New 2020 Colorado Law Creates Differences Between Federal and Colorado Taxable Income

New 2020 Colorado Law Creates Differences Between Federal and Colorado Taxable Income

By Wayne M. Lenell, CPA, PhD

On June 26, 2020, Governor Polis signed into law House Bill 20-1024, and on July 11, 2020, he signed into law House Bill 20-1420 termed the "Tax Fairness Act." With these two bills, the Colorado legislators had a twofold purpose of replacing lost income resulting from Federal tax law changes, and closing some tax benefits generally associated with higher-income taxpayers.

Colorado taxable income generally follows Federal taxable income. There are a few current differences between Federal taxable income and Colorado taxable income such as a charitable donation tax deduction for Colorado tax returns for taxpayers who do not itemize their Federal deductions, but these new laws increase the number of Federal-to-State tax differences. Following are the highlights of four new tax law changes applicable to Colorado taxpayers.

1. The 20% deduction for qualified business income (QBI) will no longer be deductible for Colorado income tax purposes for higher-income taxpayers. This results in an "add back" to Colorado taxable income from that of Federal taxable income. It only applies for tax years beginning on or after January 1, 2021 before January 1, 2023. There are also some exceptions to the "add back" rules as follows.

• It only applies to single taxpayers with an adjusted gross income greater than $500,000 and married taxpayers filing jointly with an adjusted gross income greater than $1,000,000.

• If the taxpayer files Federal Form Schedule F (for farmers) as an attachment to the Federal tax return, the "add back" does not apply. At the time of this writing, the law does not require that the farming activity produce the QBI deduction, just that the taxpayer files a Schedule F. Therefore, under the current Colorado tax law, a taxpayer could have a business producing a large profit resulting in a substantial 20% QBI deduction, but also maintain a small farm producing little or no taxable income. Because the taxpayer files a Schedule F for the farming activity, the taxpayer would not need to add back the 20% QBI deduction to Colorado income.

2. Colorado individual, estate, and trust taxpayers cannot entirely wipe out their taxable incomes with net operating loss (NOL) deductions. Prior to the Federal CARES Act of March 27, 2020, NOL deductions were limited to 80% of taxable income for Federal tax purposes and Colorado followed the Federal law. The CARES Act allows taxpayers to use an NOL to entirely eliminate taxable income for 2020. The new Colorado law simply negated the effects of the CARES Act for NO Ls. Therefore, Colorado taxpayers who, for Federal tax purposes, have applied an NOL to eliminate Federal taxable income, must add back 20% of taxable income so that the NOL deduction reduces Colorado taxable income by no more than 80%.

3. Non-corporate Colorado taxpayers who incur business losses in 2020 may deduct only up to $250,000 (for single taxpayers) and $500,000 for married taxpayers filing jointly) of the excess losses. This was the law prior to the CARES Act. The CARES Act temporarily lifted the $250,000/$500,000 limitation for deducting excess business losses. The new Colorado law reverses the CARES Act provision for excess business losses for Colorado taxpayers. Therefore, a Colorado taxpayer with a business loss deduction in excess of the $250,000/$500,000 limit for Federal tax purposes, must add back to Colorado taxable income any business losses in excess of the $250,000/$500,000 limits.

4. Colorado corporate and non-corporate taxpayers may have an "add back" to taxable income for business interest deductions. Prior to the CARES Act, taxpayers were limited to deducting business interest expenses to a maximum of 30% of adjusted taxable income. The CARES Act temporarily increased the business interest tax deduction to 50% of adjusted taxable income for taxpayers with gross receipts for the prior three years averaging $26 million or less. The new Colorado law reverses the CARES Act provision for business interest deductions. Therefore, in 2020, if a Colorado taxpayer has a Federal tax deduction in excess of 30% of adjusted taxable income, the taxpayer must add back to Colorado taxable income the amount of business interest deduction exceeding the 30% limitation.