Colo. Partly Decouples From Fed. Virus Relief Tax Breaks

By James Nani
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Law360 (July 14, 2020, 8:25 PM EDT) -- Colorado will temporarily decouple from certain federal pandemic tax-relief provisions under a bill signed by the governor as the state grapples with a pandemic-induced budget hole.

H.B. 1420, which Democratic Gov. Jared Polis signed Saturday, was passed by the Legislature in mid-June. Colorado will decouple from several pass-through and corporation tax relief provisions in the federal Coronavirus Aid, Relief and Economic Security Act , or CARES Act, for the 2020 tax year, according to a fiscal note for the bill.

A previous version of the bill would have decoupled for all tax years ending on or after the act's passage.

Senate Majority Leader Stephen Fenberg, D-Boulder, told Law360 that lawmakers felt the tax expenditures could better be used to help families, especially as the state faces a $3.5 billion budget shortfall. He noted one of the impacts of the law is increasing and extending the earned income tax credit.

"We need to look at every single expenditure we're making and ensure that it's the right priority," Fenberg said. "And some of these just didn't seem right to give tax breaks, frankly, to wealthy folks and large corporations."

The law will also limit a qualified business income deduction for pass-through business owners provided by the 2017 Tax Cuts and Jobs Act , according to the note. Under the law, owners whose adjusted gross income exceeds $500,000 must add back the federal deduction to calculate state taxable income for income tax years commencing on or after Jan. 1, 2021, but before Jan. 1, 2023. 

The law is estimated to raise $113 million for fiscal year 2021 and $23 million for fiscal year 2022. A previous version of the bill would have raised an estimated $248 million in fiscal year 2021 and $408 million in fiscal year 2022.

Amendments to the bill made before it was passed came after discussions with Polis and other stakeholders, Sen. Chris Hansen, D-Denver, a sponsor of the bill, previously told Law360.

Polis' office didn't immediately respond to requests for comment Tuesday.

The offices of the Senate and House minority leaders, both Republicans, didn't immediately respond to requests for comment. 

The law requires that for the 2020 tax year, pass-through businesses that claim an expanded federal net operating loss deduction must include in taxable income the portion of the deduction that is affected by the CARES Act's net operating loss provision. For pass-through business owners who claim an excess business loss deduction for tax year 2020, the amount exceeding the limitation in the TCJA that is allowed under the CARES Act must be added to taxable income, according to the law.

Pass-through business owners and C corporations that claim a business interest income deduction for tax year 2020 will also have to add to their taxable income the amount exceeding the limitation in the TCJA that is allowed under the CARES Act, under the law.

The law will also increase the state's earned income tax credit from 10% of the federal earned income tax credit to 15%. Additionally, it will extend the state credit to taxpayers who are otherwise eligible for the federal credit but for the absence of a valid Social Security number, beginning in tax year 2021. That will extend the credit to taxpayers who are in the state without valid immigration authorization.

Fenberg noted Colorado is limited in how much savings it can have, is required to have a balanced budget and is limited in how it can raise new revenue. Some of those limitations are required by Colorado's Taxpayer Bill of Rights, a 1992 state constitutional amendment that prevents the Colorado Legislature and local governing bodies from raising existing taxes or enacting new ones without the popular vote backing of the public. It also requires state and local governments to refund to taxpayers any revenue collected in excess of the prior year's spending.

Many Democrats in the Legislature wanted to go further in eliminating tax breaks and the governor wanted that as well, Fenberg said. But Polis also wanted some of the savings to go toward income tax cuts, according to Fenberg.

"This is the beginning of a conversation to figure out how we can make the overall tax code in Colorado a little bit more fair and a little bit more progressive, especially since obviously everybody is suffering right now," Fenberg said.

Laura Giocomo Rizzo, senior vice president of external affairs for the Denver Metro Chamber of Commerce, said the bill in its initial form would have had "devastating consequences" on employers of all sizes in the state. The group was relieved amendments were made in the Senate that kept some net operating loss deductions, sales tax exemptions and qualified business exemptions, she said.

"While we would have preferred that businesses had the opportunity to recognize the tax relief provisions afforded by the CARES Act on their state obligations as well, we understand the overwhelming impacts COVID has had on our state's budget," Rizzo said.

States across the country have considered decoupling from the federal tax changes. Mike Shaikh, a partner in the tax group of Baker McKenzie, told Law360 that Colorado, which had rolling conformity with the Internal Revenue Code, had to make a quick decision on whether to conform or decouple. Decoupling didn't come as a surprise in light of requirements that the state have a balanced budget, he said.

"Colorado's bill is indeed part of a trend. North Carolina just enacted a bill decoupling from the CARES Act in similar ways. Other states — like California — are taking it a step further by adding new limitations on NOL and credit utilization," Shaikh said. "If the 2008 recession is any indicator, we'll see a growing trend of these revenue-increasing bills along with additional auditing and enforcement measures into the next few years."

--Additional reporting by Asha Glover and Daniel Tay. Editing by Neil Cohen.

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