Can I subtract from my Colorado taxable income the dividends and capital gain distributions a mutual fund pays me from U.S. and Colorado government obligations?

Plain-English summary

A taxpayer owns shares in a mutual fund that holds U.S. and Colorado government obligations and pays out "dividends" and "capital gain distributions." The taxpayer asked whether those amounts can be subtracted from Colorado taxable income. The Department's answer turns on a key distinction: only genuine interest income qualifies — dividends and capital gain distributions do not.

The rules:

• Interest on U.S. obligations is subtractable. Colorado lets you subtract "interest income of obligations of the United States and its possessions to the extent included in federal taxable income" (§ 39-22-104(4)(a)). Report it on line 6 of Form 104.
• Interest on Colorado obligations isn't added back. Colorado doesn't tax interest on its own state/local obligations, so it's not added back (§ 39-22-104(3)(b)). (By contrast, interest on other states' obligations is added back and taxed if it was excluded federally.)
• "Dividends" may really be interest. The U.S. and Colorado don't pay dividends — so what a mutual fund labels a dividend may actually be interest. If it's interest from a U.S. obligation, it can be subtracted. But the Department can't decide in a general letter whether a given "dividend" is really interest.
• Capital gain distributions can't be subtracted. You bear the burden of showing the income is qualifying interest from U.S. obligations and not a capital gain distribution (which doesn't qualify). And private obligations don't qualify even if federally backed or guaranteed.
• No subtraction for capital gains on selling the obligations. Colorado's "Colorado company" capital-gains subtraction (§ 39-22-518) never covered the U.S. or the State of Colorado (neither is a "Colorado company"), and that subtraction was repealed for sales on or after January 1, 2010 anyway. A separate TABOR-excess subtraction for 2000–2010 (§ 39-22-104(4)(l)/(l.5)) was repealed in 2010.

Bottom line: interest from U.S. obligations — subtract it; interest from Colorado's own obligations — not added back; everything else (mutual-fund dividends, capital gain distributions, other states' obligation interest, private obligations) — no subtraction. As a GIL, this is general guidance only.

What this means for you

Individual investors holding government-bond mutual funds

Don't assume your fund's whole payout is Colorado-tax-free. Only the interest portion from U.S. obligations is subtractable, and your fund's 1099 detail (or a written breakdown from the fund) is what proves how much of a "dividend" is really qualifying interest versus a non-qualifying capital gain distribution. Keep that documentation.

Taxpayers with out-of-state municipal bonds

Interest on other states' bonds that's tax-free federally must be added back on your Colorado return. Only Colorado's own state/local obligation interest escapes Colorado tax.

Accountants and tax professionals

The qualifying item is interest on U.S. obligations (§ 39-22-104(4)(a)) and non-add-back of Colorado obligation interest (§ 39-22-104(3)(b)). Capital gain distributions and gains on sale don't qualify; § 39-22-518 was repealed for post-2009 sales and never reached U.S./Colorado obligations. The taxpayer carries the burden; FYI Income 20 and 52 list exempt sources.

Common questions

Q: Can I subtract my mutual fund's dividends from U.S. or Colorado bonds?
A: Only to the extent the "dividend" is actually interest from a U.S. obligation. True dividends and capital gain distributions can't be subtracted.

Q: What about interest on Colorado's own bonds?
A: It isn't added back, so it isn't subject to Colorado tax. Interest on other states' bonds, however, is added back and taxed.

Q: Can I subtract capital gains from selling U.S. or Colorado obligations?
A: No. Neither qualifies as a "Colorado company" under § 39-22-518, and that subtraction was repealed for sales on or after January 1, 2010.

Q: Where do I report U.S. government interest?
A: On line 6 of Colorado Individual Income Tax Form 104.

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 guidance:
- § 39-22-104(4)(a), C.R.S. (subtraction for interest on U.S. obligations)
- § 39-22-104(3)(b), C.R.S. (other states' obligation interest added back; Colorado's not)
- § 39-22-104(4)(l), (l.5), C.R.S. (2000–2010 TABOR-excess subtraction; repealed 2010)
- § 39-22-518, C.R.S. ("Colorado company" capital-gains subtraction; repealed for post-2009 sales)
- 26 U.S.C. § 103 (federal exclusion of state/local bond interest)
- Colorado Department FYI Income 20 and FYI Income 52 (exempt income sources)

