Fix Passed for NOL Carry Forward Treatment and Expansion of EIC In January, the Colorado General Assembly passed House Bill 21-1002 which restores, over time, certain business deductions contained in the CARES Act of 2020 that previously were disallowed for Colorado tax purposes

Fix Passed for NOL Carry Forward Treatment and Expansion of EIC

BY DAVID TAYLOR, CPA, AND LAURA ASBELL, CPA, MT, MBA

On Jan. 15, 2021, the Colorado General Assembly passed House Bill 21-1002 (HB21-1002). It will restore, over time, certain business deductions contained in the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 that were disallowed for Colorado tax purposes by passage of Colorado House Bill 20-1420 (HB20-1420) in June 2020 and final adoption of Colorado Department of Revenue (CDOR or Department) rule 1 CCR 201-2 - Rule 39-22-103(5.3). Internal Revenue Code Definition - Prospective. The only change HB211002 made which affects 2020 income tax returns being filed in 2021 is the expanded earned income credit discussed here.

The CARES Act retroactively provided favorable tax treatment to individuals, trusts, and estates as follows:

1. Net operating losses incurred in 2018, 2019, and 2020 could be carried back five years. 2. The excess business loss limitation under I.R.C. Section 461(l) was suspended for 2018, 2019, and 2020 for non-corporate taxpayers with losses exceeding $250,000 ($500,000 for Married Filing Jointly taxpayers). 3. The limitation for excess business interest expense under I.R.C. Section 163(j) was increased from 30% to 50% of adjusted taxable income for 2019 and 2020. 4. A technical correction was made to the federal Tax Cuts and Jobs Act of 2017 definition of qualified improvement property thereby allowing such property to be eligible for bonus depreciation. HB20-1420 and the CDOR rule prevent taxpayers from availing themselves of the first three of these favorable provisions for Colorado tax purposes. Due to an unintentional oversight in drafting HB20-1420, both it and the rule created permanent differences between federal law and Colorado law for each of these items for tax years beginning in 2018 and 2019, and for the first three items for tax years beginning in 2020. HB21-1002 clarifies that differences between the CARES Act provisions and Colorado law are intended to be timing differences and provides the mechanism for reversing them. The differences are defined as the sum of the taxpayer’s Colorado taxable income for affected years, compared to what the taxpayer’s Colorado taxable income would have been for those years if Sections 2303, 2304, 2306, and 2307 of the CARES Act had been available to the taxpayer. Under HB21-1002, any difference caused by Colorado’s decoupling from the federal law for the four items noted will be treated as a temporary difference in tax years beginning after Dec. 31, 2020. Affected taxpayers will be allowed a subtraction in computing their Colorado taxable income of up to $300,000 for their first tax year beginning after Dec. 31, 2020, and up to $150,000 per year for the next four years with any remaining timing difference allowed in full, not to exceed Colorado taxable income for any years thereafter.

Any subtraction computed under the provisions of HB21-1002 may reduce Colorado taxable income to zero but cannot reduce Colorado taxable income below zero. The deductions related to the timing differences are spread over several years to remove pressure on the state’s budget. Qualified improvement property placed in service during 2018 or 2019 is depreciated over 39 years for Colorado tax purposes. Taxpayers may not circumvent this by filing a federal accounting method change to adopt the CARES Act depreciation provisions. Individuals, estates, and trusts which have a Colorado timing difference caused by qualified improvement property must reduce the Colorado tax basis of the property to equal the federal basis so that the Colorado gain or loss from the disposition of the property is the same as the federal gain or loss. This provision applies even if the qualified improvement property is disposed of before the Colorado timing difference is fully recovered.

Note that the Colorado tax treatment of qualified improvement property is the same as the federal treatment for tax years beginning in 2020. Similar provisions apply to C corporations. HB21-1002 clarifies that C corporations which allocate or apportion income to Colorado will compute the timing differences by applying the Colorado apportionment percentage used in the year the timing difference originated.

EARNED INCOME CREDIT

HB20-1420 expanded the earned income credit to those residents who wouldn’t otherwise qualify for a federal earned income credit because the taxpayer, spouse, or a dependent did not have a work-eligible social security number. This expanded credit was scheduled to become effective in 2021. HB21-1002 accelerated the effective date to years beginning in 2020. The Colorado earned income tax credit is equal to 10% of the federal credit the individual was allowed, or would have been allowed, on the federal return if the taxpayer, spouse, or dependent had a valid social security number.

NOL CARRY FORWARD EXAMPLE

Mom and Pop are the shareholders of an S corporation, Mom’s Drycleaners, Inc. For calendar 2018, Mom and Pop had a federal net operating loss of $50,000 which could not be carried back, and only 80% of the loss could reduce federal taxable income under I.R.C. Section 172 prior to enactment of the CARES Act.

After enactment of the CARES Act, Mom and Pop carried their federal net operating loss back five years to 2013, fully utilizing it. In accordance with the CDOR rule, Mom and Pop did not carry their net operating loss back to offset prior Colorado taxable income. In April 2019, Mom’s Drycleaners, Inc. placed $5,000 of qualified improvement property into

service and claimed bonus depreciation on the full amount for federal tax purposes. Under the Internal Revenue Code prior to enactment of the CARES Act, the qualified improvement property would have been depreciated over 39 years, and a 2019 depreciation deduction of $91 would have been allowable. After claiming a $5,000 deduction for the qualified improvement property, Mom’s Drycleaners, Inc. had ordinary taxable income of $100,000 and no other separately stated items on its federal tax return.

