Does an out-of-state S corporation owe Colorado tax when an employee works remotely from Colorado, even if that employee is a non-resident military spouse exempt from Colorado tax?

Plain-English summary

An out-of-state S corporation that provides accounting and tax services asked whether it had to file Colorado Form 106 and report Colorado-source income. Its only Colorado connection was one employee working remotely from Colorado Springs. She had moved there when her spouse was reassigned to Fort Carson, and the company had filed Form DR 1059 treating her as a non-resident military spouse exempt from Colorado withholding. (Tragically, her spouse was later killed in Afghanistan; she then decided to stay in Colorado permanently, at which point her wages would become Colorado-taxable.)

The Department said the company does have Colorado-source income. The reasoning runs through how service income is sourced: an S corporation itself pays no Colorado income tax, but each shareholder is taxed on the pro rata share of the corporation's income attributable to Colorado. Income from services is apportioned to where the cost of performing the service is incurred (cost of performance, § 39-22-303.5). Because part of the cost of performing the company's accounting services — the remote employee's work — is incurred in Colorado, a portion of the company's income is apportionable to Colorado.

The key (and slightly counter-intuitive) point: the employee's personal tax status is irrelevant to the company's sourcing. The DR 1059 means she may not be a Colorado resident and her wages may not be Colorado-taxable — but that says nothing about whether the company's cost of performance occurred in Colorado. The Department's analogy: a company can temporarily place employees in Colorado for a project, and the resulting income is Colorado-source because the cost is incurred here, regardless of those employees' residency or personal liability. Finally, the non-resident shareholders have nexus with Colorado because the pass-through entity does (here, via the $50,000 payroll threshold).

This is an early, clean statement of the cost-of-performance rule for remote service work, later expanded in [[gil-14-011-s-corporation-colorado-source-of-income]] (a remote out-of-state S corp where a Colorado client alone was not nexus, but Colorado-incurred performance cost was sourced here).

What this means for you

Out-of-state S corps and partnerships with a remote Colorado worker

If you provide services and an employee performs some of that work from Colorado, you likely have Colorado-source income and a Form 106 filing obligation, and your shareholders/partners owe Colorado tax on their Colorado share. Remote work doesn't escape sourcing — the question is where the cost of performing the service is incurred, and a Colorado-based worker puts some of it here.

Employers of military spouses (and others with withholding exemptions)

A valid DR 1059 (or any reason an employee's wages aren't Colorado-taxable) protects the employee, not the company. Don't read a withholding exemption as eliminating the company's own apportionment to Colorado — those are two separate questions.

Accountants and tax professionals

Separate the two analyses cleanly: (1) the individual employee's residency/withholding (DR 1059, § 39-22-103(8)); and (2) the entity's cost-of-performance apportionment (§ 39-22-303.5). A non-resident, non-taxable employee can still generate Colorado-source income for the employer. Pass-through nexus flows to owners under Reg. 39-22-301.1 once the entity crosses a threshold such as $50,000 payroll.

Common questions

Q: Does a remote Colorado employee create Colorado-source income for my out-of-state company?
A: For a service business, generally yes. Service income is apportioned to where the cost of performing the service is incurred, so a Colorado-based worker puts part of that cost — and the related income — in Colorado.

Q: My employee is an exempt military spouse. Doesn't that mean no Colorado income?
A: No. The exemption protects the employee's wages from Colorado tax. It does not change whether the company's cost of performance — and therefore Colorado-source income — occurred in Colorado.

Q: Who actually pays the Colorado tax for an S corporation?
A: The S corporation files Form 106 but isn't itself taxed; each shareholder is taxed on the pro rata share of income attributable to Colorado.

Q: Can I rely on this letter?
A: No. A General Information Letter is general guidance, not binding on the Department. For a binding determination on your facts, request a private letter ruling (which requires a fee).

Citations and references

Statutes, rules, and forms:
- § 39-22-322(1), (2), C.R.S. (S corp not taxed; shareholder taxed on Colorado share)
- § 39-22-109(1), (2), (2)(a)(VI), C.R.S. (nonresident Colorado-source income; S-corp income sourced as apportioned)
- § 39-22-303.5, C.R.S. (services sourced by cost of performance)
- § 39-22-103(8), C.R.S. (resident definition excludes a military spouse present only because of the servicemember's assignment)
- Department Regulation 39-22-301.1 (nexus thresholds; $50,000 payroll)
- Form DR 1059 (Military Spouse Withholding Exemption); Form 106

Related rulings:
- [[gil-14-011-s-corporation-colorado-source-of-income]] — remote out-of-state S corp; Colorado client alone is not nexus, but Colorado-incurred cost of performance is sourced here

