Does an out-of-state S corporation that does IT consulting remotely for a Colorado client have to file a Colorado income tax return?

Plain-English summary

An out-of-state S corporation does IT consulting and builds accounting software, working entirely remotely — connecting to clients over a VPN with no travel to Colorado (and subcontracting some work to a company outside the U.S.). One of its clients is in Colorado, so it asked whether it must register and file a Colorado income tax return.

The Department's framework (it didn't make a determination):

• S corporation flow-through. The S corporation itself doesn't pay Colorado income tax, but its shareholders must file Colorado returns if the company does business in Colorado or derives Colorado-source income — which turns on substantial nexus.
• Nexus thresholds. A company has substantial nexus if it exceeds any one of: $50,000 property, $50,000 payroll, $500,000 sales, or 25% of total property, payroll, or sales (Rule 39-22-301.1).
• Services are sourced by cost of performance. Sales of services are apportioned to Colorado by the percentage of the company's costs of performing the service that are incurred in Colorado. A company that performs everything remotely from outside Colorado likely incurs no Colorado costs, so it has no Colorado sales — and with no Colorado property or payroll either, no nexus and no filing duty.
• If it does incur Colorado costs, then it must do one of three things under § 39-22-601(2.5): file a composite return and pay Colorado tax on the apportioned service revenue, withhold Colorado tax on distributions to shareholders, or file Form 107 (each shareholder agrees to be subject to Colorado tax on their share).

The key: just having a Colorado client doesn't create a Colorado filing obligation for a remote service provider — what matters is whether the cost of performing the work touches Colorado (and whether any nexus threshold is crossed). As a GIL, this is general guidance only.

This sits with the other nexus letters — [[gil-16-001-lcc-employee-in-colorado]] and [[gil-16-004-sales-and-income-tax-nexus]] — and with the cost-of-performance service sourcing in [[plr-15-006-apportionment-of-corporate-income-tax]].

What this means for you

Remote service providers with out-of-state operations

A Colorado customer alone doesn't put you on the hook. Colorado sources service revenue by where you incur the cost to perform — so if your people and work are all outside Colorado, you likely have no Colorado sales and no filing duty. Track where your cost of performance actually sits.

S corporations with any Colorado-source income

If you do cross into Colorado (Colorado costs of performance, or any threshold), the shareholders bear the filing obligation, and you choose among a composite return, withholding, or Form 107 consent.

Accountants and tax professionals

Two gates: the Rule 39-22-301.1 thresholds, and cost-of-performance sourcing for services. Note the § 39-22-601(2.5) menu (composite / withholding / Form 107) only matters after there's Colorado-source income.

Common questions

Q: One of our clients is in Colorado. Do we owe Colorado income tax?
A: Not just for that. You need substantial nexus, and for services Colorado looks at the share of your performance costs incurred in Colorado. Working entirely remotely from out of state likely means no Colorado sales and no filing duty.

Q: What are the nexus thresholds?
A: Exceeding any one of $50,000 property, $50,000 payroll, $500,000 sales, or 25% of total property, payroll, or sales.

Q: If we do have Colorado-source income, how do the shareholders handle it?
A: The S corporation files a composite return, withholds Colorado tax on distributions, or files Form 107 with shareholders agreeing to Colorado tax (§ 39-22-601(2.5)).

Q: Can I rely on this letter?
A: No. It's a General Information Letter — general guidance only, not binding on the Department. A binding answer requires a private letter ruling.

Citations and references

Statutes and rules:
- 1 CCR 201-2, Department Rule 39-22-301.1 (substantial-nexus thresholds)
- § 39-22-601(2.5), C.R.S. (S-corp composite return / withholding / Form 107)
- § 39-22-303.5, C.R.S. (single-sales-factor; services sourced by cost of performance)
- 1 CCR 201-1, Rule 24-35-103.5 (GIL/PLR procedure)

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-14-011.pdf

Original ruling text

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

GIL-14-011
April 28, 2014
XXXXXXXXXXXXXXX
Attn: XXXXXXXXXXX
XXXXXXXXXXXXXXX
XXXXXXXXXXXXXXX
Re: S Corporation Colorado Source of Income
Dear XXXXXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXX (“Company”) a request for guidance to
determine whether Company will be subject to filing a Colorado income tax return.
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 Rule 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 Department Rule 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
1. Is Company subject to Colorado income taxes?
2. Is Company required to register with the Department?
Background
Company is an S Corporation located in another state that provides IT consulting services and
designs accounting software systems to meet client’s needs. All work by Company is completed
remotely outside of Colorado. Company provides its services by connecting to the client’s system
through a virtual private network (VPN); there is no travel to Colorado to perform Company’s
services. A portion of the work is subcontracted to another company located outside of the United
States and that work is also performed remotely outside Colorado.

Company would like to know if it needs to register in Colorado because one of its clients in located
in Colorado, and whether Company is liable for Colorado income taxes for this particular
assignment.
Discussion
An S-Corporation’s members, partners, owners, shareholders or beneficiaries must file a Colorado
income tax return if the S Corporation does business in Colorado or derives income from Colorado
sources. A corporation is considered to be doing business in Colorado if it has substantial nexus
with Colorado. Substantial nexus is established when a business entity organized outside of
Colorado has property, payroll or sales that exceed any of the following thresholds in any tax
period:
(i) a dollar amount of $50,000 of property; or
(ii) a dollar amount of $50,000 of payroll; or
(iii) a dollar amount of $500,000 of sales; or
(iv) twenty-five percent of total property, total payroll or total sales.1
Company states it has neither property nor payroll in Colorado. Sales are apportioned to
Colorado based on the percentage of costs incurred by Company in Colorado to perform the
service. It appears that Company does not incur costs in Colorado to perform the service,
although this is not clear from the relatively few facts provided. If Company does not satisfy
any of these three criteria, then it has no obligation to file a Colorado income tax return.
If Company incurs in Colorado a cost to perform the service, then Company must either file a
composite return and pay Colorado income tax based on the apportionment of the service
revenues to Colorado, withhold Colorado income taxes from distributions to shareholders, or
Company can submit Form 107 in which shareholders agree to be subject to the laws of
Colorado and to file and pay all taxes related to their share of distributions of Company’s
income earned from Colorado sources.2
Miscellaneous
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
1 Department Regulation 39-22-301.1
2 See, 39-22-601(2.5), C.R.S.

2