On its 2019 Colorado income tax return, Mom’s Drycleaners, Inc. must report a modification to its federal taxable on line 1 of its Colorado tax return of $4,909 ($5,000 minus $91). Mom’s Drycleaners, Inc. would also report the modification to Mom and Pop with an explanation so that they properly compute their 2019 Colorado taxable income and compute their net timing difference correctly in 2021. Mom’s Drycleaners, Inc. also must reduce the tax basis of the qualified improvement property to zero for future years so that its basis equals the federal tax basis of such property. On their 2019 individual income tax return, Mom and Pop reported federal taxable income of $220,000. On their 2019 Colorado income tax return, Mom and Pop would report federal taxable income of $224,909 on line 1, reflecting the disallowed deduction for the qualified improvement property from Mom’s Drycleaners, Inc. Mom and Pop would not be allowed a deduction or subtraction on their 2019 Colorado income tax return for the 2018 net operating loss because the loss was carried back to 2013 for federal purposes. Therefore, it was not included in their 2019 federal taxable income. In 2020, Mom’s Drycleaners, Inc. placed $20,000 of qualified improvement property into service and claimed a 100% bonus depreciation deduction on its federal Form 1120S. The bonus depreciation deduction is allowed in full for 2020 so no Colorado timing difference is created for the 2020 qualified improvement property. In 2021, Mom and Pop would compute their cumulative Colorado timing difference caused by differences between federal and Colorado tax laws: $54,909 - the $50,000 net operating loss from 2018 plus the $4,909 difference related to the qualified improvement property acquired by Mom’s Drycleaners, Inc. This cumulative timing difference will be allowed as a subtraction on Mom and Pop’s Form 104 beginning in 2021 and carrying forward to future years until fully utilized. Assuming Mom and Pop’s federal taxable income for 2021 was at least $54,909, the subtraction is fully utilized in 2021 because it is less than the $300,000 limit applicable to 2021, and it does not reduce Mom and Pop’s Colorado taxable income below zero.

David Taylor, CPA, is a Tax Partner with BDO USA LLP, Denver. Contact him at detaylor@bdo.com. Laura Asbell, CPA, MT, MBA, is a Senior Tax Manager with CBIZ & Mayer Hoffman McCann P.C., Denver. Contact her at lasbell@cbiz.com. Both are members of the COCPA/CDOR Working Group which meets with the Department to address issues and provide input on processes and proposed rules. To join the working group, email Mary E. Medley, mary@cocpa.org.

1 CCR 201-2 - RULE 39-22-103(5.3). INTERNAL REVENUE CODE DEFINITION - PROSPECTIVE.

Basis and Purpose. The statutory bases for this rule are sections 2-4-202, 39-21112, 39-22-103(5.3), 39-22-104, and 39-22-304, C.R.S. The purpose of the rule is to clarify that the term “internal revenue code” incorporates changes to federal statute only on a prospective basis. “Internal revenue code” does not, for any taxable year, incorporate federal statutory changes that are enacted after the last day of that taxable year. As a result, federal statutory changes enacted after the end of a taxable year do not impact a taxpayer’s Colorado tax liability for that taxable year. Changes to federal statutes are incorporated into the term “internal revenue code” only to the extent they are in effect in the taxable year in which they were enacted and future taxable years.

Alert

RETROACTIVE TAX CHANGES AND COLORADO RETURNS

According to Colorado Rule 39-22-103(5.3), federal statutory changes enacted after the last day of a tax year do not impact a taxpayer’s Colorado tax liability for that taxable year. For example, the CARES Act amendment that retroactively changed the depreciable life for Qualified Improvement Property from 39-year to 15-year property, making it eligible for bonus depreciation, applies only to Colorado tax years ending on or after March 27, 2020. Thus, a taxpayer may amend the federal 2018 or 2019 return for the change but not the Colorado return. The Colorado regulation affects not only the retroactive provisions of the CARES Act but also possibly any retroactive federal legislation. For example, IRC Code §222(e) provides up to a $4,000 above-the-line deduction for tuition and related education expenses. That deduction expired on Dec. 31, 2017. It was retroactively extended by the Taxpayer Certainty and Disaster Tax Relief Act of 2019. Since that Act was signed on Dec. 20, 2019, the retroactive deduction allowed in amending a taxpayer’s 2018 federal return is not allowed for the 2018 Colorado return. It only is allowed for Colorado tax years ending on or after December 20, 2019. See Colorado Publication, CARES Act Tax Law Changes and Colorado Impact (September 2020), tax.colorado.gov/sites/tax/files/ CARESGuidance_0.pdf.

COLORADO TREATMENT – PPP LOANS

The exclusion of covered loans from gross income under section 1106(i) of the CARES Act was a prospective provision in effect during the tax year. As such, covered loans excluded from federal taxable income will be similarly excluded from Colorado taxable income.

The amendments to the CARES Act by section 276 of the COVID-Related Tax Relief Act of 2020 – which clarified that deductions and basis increases may not be denied, nor may tax attributes be reduced, because of the exclusion of covered loan forgiveness from gross income – became law on Dec. 27, 2020. Therefore, these changes will impact the Colorado tax liability for calendar-year taxpayers. The Colorado tax liability of taxpayers whose tax years ended before Dec. 27, 2020 will not be impacted by these amendments in accordance with 1 CCR 201-2, Rule 39-22-103(5.3).