Colorado is the latest state to give pass-through entity owners and shareholders a workaround for the federal $10,000 cap on state and local tax (SALT) deduction. To date, 22 other states have proposed or enacted similar legislation, but Colorado is the first one to permit a retroactive election. This is certainly good news for Denver pass-through entities, including S-corporations, and Limited Liability Partnerships (LLPs) that can now file an amended state return. In fact, it is estimated that upwards of almost 20 percent of eligible entities are expected to take advantage of this opportunity. To help clients, prospects, and others, Hanson & Co has provided a summary of the key details below.
The SALT Cap
The SALT cap goes back to the Tax Cuts and Jobs Act (TCJA). Before TCJA, state and local taxes were fully deductible on the federal tax return. Among other provisions, TCJA capped the SALT deduction at $10,000 between 2018 and 2025. This cap extended to owners and shareholders of pass-through entities (PTEs), who pay taxes based on what flows through from the entity’s profits to individual tax returns.
The cap is scheduled to remain in effect through 2025 unless Congress repeals it, which hasn’t happened yet and doesn’t seem likely at this point. That’s why several states have made their own SALT cap workarounds for PTE owners and shareholders. Doing so shifts the state tax liability from the individual partner or owner to the entity, which isn’t limited by a cap on deductions.
About Colorado’s SALT Parity Act
The Colorado SALT Parity Act was first enacted in 2021 and amended in May 2022. The Act is effective as of January 1, 2022, and – unlike any other state so far –retroactive to January 1, 2018. It works as a refundable tax credit at the owner level and is intended to keep Colorado revenue neutral and thus avoid double taxation on the owners. Partnerships and S-corporations would see a lower federal taxable income as a result.
Under this law, shareholders of pass-through entities (PTEs) have the option to pay state tax at the entity level, rather than passing liability on to individuals. The profits passing to each partner would be reduced, resulting in lower individual taxes. Since the entity would be paying the state tax, there would be no limitation on the SALT deduction.
To make the election for the 2022 or future tax years, entities would make a check-the-box election on the annual state income tax return. It’s an annual election that applies to all owners. PTEs would need to provide information on the return to identify all owners who would receive the refundable credits.
Colorado won’t assess late filing penalties or interest for entities making a retroactive election. Additionally, Colorado’s Department of Revenue will have one year after composite returns are filed to audit the return. It will not pay interest on refunds if it determines a tax adjustment in favor of the entity. Final determinations can be enforced at any time within six years after a determination is made.
Considerations Before Electing the Colorado PTE Workaround
If a PTE intends to make the election for 2022, it must remit quarterly estimated payments in April, June, September, and December according to the same schedule as C-corps. The electing PTE tax rate is currently 4.5 percent. In past years, the tax rate was:
- 2018 and 2019: 4.63 percent
- 2020: 4.55 percent
- 2021: 4.5 percent
To calculate estimated tax, PTEs would multiply the tax rate by their annual income, then divide by four; or divide by the quarterly income. A tax advisor can help with these calculations.
While Colorado recognizes the PTE deduction, there still isn’t a federal pass-through election. And PTEs with several owners or shareholders could find the retroactive election too labor-intensive for the result.
Even if a PTE plans to make the SALT election in 2022, doing so in previous years may not always get the best tax result. Making the retroactive election could cause issues for PTE owners, like:
- Limiting individual deductions and credits or
- Dealing with the federal statute of limitations for a retroactive election all the way back to 2018.
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