Colorado regulation changes impact NOLs, FSI exclusion, and Section 78 subtraction

In detail

Net operating losses 

Prior to the Rule Changes, Rule 39-22-504(2) generally provided that Colorado’s NOL was computed “the same as a federal net operating loss except that the Colorado loss is computed using the modified federal income allocated and apportioned to Colorado.” 

Effective on April 5, 2023, Rule 39-22-504(2) was stricken in its entirely and replaced with the guidance described below. 

Allocation of federal NOL to Colorado 

Similar to the historical Rule, Colorado provides that a Colorado NOL “is allowed in the same manner as a federal net operating loss, except that the Colorado net operating loss is computed as only that portion of the federal net operating loss that is allocated to Colorado.” The Rule Changes provide the following new guidance: 

• Combined, consolidated, and combined-consolidated returns. Colorado NOLs are calculated with respect to only the C corporations that are included in such return and based upon the federal NOL determined with respect to only such group of C corporations.
• Separate returns. NOLs are calculated with respect to only that filing C corporation based upon its federal NOL.
• Modified federal NOL. The federal NOL is modified by: 
  • Colorado addition modifications under CRS 39-22-304(2), 
  • Colorado subtraction modifications under CRS 39-22-304(3), and  
  • foreign source income exclusions under CRS 39-22-303(10).
• Allocation and apportionment of modified federal NOLs. Taxpayers subtract nonapportionable income from the modified federal NOL (unless an election is made to treat all income as apportionable). The remaining amount is apportioned pursuant to the state’s apportionment rules.
• Colorado NOL limitation. Generally, a taxpayer’s Colorado NOL cannot exceed its federal NOL.
• Colorado NOLs are computed pursuant to laws in effect during the loss year.

NOL carryforwards 

Enacted on June 26, 2020, H.B. 1024 modified CRS 39-22-504(3) to provide that: (1) NOLs of corporations generated in income tax years commencing before January 1, 2021, may be carried forward for the same number of years as allowed for a federal NOL and (2) NOLs of corporations generated in income tax years commencing on or after January 1, 2021 may be carried forward for 20 years  

Pursuant to the Rule Changes, Rule 39-22-504(2) provides that: 

• The entire amount of any Colorado NOL shall be first carried forward to the tax year immediately following the tax year in which the loss was sustained.
• In the event a C corporation has available for deduction Colorado NOLs originating in multiple tax years, the C corporation must first deduct the loss arising from the earliest tax year. 
• If all or any part of an available NOL may not be deducted because of limitations described below, the part that may not be deducted may be carried forward to the next tax year, but in no event may a loss be carried forward beyond the time periods prescribed in CRS 39-22-504(3). 

Limits on the Colorado NOL deduction 

Pursuant to the Rule Changes, Rule 39-22-504(3) provides generally that a Colorado NOL is subject to the same limitations imposed upon a federal NOL, including (a) IRC Section 172 (a)(2) (the 80% limitation); (b) IRC Sections 381, 382, and 384; and (c) Treas. Reg. 1.1502-21.

80% limitation 

Enacted on July 11, 2020, H.B. 1420 provides that, for losses incurred after December 31, 2017, the 80% limitation in IRC Section 172(a)(2) applies without regard to the amendments made under section 2303 of the CARES Act. Based on this change, Colorado will apply the 80% limitation and the original application of taxable income enacted prior to the CARES Act.  

Pursuant to the Rule Changes, Rule 39-22-504-2(3)(b)(ii) provides that: 

• The 80% limitation applies to Colorado NOL deductions claimed for losses arising in tax years beginning after December 31, 2017, regardless of the tax year for which the deduction is claimed. 
• The 80% limitation applies with respect to a C corporation’s Colorado taxable income before the NOL deduction determined under the rule. Federal taxable income is determined with regard to any deduction allowed under Section 250.
• The 80% limitation applies with respect to Colorado taxable income after the deduction of any Colorado NOL deduction allowed under Sec. 39-22-504 for a loss arising in a tax year beginning prior to January 1, 2018. 

An April 2023 update to the Department’s CARES Act Tax Law Changes & Colorado Impact guidance provides that “the Colorado C Corporation Income Tax Return (form DR 0112) for tax years 2019 and later includes a specific line for deducting Colorado net operating losses arising in tax years beginning after December 31, 2017, that are subject to the 80 percent limitation. Therefore, although the CARES Act suspended this limit, C corporations may not amend their returns to claim additional net operating losses despite the recent” decision in Anschutz v. Department of Revenue, determining that retroactive changes in federal law can affect a taxpayer’s Colorado taxable income. Please click here for our Insight providing more detail on the revised guidance and click here for our Insight summarizing Anschutz.

SRLY and Treas. Reg. 1.1502-21 

The Rule Changes provide that Treas. Reg. 1.1502-21 is “incorporated by reference.” The Rule provides considerable guidance and examples regarding SRLY applications.

Among other provisions, the Rule Changes state that “[f]or its application to the Colorado net operating loss deduction, the net operating loss limitation prescribed by section 382 of the Internal Revenue Code shall be apportioned to Colorado using the Colorado apportionment fraction for the old loss corporation for the last full tax year prior to the change in ownership.”  

Observation: The Section 382 apportionment treatment is not set forth in Colorado statutes.

Observation: The Rule Changes provide a specific methodology for calculating the SRLY limitation. Previously, the Department had not provided guidance and taxpayers used various methods. 

Section 78 

The Rule Changes adopt new Rule 39-22-304(3)(j), which provides the following: 

General rule 

Colorado allows a subtraction for Section 78 amounts. The subtraction is limited to the amount treated as a dividend and included in a C corporation’s federal taxable income under IRC Section 78. The subtraction is not allowed for any part of an amount treated as a dividend pursuant to IRC Section 78 that is deducted in the calculation of federal taxable income. 

Coordination with Section 250 

No subtraction is allowed for any amount treated as a dividend pursuant to IRC Section 78 that is: 

• attributable to GILTI pursuant to IRC Sections 951A and 960(d), and 
• deducted, pursuant to IRC Section 250(a)(1)(B)(ii) [the Section 78 amount included in the 50% GILTI deduction], in the calculation of federal taxable income.