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-15-001.pdf

Original ruling text

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

GIL-15-001
January 21, 2015
XXXXXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXX
Re: Dividend and Capital Gain Distributions from Colorado and U.S. Obligations
Dear XXXXXXXXXX,
You (“Taxpayer”) submitted a request for guidance to determine the whether dividends and
capital gain distributions from the United States and Colorado obligations through ownership of
shares of a mutual fund can be subtracted from federal taxable 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 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.
Issues
1. May dividend or capital gains distributions earned from United States and Colorado
obligations due to the ownership of mutual funds be subtracted from federal taxable
income?
2. If so, where is this reported on Form 104?
Background
Taxpayer owns shares in a mutual fund from which taxpayer receives dividend income and capital
gains distribution income derived from obligations of the United States and of Colorado. Taxpayer
represents that the Internal Revenue Service treats interest income, dividend income and capital
gains distribution income derived from obligations of the United States as ordinary income subject to
tax. Taxpayer also represents that the Internal Revenue Service treats dividend income and capital
gains distribution income derived from obligations of Colorado as ordinary income subject to tax, but

treats interest income from a bond used to finance government operations of any state, the District of
Columbia, a possession of the United States, or any of their political subdivisions generally as nontaxable.
Discussion
Colorado allows taxpayers to subtract from their federal taxable income “an amount equal to any
interest income of obligations of the United States and its possessions to the extent included in
federal taxable income.”1 Similarly, interest income on obligations of the State of Colorado or its
political subdivisions is not added back into federal taxable income when excluded from gross
income for federal income tax purposes.2
The Department in unaware of any circumstance in which the United States or State of Colorado
would pay dividends. It may be the case that what the mutual fund is characterizing as a dividend is
really interest income. If the dividend paid by the mutual fund is indeed interest income from a United
States obligation3, the interest income can be subtracted from federal taxable income to the extent
the income is included in federal taxable income. The Department does not have sufficient
information and is unable to make a determination in a general information letter about whether the
dividends Taxpayer receives is interest income.
Interest income derived from an obligation issued by a state or local government is generally
excluded from federal taxable income.4 The issuer of such interest income should be able to tell you
whether the interest is subject to federal income tax. Colorado, on the other hand, taxes interest
income from obligations of other states or their political subdivisions, but not the interest income
derived from obligations of the State of Colorado and its political subdivisions.5 To implement this,
Colorado law requires taxpayers to add to their Colorado taxable income the interest income derived
from obligations of other states (but only if such income has been excluded from federal gross
income), but not add back interest income derived from obligations of the State of Colorado or its
subdivisions.6
Mutual funds may contain assets other than obligations of the United States. Taxpayer has the
burden of demonstrating both that the income is derived from the obligations of the United States
and that such income is interest income and not capital gain distribution income (which cannot be
subtracted). Finally, interest on obligations of a private entity do not qualify for this subtraction, even
if the obligation is backed or protected by federal programs.
We note that there was, for tax years 2000-2010, another subtraction for the aggregate of any
interest income, dividend income, and net capital gains to the extent included in federal taxable
income if financial reports certified that the amount of excess state tax revenues for the state fiscal
year ending in that income tax year exceeded the limitation on state fiscal year spending.7 However,
this subtraction was repealed by the Colorado General Assembly in 2010 and is no longer available.
Finally, your inquiry raises the question of whether capital gain earned on the sale of obligations of
the United States and the State of Colorado can be subtracted from federal taxable income.
Colorado allows a subtraction for certain Colorado-source capital gains.8 In prior years, the statute
allowed a subtraction for capital gains arising from the sale of stock in a “Colorado company”.
Capital gains arising from the sale of stock in a non-Colorado company were not eligible for the
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§39-22-104(4)(a), C.R.S.
§39-22-104(3)(b), C.R.S.
See Department FYI Income 20 for a list of exempt sources of income.
§103 I.R.C.
See Department FYI Income 52 for a list of exempt sources of income.
§39-22-104(3)(b), C.R.S.
§39-22-104(4)(l) and (l.5), C.R.S.
§39-22-518, C.R.S.
DR 4010A (06/11/14)

subtraction. Neither the United States nor the State of Colorado qualify as a “Colorado company”.
Therefore, capital gains earned on such assets cannot be subtracted from Colorado taxable income.
We also note that in 2010, the Colorado General Assembly amended this statute to eliminate the
subtraction for capital gains arising on or after January 1, 2010 from the sale of stock in a Colorado
company.
To subtract the Unites States government interest, report the income on line 6 of Colorado Individual
Income Tax Form 104.
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

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DR 4010A (06/11/14)