Colorado has long been considered a “rolling conformity” state with respect to its state income tax conformity to the Internal Revenue Code (IRC). Essentially, Colorado adopts IRC provisions and amendments unless state legislation is enacted to specifically de-conform from them. Historically, this rolling conformity was perceived as automatic, without limitation, when a provision or an amendment to the IRC took effect.
When the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted on March 27, 2020, it made several retroactive changes to the IRC that affected the 2018 and 2019 tax years. Therefore, taxpayers were surprised when the Colorado Department of Revenue (DOR) instituted Emergency Rule 39-22-103(5.3) in June 2020—which subsequently became permanent in September 2020—clarifying that changes to the IRC would only be adopted in the state income tax code for the tax year in which they were enacted and for prospective tax years. The emergency rule thereby prohibited the application of retroactive provisions of the CARES Act to reduce federal taxable income via means of enhanced net operating losses, excess business losses, business interest expense, and accelerated depreciation.
Prior to the emergency rule’s enactment, businessman Philip Anschutz and his wife Nancy amended their 2018 federal and Colorado tax returns to request income tax refunds as a result of the enhanced excess business loss deduction provided by the CARES Act. When the Colorado DOR denied the refund based on the interpretation of the statute in the emergency rule, the Anschutzes filed in City and County of Denver District Court arguing the language of the statute automatically adopts IRC amendments regardless of whether such amendments are for tax years prior to the year of enactment. The district court ruled in favor of the Colorado DOR; however, the Colorado Court of Appeals recently reversed in favor of the Anschutzes, deciding the emergency rule was in conflict with the plain language of the statute.
The Colorado General Assembly enacted Section 39-22-104(3)(l)-(n) in July 2020 de-conforming from the enhanced net operating loss, excess business loss, and business interest expense provisions of the CARES Act, specifically for income tax years ending on and after enactment of the CARES Act, but before January 1, 2021, as well as income tax years beginning on and after enactment of the CARES Act, but before January 1, 2021. To afford taxpayers an equitable adjustment for the de-conformities created by §39-22-104(3)(l)-(n) and the emergency rule, the General Assembly also enacted a subtraction modification in §39-22-104(4)(z) in January 2021 for the difference between federal taxable income determined under the CARES Act and federal taxable income as interpreted under state income tax law by the DOR. The Anschutzes’ victory, nonetheless, may provide both corporate and individual taxpayers a potential refund opportunity for certain tax years. Taxpayers who would have benefited from provisions such as enhanced net operating losses, excess business loss deductions, business interest expense, and accelerated depreciation on qualified improvement property should contact their tax advisor to assess whether a protective refund claim should be filed for any tax years affected by Colorado’s de-conformity from the CARES Act as a result of the emergency rule.