May 24, 2022
Colorado makes elective pass-through entity tax retroactive to 2018
On May 16, 2022, Colorado Governor Jared Polis signed Senate Bill 22-124 (SB 22-124), which makes Colorado's elective pass-through entity (PTE) tax (enacted in 2021 by the SALT Parity Act1) retroactive to January 1, 2018. SB 22-124 makes other changes to the PTE tax, as well as the resident credit for taxes paid to other states.
Retroactive application of SALT Parity Act
The SALT Parity Act was intended to enable most Colorado PTE2 owners to deduct, for federal income tax purposes, state and local taxes exceeding the annual federal $10,000 deduction limitation ($5,000 for married individuals filing separately) imposed by IRC Section 164(b)(6) (the SALT deduction limitation), consistent with IRS Notice 2020-75 (see Tax Alert 2020-2690). As originally enacted, the Colorado PTE election was available for tax years beginning on or after January 1, 2022.
SB 22-124 amends the SALT Parity Act to allow PTEs and their owners to retroactively make the election. For tax years beginning on or after January 1, 2018, but before January 1, 2022, a PTE can make the election by filing an amended composite tax return on or after September 1, 2023, but before July 1, 2024, for the applicable years. The Colorado Department of Revenue (Department) will issue the returns necessary to make the retroactive election(s). The procedure for making the election for tax year 2022 and thereafter is unchanged by SB 22-124 (i.e., a PTE tax election must be made on the return filed by the electing PTE and is binding on all the electing PTE's owners).
SB 22-124 specifies that the Department will not assess any late-filing interest or penalty for filing amended composite returns. The Department will have one year from the date the composite amended return is filed to make proposed adjustments but will not have to pay interest on any refunds. The Department must make any assessments within one year after a final determination is issued under Colo. Rev. Stat. 39-22-103(8). These final determinations may be enforced at any time within six years of the date of the determination.
Imposition of tax, electing PTE tax computation and electing PTE owner credits
SB 22-124 amends Colo. Rev. Stat. 39-22-344 to apply the corporate tax rate to electing PTEs for the income tax year for which the election is made.
As originally enacted, the SALT Parity Act taxed an electing PTE based on its owners' distributive shares of Colorado-sourced income and income attributed to other states. The electing PTE's income was then excluded from the PTE owners' Colorado income tax bases. The electing PTE, not its owners, could claim credits for taxes that were paid to other states and attributable to the electing PTE's activities in those states.
SB 22-124 converts the income exclusion into a refundable tax credit available to the PTE owners. Specifically, SB 22-134 enacts new Colo. Rev. Stat. 39-22-347, which expressly states that the Colorado legislature's replacement of the income exclusion with the tax credit is intended to be revenue neutral and to avoid double taxation on electing PTE owners.
For tax years beginning on or after January 1, 2018, new Colo. Rev. Stat. 39-22-348(2) allows electing PTE owners to claim a credit against individual income tax equal to their pro rata share of the tax paid by the electing PTE on their income. Electing PTEs will need to provide sufficient information on their return to identify the owners entitled to the credit. Credits exceeding the electing PTE owner's Colorado income tax liability will be refunded to the PTE owner.
SB 22-124 also amends Colo. Rev. Stat. 39-22-346 to require electing PTE owners to compute their resident credit, allowed under Colo. Rev. Stat. 39-22-108, without regard to the credit allowed by Colo. Rev. Stat. 39-22-347 (i.e., the credit for an electing PTE owner, described previously).
Changes to Colorado resident credit for non-electing PTE owners
Colo. Rev. Stat. 39-22-108 allows Colorado residents to claim a credit for taxes paid to other states. It has been unclear whether a Colorado resident investor in a PTE that did not make the Colorado PTE election could claim a resident credit for taxes paid by a PTE electing into a "SALT deduction cap workaround" regime in another state. SB 22-124 adds new Colo. Rev. Stat. 39-22-202(4), which deems a Colorado partner to have paid tax, for purposes of the resident credit, equal to its pro rata share of income tax paid by the partnership to "a state that does not measure the income of partners of a partnership by reference to the income of the partnership." This change seems intended to allow a Colorado resident to claim a credit for taxes paid by a PTE electing a "SALT deduction cap workaround" in another state.
Colorado is the first state to make its elective PTE regime retroactive. PTEs and their owners subject to Colorado taxation should consider these changes and follow the necessary procedures for making retroactive PTE elections under Colorado’s new law. For federal income tax purposes, it is uncertain whether the IRS will respect such a lengthy retroactive election under Notice 2020-75 even if allowed by a state. EY will continue to monitor developments in this area.
1 2022 Colo. Sess. Laws ch. 300 (CO HB21-1327); See Tax Alert 2021-1220.
2 The election is available to both partnerships and S corporations (including limited liability companies treated as either a partnerships or S corporations).