Colorado Adopts Important Changes to Corporate, Individual, and Sales Tax Rules

The Colorado legislature recently passed two tax bills that together will update aspects of the state’s income and sales tax regimes beginning in 2027. Gov. Jared Polis signed H.B. 26-1289 June 3 and H.B. 26-1223 June 4.

H.B. 26-1289

Beginning with the 2027 tax year, H.B. 26-1289 makes several important changes. Combined corporate income tax filings will default to a worldwide basis with an option to make a water’s-edge election, binding for 10 years, for C corporation affiliated groups. Irrespective of whether a taxpayer makes a water’s-edge election, a controlled foreign corporation (CFC) incorporated in a foreign jurisdiction for tax avoidance purposes will be included in the combined return.

That change makes redundant the deduction for amounts included in federal taxable income under Internal Revenue Code Sections 951(a) and 951A(a) related to CFCs incorporated in foreign jurisdictions for tax avoidance purposes. The corporate deduction is unnecessary because those CFCs would be automatically included in a combined return filed under a worldwide or water’s-edge basis. Thus, the Sections 951(a) and 951A(a) income should be eligible for elimination because it is an item of income recognized between two combined reporting members.

The Department of Revenue will issue procedures for electing, terminating, or changing the composition of the group or its members at a later date.

The bill also repeals the exclusion for domestic corporations with more than 80% of their property and payroll in locations outside the U.S, effectively making such corporations subject to corporate tax.

Other notable changes include:

• Eliminating the state income tax deduction for wages and salaries because of the disallowed federal deduction and related credit interaction under IRC Section 280C;
• Updating restrictions to and repealing several corporate and individual tax credits, including those for designated enterprise zones;
• Creating a state income addback of federally deducted capital gains invested in non-Colorado qualified opportunity funds; and
• Updating the countries designated as “listed jurisdictions” for purposes of foreign income inclusions applicable to affiliated corporate groups.

H.B. 26-1223

Computer Software Subject to Sales Tax

H.B. 26-1223 modifies the definition of tangible personal property to include all computer software and repeals the long-standing sales and use tax exemption for downloaded software, including mobile applications and software as a service (SaaS), beginning January 1, 2027. The sale, storage, use, or consumption of downloaded software subject to a negotiated license agreement or custom-developed for a specific user remains exempt.

The bill allows local governments and special districts to adopt taxability and definition changes through local elections, but some localities already tax SaaS.

Expanded Family Affordability Tax Credit

H.B. 26-1223 also creates a new refundable tax credit, available in addition to the child tax credit and family affordability tax credit, with a gradual phase-out based on the taxpayer’s income and the number and ages of the taxpayer's qualifying children. The total credit amount is adjusted annually based on legislative council staff projections.