26 May 2026 Colorado legislature approves tax changes that include a move to worldwide combined reporting with an available water's edge election
Before adjourning its 2026 legislative session on May 13, 2026, the Colorado legislature approved and sent to Governor Jared Polis House Bill 26-1289 (HB 1289, the bill), which would make changes to income taxes, credits and incentives, sales and use taxes, cigarette and tobacco excise taxes and motor fuels taxes. Most of the changes in the bill would take effect in tax year 2027. This Tax Alert focuses on the corporate income tax changes made by HB 1289. Colorado recently moved to a traditional combined reporting methodology beginning in 2026 (Tax Alert 2024-0986). HB 1289 would make worldwide combined reporting the default filing methodology for tax years beginning on or after January 1, 2027, with the option to make a water's edge election. Taxpayers would make the water's edge election on a timely filed original return. Once made, the election would be binding for 10 years. Upon expiration of the 10-year period, the combined group could withdraw the election on a timely-filed original return for the first tax year after the end of the 10-year binding period. If not withdrawn, the election would be binding for a new 10-year period. If withdrawn, the withdrawal would be binding for 10 years. Withdrawals of a water's edge election, or reinstatements of a withdrawn water's edge election, within the 10-year binding periods would be possible upon a showing of reasonable cause based on extraordinary hardship due to unforeseen changes in state tax laws or policies. The water's-edge group would include all domestic members of the affiliated group, including domestic 80/20 corporations, foreign corporations if they have at least 20% of their property and payroll in the United States, domestic international sales corporations, export trade corporations and corporations incorporated in tax-haven jurisdictions (Tax Alert 2025-1788). The bill would eliminate dividends, subpart F income and net controlled foreign corporation tested income between members of the combined group. The water's edge return would include income and apportionment factors of other otherwise excludable affiliates to a limited extent. The new rules would bring in effectively connected income (and related factors) of excluded members. Another provision would disallow deductions taken by includable affiliates for amounts paid to excludable affiliates for services and intangibles. Colorado uses a listed jurisdiction approach in its tax-haven rules. Starting in tax year 2027, HB 1289 would remove Lichtenstein from Colorado's list of tax havens and require the Department of Revenue to periodically evaluate whether each of the listed jurisdictions should remain on the list. HB 1289 also would modify the computation of corporate net income for tax years beginning on or after January 1, 2027, by:
HB 1289 continues the evolution of Colorado's combined reporting system from the "3 of 6" test, to a traditional unitary combined reporting system, and now to a worldwide combined reporting system with a water's edge election. Colorado's water's edge system will again make it unique among states, as it will include income that would normally be excluded in a more traditional water's edge approach, such as including domestic 80/20 corporations and requiring income adjustments such as adding the effectively connected income of, and disallowing certain expenses paid to, otherwise excluded members. The Colorado legislature has also considered other tax changes, such as decoupling from many One Big Beautiful Bill Act changes and limiting net operating loss deductions and carryforwards. These changes were not passed this legislative session.
Document ID: 2026-1129 | ||||||||
