Colorado Significantly Modifies PTE Tax Election Regime; Makes Election Retroactive to 2018

June 2022

BY

Scott SmithBDO National Tax Office Managing Director, Technical Practice Leader - State & Local Taxes

Kent DeBruinBDO National Tax Office Senior Manager, State & Local Taxes


On May 16, 2022, Colorado enacted S.B. 22-124 to significantly modify its pass-through entity (PTE) elective tax regime (referred to as the “SALT Parity Act”). The legislation makes Colorado’s PTE tax election available retroactively to 2018. It also replaces the income subtraction for electing PTE owners with a refundable tax credit.
 

PTE Tax Election Retroactive to 2018

Colorado originally enacted the SALT Parity Act in 2021, and the election was available for income tax years commencing on or after January 1, 2022. However, S.B. 22-124 retroactively makes the PTE election available for income tax years commencing on or after January 1, 2018.
 
For income tax years commencing on or after January 1, 2018, but before January 1, 2022, eligible PTEs must make the binding retroactive election on or after September 1, 2023, but before July 1, 2024. The retroactive election is made by filing a “composite amended tax return” for all of the years for which the election is made pursuant to a form to be established by the Department of Revenue (Department). If an eligible PTE elects to retroactively file the amended composite tax return, penalties for late filing and interest are waived. This legislation also provides that the Department has one year from the date the composite amended return is filed to audit the return and issue any written proposed adjustment. The Department must make any assessment of additional tax within one year after a “final determination” is made under C.R.S. section 39-21-103(8).
 
For tax years commencing on or after January 1, 2022, the annual, binding election requirement continues to be made on the return filed pursuant to C.R.S. section 39-22-601. An electing PTE is treated as a C corporation for purposes of estimated tax payments, but no estimated payments are required for any income tax years commencing prior to January 1, 2023. [See also Supplemental Instructions for Partnerships and S Corporations Making an Election Under the SALT Parity Act]. 
 
S.B. 22-124 also changed the tax rate on electing PTEs from 4.55% to the corporate income tax rate for the applicable tax year.  Thus, different tax rates will apply to the various years of a retroactive election, as follows: 
  • 2018 and 2019:  4.63%
  • 2020:  4.55%
  • 2021:  4.50%
For 2022, the Colorado corporate rate remains 4.50%; however, Colorado income tax rates are subject to change pursuant to the state’s “TABOR amendment.”
 

Changes to Elective PTE Tax Calculation and Effect on Owners

Originally, Colorado’s SALT Parity Act allowed owners of electing PTEs a subtraction of their distributive share of income (and exclusion of other distributive share items) from their federal taxable income starting point when calculating their Colorado taxable income. S.B. 22-124, however, retroactively replaced the subtraction with a refundable tax credit equal to the owner’s share of the PTE tax paid at the entity level for the applicable tax year of the election. Thus, owners of an electing PTE now must include their distributive share of income and other items when calculating their Colorado income tax liability, but will offset that liability with the PTE tax credit.
 
Any income tax credits allowed under Colorado law that are attributable to the activities of the electing PTE are passed through to, and must be claimed by, the electing PTE owners. S.B. 22-124 also repealed a prior provision that allowed an electing PTE to carry forward net operating losses (NOLs) and excess credits as long as a Colorado PTE tax election was in effect for the carryforward year.
 

Other State Tax Credit (OSTC)

Under the prior version of the SALT Parity Act, electing PTEs, but not Colorado-resident owners, were entitled to a credit for income taxes paid to other states. That provision was repealed by S.B. 22-124. 
 
S.B. 22-124 explicitly provides a credit to Colorado-resident partners for the resident partner’s pro rata share of any “net income tax” (defined as “any tax imposed on, or measure by, a partnership’s net income”) paid by the partnership to other states in accordance with C.R.S. section 39-22-108, Colorado’s other state tax credit (OSTC) statute. The OSTC is calculated without regard to the Colorado PTE tax credit. 
 
The OSTC statute does not contain specific authority that allows a Colorado-resident shareholder of an S corporation an OSTC for entity-level taxes paid by an S corporation to another state. However, prior to the enactment of S.B. 22-124, the Department administratively allowed Colorado-resident S corporation shareholders to claim the OSTC for income taxes paid by the S corporation to other states. See FYI Income 17, Credit for Income Tax Paid to Another State. That guidance did not allow a similar credit for Colorado-resident partners, but S.B. 22-124 now does.
 
This legislative fix, combined with the previously issued administrative guidance, appears to allow Colorado-resident owners of PTEs to claim an OSTC for other elective (and mandatory) PTE taxes paid to other states, as long as those other state taxes are on or measured by the entity’s net income. However, like most other states’ OSTCs, the credit is the lesser of the actual tax paid to the other state or the tax that would have been paid using Colorado rates.
 

Owner Amended Returns and Refunds

If a PTE makes a retroactive election, owners will also be required to prepare and file amended Colorado tax returns, recalculate their Colorado income tax liabilities, and apply their pro rata PTE tax credit.  However, given that the retroactive election cannot be made until on or after September 1, 2023, and before July 1, 2024, the filing of such amended returns is still more than 14 months away. 

Generally, Colorado imposes a four-year limitations period on claiming refunds (one year after close of the federal limitations period on refunds).  For 2018 amended returns, that limitations period will have expired by September 1, 2023, (unless the original return was filed on the October 15, 2019, extended due date). Although S.B. 22-124 waived the Colorado limitations period on refund claims, that provision could be construed as only waiving the limitations period for refunds claimed on the electing PTE’s “amended composite tax return.” Thus, at a minimum, there is a lack of clarity, and it is uncertain whether PTE owners could be foreclosed from claiming refunds, especially for the 2018 tax year. Hopefully, Colorado enacts future legislation to fix this oversight, or the Department can provide guidance.