Colorado’s State Tax Deduction Work-Around

Under the Tax Cuts and Jobs Act of 2017, Congress limited individuals’ deduction for state and local taxes to $10,000. Since, many states have experimented to reduce this limitation’s burden on their residents.

Colorado’s attempt to lessen the impact on small business owners—the “SALT Parity Act”—was signed into law on June 23, 2021. Beginning January 1, 2022, “flow-through entities” (i.e., businesses taxed as partnerships or S-Corporations) may elect to be taxed at the entity level. By doing so, the entity’s state taxes are paid and deducted by the business (not subject to the limitation), reducing the profit flowing through to the individual owners. Consequently, the owner’s overall federal income tax is reduced. In effect, it allows a deduction for state taxes paid directly by the entity that normally would “flow-through” to and be paid by the owners (but limited to $10,000). The election is made through a “check-the-box” on the business’s annual Colorado income tax return.

The Internal Revenue Service appears to have given its approval of this approach (although the election only applies at the state level—for federal purposes, the partnership/S-Corporation will still have “flow-through” treatment). With the IRS’s stated approval of this approach, Colorado recently expanded the SALT Parity Act, allowing Colorado flow-through entities to make the election retroactively back to 2018 (the first year of the Federal SALT deduction limitation). Businesses may make this retroactive election between September 1, 2023, and July 1, 2024.

There are several individualized factors business owners should consider before making this election—it is not a “one-size fits all” approach. For instance, reducing the flow-through profit to the owners, while regaining the benefit of the state taxes paid, may reduce other available deductions and credits. And the federal statutes of limitations may bar some (if not all) of the benefits one might hope to obtain through a retroactive election. All of these factors (and others) should be fully explored and discussed with the companies’ and owners’ tax professionals prior to making any election.

If you have questions, contact Anderson & Jahde for competent, professional tax help.

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