Colorado Enacts More Tax Changes

In 2025, Colorado enacted several significant tax changes. On June 3, Colorado enacted H.B. 26-1289, which includes more changes to income taxes, various excise taxes, motor fuels taxes, and sales and use taxes. Following are highlights of the key provisions of the bill.

Worldwide combined filing for unitary corporations

Prior to the 2026 tax year, Colorado used a unique rule to determine if a group of affiliated entities was subject to unitary combined reporting. In 2024, that rule was simplified effective beginning with a corporation’s 2026 tax year. H.B. 26-1289 again changes Colorado’s combined filing regime. Effective beginning with a corporation’s 2027 tax year, Colorado will adopt worldwide combined reporting by default. Taxpayers can make a water’s-edge election that allows taxpayers to exclude some non-U.S. entities from the combined reporting group, but certain foreign activity still is included. The water’s-edge group includes all domestic members of the affiliated group (including 80/20 companies), foreign corporations with at least 20% of their payroll and property in the U.S., export trade corporations, and domestic international sales corporations.

Additionally, Colorado will employ a “blacklist” approach to tax havens, meaning that any corporation incorporated in a listed jurisdiction also is included in the water’s-edge group. Beginning in the 2027 tax year, H.B. 26-1289 removes Liechtenstein from the list of countries presumed to be tax havens. The bill also requires that the Department of Revenue engage a contractor every four years to evaluate the listed jurisdictions and confirm they should remain listed. If the contractor concludes a country no longer is determined to be a tax haven, a recommendation to remove it will be submitted to the legislature and the governor.

The Colorado water’s-edge election must be made on a timely filed original return and is binding for 10 years, with an automatic renewal unless the taxpayer withdraws the election after the last year of the binding period. A taxpayer that withdraws the election after the initial 10-year binding period is precluded from another election for the next 10 years. However, early revocation may be allowed in limited circumstances.

A combined group reporting on a water’s-edge basis will eliminate intercompany dividends, subpart F income, and net controlled foreign corporation tested income (NCTI, formerly global intangible low-taxed income or GILTI) to the extent that the non-U.S. entity associated with those items is included in the water’s-edge group.

Repeal of deduction for federally nondeductible salary and wages

Beginning in 2027, Colorado repeals its deduction for wages and salaries that are disallowed under IRC Section 280C. Historically, when a taxpayer claimed federal credits (such as the federal research and development credit) and IRC Section 280C required a reduction in the federal wage deduction, Colorado allowed a state-level adjustment that effectively restored the deduction. H.B. 26-1289 eliminates that benefit by disallowing these expenses, even though Colorado does not provide a corresponding state credit.

Tax credits

Numerous Colorado tax credits are revised or modified by H.B. 26-1289. Some of the more notable changes are as follows:

• Sustainable aviation fuel (SAF) credit. H.B. 26-1289 creates a new credit for the purchase of sustainable aviation fuel. The credit generally is structured on a per-gallon basis and is subject to annual statewide limits.
• Renewable energy enterprise zone credit. H.B. 26-1289 extends and expands the credit for renewable energy and industrial clean energy investments. It also allows certain taxpayers to elect a refund or payment mechanism rather than relying solely on tax liability. The bill also expands eligible projects to include certain biomethane usage equipment.
• Vacant building rehabilitation credit. H.B. 26-1289 modifies the credit for rehabilitating vacant buildings, including additional eligibility requirements and limitations. For example, qualifying buildings generally must have been vacant for a specified period, and per-building credit limits apply.
• Enterprise zone incentives. H.B. 26-1289 narrows several enterprise zone incentives:
  • The employer-sponsored health insurance credit includes a new limitation to apply only to businesses with fewer than 50 employees.
  • The research and experimental activities credit requires a minimum spending threshold of $150,000.
  • Commercial vehicle enterprise zone incentives are repealed.

Sales and use tax

H.B. 26-1289 makes the following changes to sales and use tax:

• The exemption for property used in space flight is repealed as of Jan. 1, 2027.
• A new exemption is created for the storage, use, or consumption of construction and building materials used in railroad construction for public passenger rail projects under government contracts.
• The exemption related to Colorado beetle-killed wood is reinstated and extended from July 1, 2027, until June 30, 2032.

Motor fuels and cigarette, tobacco, and nicotine taxes

H.B. 26-1289 reduces or eliminates distributor allowances that historically compensated fuel distributors for evaporation, handling losses, and tax collection costs. The allowance for fuel loss is reduced from 2% to 1%. Additionally, a previously allowed 0.5% collection allowance is repealed.

H.B. 26-1289 also repeals several cigarette, tobacco, and nicotine wholesaler, stamp, and products collection discounts that previously were allowed. These provisions don’t increase the statutory tax rates on cigarettes or tobacco products; rather, they eliminate compensation paid to wholesalers and distributors for collecting and remitting the tax.

Looking ahead

Colorado’s recent tax changes are varied and include changes to income taxes, various excise taxes, motor fuels taxes, and sales and use taxes. The changes add complexity, and taxpayers should consult their advisers to determine how they might be affected.