May 5, 2023
Colorado Department of Revenue adopts and amends income tax rules
On April 5, 2023, the Colorado Department of Revenue (Department) amended three administrative rules and adopted one new rule on corporate income tax. These rules relate to (1) NOLs for corporations, individuals, estates and trusts, (2) Colorado’s unique foreign-source income exclusion and (3) Internal Revenue Code (IRC) Section 78 dividends. The amended and new rules take effect May 30, 2023.
NOLs – corporations
Colorado Revised Stat. (CRS) 39-22-504 permits an NOL “in the same manner that it is allowed under the [IRC] except as otherwise provided….” The former administrative rule, Colorado Code of Regulations (CCR) 39-22-504(2).1, provided that the Colorado NOL “is computed the same as a federal [NOL] except that the Colorado loss is computed using the modified federal income allocated and apportioned to Colorado.” This suggested that Colorado modifications to the federal taxable income (FTI) starting point could result in a “Colorado NOL.”
The Department adopted CCR 39-22-504-2 for Colorado NOLs for corporate taxpayers. The amended rule allows a Colorado NOL in the same manner as the federal NOL, but considers the Colorado NOL to be only that portion of the federal NOL allocated to Colorado, subject to Colorado addition and subtraction modifications and Colorado’s foreign-source income exclusion. If the Colorado NOL, as computed under the rule, exceeds the federal NOL, however, CCR 39-22-504(1)(d) limits the Colorado NOL to the federal NOL. If a group of corporations filing combined, consolidated or combined-consolidated Colorado returns do not collectively have a federal NOL, based on the group of corporations included in the Colorado return, the group does not have a Colorado NOL for that year. A similar limitation applies for separate filers.
For combined, consolidated and combined-consolidated returns, the amended rule establishes that the Colorado NOL is calculated only for the C corporations that are included in the return and based on the federal NOL that is determined only for the group included in the return. For separate return filers, the Colorado NOL is calculated only for that C corporation and based on the federal NOL that is determined only for that C corporation. Provisions of the rule on combined, consolidated, combined-consolidated, and separate filing and the modification, allocation and apportionment provisions in paragraphs of the amended rule apply in accordance with the law in effect for the tax year in which the loss was sustained.
The amended rule also addresses the following topics: (1) carryforward of Colorado NOLs; (2) limitations on the Colorado NOL deduction, including the 80% limitation that applies starting in 2018, IRC Sections 382 and 860E limitations, and SRLY limitations; and (3) Colorado taxable income before the NOL deduction for purposes of determining Colorado NOLs and limits on it.
NOLs – individuals, estates and trusts
The Department adopted amended CCR 39-22-504-1 for Colorado NOLs for individuals, estates and trusts. Under the general rule, an individual, estate or trust may deduct an NOL in the same manner as allowed under the IRC; in calculating Colorado income, however, an addition to federal taxable income is required for the portion of NOL not allocated to Colorado. The rule includes guidance for calculating the addition for full-year Colorado residents, Colorado nonresidents and part-year Colorado residents.
The Department adopted amendments to CCR 39-22-303(10) on the foreign-source income exclusion. The rule defines foreign-source income and outlines how to calculate the amount of foreign-source income considered in a corporation’s allocated and apportioned net income. It also describes the requirements for reporting changes to that amount.
When allocating or apportioning income, a C corporation’s foreign source income generally is considered only to the extent provided in CRS Section 39-22-303(10) and this rule. When a combined, consolidated or combined-consolidated return is filed, the foreign-source income exclusion is calculated only for the group of C corporations included in the return and based on the foreign tax credit or deduction determined only for the group in the return. For C corporations filing separately, the foreign-source income exclusion is calculated only for that C corporation and based on the foreign tax credit or deduction determined only that corporation.
Foreign-source income is defined as taxable income from sources outside the United States (US), as used in IRC Section 862, and includes any taxable income from sources outside the US that are considered in calculating the limit on the federal foreign tax credit under IRC Section 904(a). Based on IRC Section 862(b), taxpayers must deduct from “gross income from sources without the US” any expenses, losses and other deductions properly apportioned or allocated to Colorado, including any deduction allowed under IRC Section 250 and a ratable part of any other expenses, losses or deductions that cannot be allocated to some item or class of gross income. “Gross income from sources without the US” includes: (1) types of income enumerated under IRC Section 862(a); (2) income allocated to non-US sources under IRC Section 863; (3) amounts included in the corporation’s federal taxable income under IRC Sections 951 or 951A; (4) dividends received by the corporation under IRC Section 78; and (5) any item of income treated as arising from non-US sources under a treaty obligation with the US as described in IRC Sections 245(a)(10), 904(d)(6) or 904(h)(10).
In allocating and apportioning a corporation’s Colorado income, the rule explains how to determine the amount of the foreign tax deducted for federal purposes that must be subtracted, and the amount of the federal credit for foreign tax that must be excluded. The provisions for the foreign tax credit exclusion are extensive and include discussions on, among other things, (1) separate exclusion calculations for certain categories of income, (2) the coordination with certain combined or combined-consolidated reporting provisions, (3) the effective federal corporation income tax rate, and (4) redeterminations under IRC Section 905(c).
Finally, if a foreign tax credit is claimed, the foreign-source income exclusion is computed via the following formula: (Foreign source income – IRC Section 78 gross up) x (Foreign taxes paid or accrued / ((federal income tax / federal taxable income) / foreign source income))). In computing the foreign-source income exclusion ratio, the amended rule includes IRC Section 78 income in the denominator of the ratio even though it receives a separate exclusion under CRS Section 39-22-304(j).
IRC Section 78 dividends
The Department adopted new CCR 39-22-304(3)(j) for corporate subtractions for IRC Section 78 dividends. The rule generally limits the subtraction allowed under CRS Section 39-22-304(3)(j) to the amount treated as a dividend and included in a C corporation’s FTI under IRC Section 78. A subtraction is not allowed for any part of an amount that is treated as a dividend under IRC Section 78 and deducted in the calculation of FTI. A subtraction also is not allowed for an amount that is (1) treated as a dividend under IRC Section 78, (2) attributable to global intangible low-taxed income under IRC Sections 951A and 960(d), and (3) deducted under IRC Section 250(a)(1)(B)(ii) in the calculation of FTI. Only C corporations subject to Colorado corporate income tax may claim the subtraction.
The foregoing rules were adopted on April 5, 2023, and take effect May 30, 2023. The amended NOL rule precludes a corporate taxpayer without a federal NOL from claiming a Colorado NOL. This appears to be a change in policy as observed in Department audits of corporations. Regarding the foreign-source income exclusion, the requirement for a corporation that has elected to claim foreign tax credits to separately calculate the exclusion for each of the four identified categories seems to conflict with the aggregate approach of the Colorado statute. See CRS Sections 39-22-303(10)(b)(I), (10)(b)(II), (10)(b)(III). It also adds administrative complexity to the computation, but, as indicated in working group meetings, the Department believes that taxpayers should be able to get necessary information from Forms 1118.
EY will continue to monitor developments in this area.
Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor