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On January 21, 2021, Colorado Governor Jared Polis signed House Bill 21-1002 (HB 21-1002), which allows taxpayers that accelerated certain federal income tax deductions under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to subtract the corresponding state income tax benefit starting in 2021. HB 21-1002 is intended to offset previous decoupling¹ from certain provisions of the CARES Act.

This new Colorado subtraction specifically concerns modifications to the following federal income tax deductions enacted under the CARES Act:

• Retroactive changes to net operating losses (NOLs) under IRC Section 172(b)(1)(D) (CARES Act Section 2303)
• Relaxation of IRC Section 461(l) limitations on deduction of excess business losses by individuals (CARES Act Section 2304)
• Business interest expense limitations under IRC Section163(j)) (CARES Act Section 2306)
• Qualified improvement property (QIP) under IRC Section 168(e)(3)(E) (CARES Act Section 2307))

For income tax years beginning on or after January 1, 2021, but before January 1, 2022, the subtraction equals:

• The difference between the taxpayer's Colorado taxable income for tax years ending before March 27, 2020, as calculated under applicable state law at the time the return was due (taxable income for the specified tax years²) and the taxpayer's Colorado taxable income as calculated under federal and state law as modified by the CARES Act (taxable income for the modified specified tax year"³)

Plus

• The sum of any amounts added back to reflect the retroactive application of the CARES Act changes to IRC Sections 172(b)(1)(D), 461(l) and 163(j)

Additional provisions address modifications for corporations that must apportion or allocate income to Colorado.

The subtraction is limited to the lesser of the taxpayer's Colorado taxable income or $300,000. Unused amounts can be carried forward to subsequent tax years until exhausted for tax years beginning on or after January 1, 2022, but before January 1, 2026; the amount subtracted for these years, however, is limited to the lesser of the taxpayer's Colorado taxable income or $150,000. Beginning in 2026, the subtraction may not exceed the taxpayer's Colorado taxable income. Further, the subtraction must be first applied to the earliest income tax year possible.

Taxpayers that apply the subtraction for QIP must calculate the gain or loss on the QIP's sale for purposes of the subtraction allowed under Colo. Rev. Stat. Section 39-22-104(4)(b) (individuals, estates and trusts) or Colo. Rev. Stat. Section 39-22-304(p) (corporations) using the basis reported on the taxpayer's federal income tax return at the time of the sale.

Implications

Individual and corporate taxpayers may need to consider the application of these provisions for tax years beginning in 2021 and keep in mind that its utilization is capped according to the schedule noted previously.

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ENDNOTES

¹ Colorado has rolling conformity to the Internal Revenue Code. In response to the CARES Act, House Bill 20-1420 (HB 20-1420) was enacted in July 2020, requiring taxpayers to add back the difference between interest deducted for federal income tax purposes under the CARES Act amendments to IRC Section 163(j) and interest that would have been deducted under IRC Section 163(j) before the CARES Act. HB 20-1420 also limited the Colorado NOL deduction to 80% of taxable income notwithstanding the CARES Act provision allowing federal NOLS to offset 100% of taxable income. Under regulations from the Colorado Department of Revenue, Colorado adopts changes to the IRC on a prospective basis only. The regulations prohibit taxpayers from applying the retroactive change in the CARES Act to the treatment of QIP as eligible for 100% bonus depreciation.

² The law defines "taxable income for the specified tax years" as "the taxpayer's Colorado taxable income for tax years ending before March 27, 2020, as calculated under Colorado law applicable to the taxpayer's return as of the date the return was due."

³ The law defines "taxable income for the modified specified tax years" as "the taxpayer's Colorado taxable income for tax years ending before March 27, 2020, as calculated under the Internal Revenue Code and Colorado law applicable to the taxpayer's return as of the date the return was due, as modified by the application of retroactive provisions of the CARES Act applied to the calculation of the taxpayer's federal taxable income, but only to the extent the taxpayer appropriately applied those provisions to the taxpayer's federal income tax return for each year."