Source

• Landing page: Colorado All Letter Rulings
• Original PDF: GIL-13-024.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-13-024
October 2, 2013
XXXXXXXXXXXXXXXX
ATTN: XXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
Re: Colorado Source Income
Dear XXXXXXXX,
You submitted a request for guidance to determine whether Company needs to file Form 106
and report Colorado source income.
The Colorado Department of Revenue (“Department”) issues general information letters and private
letter rulings. A general information letter provides a general overview of the relevant tax issues
and is not binding on the Department. A private letter ruling provides a specific determination for a
specific set of facts, is binding on the Department but not on the taxpayer, and requires payment of
a fee. For more information about general information letters and private letter rulings, please see
Department regulation 24-35-103.5 at www.colorado.gov/revenue/tax > Tax Library > Rulings.
The Department initially treats your request as one of a general information letter. If you would like
the Department to issue a private letter ruling on the issues you raise, you can resubmit a request
and fee in compliance with regulation 24-35-103.5. It is important to remember that general
information letters, such as this one, are general discussions of tax law and are not a determination
of the tax consequence of any particular action or inaction.
Issue
Is the Company required to file Form 106 and report Colorado source income?
Background
Company is an S corporation located outside of Colorado that provides accounting and tax
services. An employee of Company has worked remotely from Colorado Springs, Colorado since
the summer of 2012 when her spouse was reassigned to Ft. Carson Army Base, located just
outside Colorado Springs. Company filed Form DR 1059, “Exemption from Withholding for a
Qualifying Spouse of a U.S. Armed Forces Servicemember.”

The employee’s spouse was killed while completing a tour in Afghanistan. Company’s employee
was told she would continue to have the same status and benefits for one year from the date of
death. The employee has decided to reside permanently in Colorado, at which point the employee’s
payroll will become subject to Colorado income tax and Company will begin withholding state
income tax.
Discussion
S corporations are not subject to Colorado income tax.1 However, each shareholder’s pro rata
share of the S corporation’s income attributable to Colorado is subject to Colorado income tax.2 If
the shareholder is a nonresident individual, then the Colorado tax is apportioned in the ratio of
Colorado nonresident federal adjusted gross income to total federal adjusted gross income.3 The
Colorado nonresident federal adjusted gross income is the income that is derived from sources
within Colorado.4 A shareholder’s income from an S Corporation is derived from sources in
Colorado to the extent that the income, gain, loss, and deductions are allocated and apportioned to
Colorado.5 Company is a service provider. Income from services, such as accounting services, is
apportioned based on where the costs to perform the services are incurred.6 Because some
portion of Company’s cost of performing its accounting service is incurred in Colorado, a portion of
Company’s income is apportionable to Colorado.
You note that the employee filed DR 1059, “Exemption from Withholding for a Qualifying Spouse of
a U.S. Armed Forces Servicemember.” This is a declaration by the employee that she is not a
resident of Colorado, and is in Colorado solely because her spouse is in active military service and
is stationed in Colorado.7 Although the employee may not be treated as a resident of Colorado
and her income may not be subject to Colorado income tax, this does not mean that the income of
an S Corporation or its shareholders is not apportionable to Colorado.
For example, a corporation whose headquarters are located outside Colorado may temporarily
locate some of its employees in Colorado to work on a project. Income from this work in Colorado
is apportioned to Colorado because a portion of the cost of that service is incurred in Colorado.
Neither the residency of the employees nor their liability for Colorado income tax is relevant to the
question of whether the cost of the performance of a service is performed in Colorado. Thus,
Company’s income is apportioned to Colorado in proportion to the costs incurred in Colorado to
perform such service.
Finally, your inquiry raises the question of nexus for non-resident shareholders of the S
corporation. Members of a pass-through entity have nexus with Colorado if the pass-through
entity has nexus with Colorado. A corporation will have nexus in Colorado if it has, among
other qualifiers, fifty thousand dollars in payroll in Colorado.8
Miscellaneous
1 §39-22-322(1), C.R.S.
2 §39-22-322(2), C.R.S.
3 §39-22-109(1), C.R.S.
4 §39-22-109(2), C.R.S.

5 §39-22-109(2)(a)(VI), C.R.S.
6 §39-22-303.5, C.R.S.

7 §39-22-103(8), C.R.S. (defining resident individuals to exclude an individual who is in Colorado only because their

spouse is an active member of the military and is stationed in Colorado).

8 Department Regulation 39-22-301.1.

2

This letter represents the good faith opinion of Department personnel who are knowledgeable on
state taxes issues. However, the Department does not make a specific determination here on any
of the issues raised and the Department is not bound by this general information letter.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this redacted letter
will be made public within 60 days of the date of this letter. Please let me know in writing within that
60 day period whether you have any suggestions or concerns about this redacted letter.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

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