polis and the state legislature, Colorado acted swiftly to respond to a significant budgetary gap caused in large part by the enactment of the OBBBA. Colorado’s enactment of legislation specifically decoupling from some of the income tax changes made by the OBBBA is not surprising, with many states likely to examine and address the OBBBA’s domestic and international tax effects over the next several months either through special legislative sessions or through the regular legislative process.

The creation of a tax credit sale program will provide Colorado with a novel opportunity to quickly realize revenue by providing taxpayers a mechanism to buy discounted credits that can be applied to their insurance premium or corporation income tax obligations. It will be interesting to see the extent to which taxpayers have interest in purchasing these credits to effectively prepay their taxes, and whether the discounted purchases will be made at 80% or an amount much closer to 100%. Of course, by selling taxpayers discounted credits, Colorado will not realize the full amount of tax that companies might otherwise owe, which could adversely affect the state’s revenues in future years.

Finally, Colorado’s elimination of vendor fees follows the general trend of states deemphasizing payments as a means to support vendors that often incur significant costs in collecting and remitting sales tax. This is a particularly thorny issue in Colorado, which operates its sales tax regime through home rule, in which filings and payments to numerous localities makes it very complex for retailers to comply without significant efforts. The elimination of vendor fees may increase the likelihood that a remote retailer challenges the Colorado sales and use tax system as being too burdensome and contrary to the dictates of the Wayfair decision.¹⁴ In Wayfair, the U.S. Supreme Court approved the imposition of sales tax collection and remittance requirements on remote retailers meeting certain sales and/or transactional thresholds in the state, and endorsed proactive efforts by states to reduce sales tax compliance burdens for remote retailers in coming to its decision.