Colorado pass-through entity tax updates: What you need to know
Colorado and PTET: A summary
Colorado waived underpayment of estimated tax penalties for the PTE tax until tax year Jan. 1, 2023.
- Prior to this bill, all income and credits were accounted for at the entity level and weren’t reported on the PTE owner’s return. Now, the income and credits will flow to the PTE owner’s income tax return, including taxes paid to other states.
- The bill provides that partners of a partnership will be allowed a credit on their return for PTE taxes paid in other states. Prior to this bill, it appeared only shareholders of a S corporation were allowed a credit for PTE taxes paid to other states.
- PTE owners can retroactively elect the PTE tax for tax years beginning Jan. 1, 2018.
Retroactivity for Colorado’s PTET
Colorado is the first state to allow a PTE election retroactively starting in 2018. Colorado state permits taxpayers to file retroactive PTE tax returns for tax years 2018 through 2021 between Sept. 1, 2023 and July 1, 2024. Colorado is planning on releasing a “composite” form that will allow the entity and PTE owners to amend 2018, 2019, 2020, and 2021 at one time on a single form. The form will not permit changes to previous years other than those directly related to the retroactive PTE election.
Colorado is the first state to allow a PTE election retroactively starting in 2018.
The IRS previously released Notice 2020-75 in November 2020, allowing a federal deduction for PTE taxes. Although not specified in Notice 2020-75, the IRS was likely not expecting states to apply PTE taxes retroactively, and it’s unclear if the IRS will allow a federal deduction for PTE taxes paid retroactively.
PTET election and payment process
On Oct.11, 2022, Colorado released Form DR 1705. This permits entities to make a 2022 PTE election in 2022, prior to filing an income tax return. Estimated payments can be made on the Composite Filing Voucher, Form DR 0106 EP. If companies wish to wait and make the election and payment, they can make a payment on the PTE filing Form DR 0106. However, the PTE payment may not be deductible for federal income tax purposes until 2023.
Pitfalls under PTE tax regimes
While PTE taxes in general and retroactivity can be immensely beneficial for PTE owners in terms of tax savings, there are situations where taxpayers may end up paying more income tax under a PTE tax regime.
As an example, owners of PTEs should ensure a credit for taxes paid is allowed for PTE taxes in their state of residency. Otherwise, the individual may end up paying tax on the same income twice and receiving only a partial benefit for the federal income tax deduction.
Research and modeling are highly recommended before making an election or payment. Taxpayers should weigh the benefits of the PTE election against the cost of compliance required to ensure pitfalls are avoided. This is especially important when considering Colorado’s retroactive election.
How we can help with Colorado’s PTET
If you have questions about the impact of a PTET election, especially in the state of Colorado, please contact your Plante Moran advisor or one of the authors to discuss the specific facts and circumstances of your situation.