How does Colorado source a nonresident partner’s business income and other partnership items?

Plain-English summary

Colorado gave three sourcing rules for a nonresident partner. Ordinary business income reported in box 1 of Schedule K-1 is apportioned under the business-income rules in § 39-22-303.6, even when the partnership has not elected to use those rules for every item. Other items, including rents, royalties, and gains, are generally sourced item by item under § 39-22-109 unless the partnership has made that broader election.

For the sale of a single-member LLC that is disregarded for federal income tax, the Department treats the transaction as a sale of the LLC's assets. A nonresident partner sources the resulting gain as if the partner sold those assets directly. The asset type and location therefore matter.

What this means for you

Nonresident partners

Do not apply one allocation percentage to every line of the partnership's K-1 without checking the item. Ordinary business income and separately reported gains or rents can follow different rules.

Partnerships and advisers

Document whether the partnership made the election under § 39-22-203(1)(a), and identify the assets behind a sale of a disregarded LLC. The letter says the federal character of an item carries through to the partner for Colorado sourcing.

Common questions

Q: Is box 1 ordinary income apportioned even without the partnership election? A: Yes. The Department says ordinary business income is apportioned under § 39-22-303.6 even if the partnership did not elect that treatment for every item.

Q: How are real-property gains sourced?
A: The letter says gain or loss on real or tangible personal property is Colorado-source if the property is located in Colorado, unless the broader apportionment election applies.

Q: Is selling a disregarded LLC treated as selling an intangible interest? A: For the transaction described, the federal treatment is an asset sale, and the partner sources gain as though those assets were sold directly.

Q: Does this bind the Department for another partnership? A: No. A General Information Letter is not a specific, binding determination.

Citations and references

• § 39-22-109, C.R.S. (nonresident sourcing)
• § 39-22-303.6, C.R.S. (business-income apportionment)
• § 39-22-203(1)(a), C.R.S. (partnership election)
• 1 CCR 201-2, Rule 39-22-109(3)(c) (partnership items)
• 26 U.S.C. § 702(b) (character of partnership items)
• IRS Rev. Rul. 99-5, 1999-1 C.B. 434 (federal treatment of a disregarded LLC interest sale)

The letter states: “Other items of income, such as gain, loss, rents, and royalties, that may flow through from a partnership to its nonresident partners are sourced separately under section 39-22-109, C.R.S.”

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/default/files/documents/GIL%2022-003.pdf

Original ruling text

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

GIL 22-003
April 25, 2022
XXXXXXXXXX
XXXXXXXXXX
Via Electronic Mail: XXXXXXXXXX
Re: Sourcing nonresident partner’s distributive share of partnership income Dear XXXXXXXXXX: You submitted a request for a general information letter regarding the sourcing of a nonresident partner’s distributive share of partnership 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, but 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, and requires payment of a fee. For more information about general information letters and private letter rulings, please see 1 CCR 201-1, Rule 24-35-103.5. Issues How is a nonresident partner’s distributive share of ordinary business income1 sourced under section 39-22-109, C.R.S.? How is a nonresident partner’s distributive share of other items of partnership income2 sourced under section 39-22-109, C.R.S.? How is a nonresident partner’s distributive share of the gain from the sale of a disregarded entity by the partnership sourced under section 39-22-109, C.R.S.? Discussion Sourcing of the nonresident partner’s distributive share of ordinary business income For nonresident partners,3 Colorado-source income from partnership activity is determined pursuant to section 39-22-109, C.R.S., or, at the partnership's election, apportioned and

1 As used within this general information letter, the term “ordinary business income” refers to a partner’s distributive

share of ordinary business income properly reported in box 1 of IRS Schedule K-1 (Form 1065). 2 As discussed within this general information letter, other items of partnership income includes any income properly reported in any box of IRS Schedule K-1 (Form 1065) other than box 1. 3 A resident partner’s distributive share of partnership income is not apportioned, regardless of whether any or all of that income is derived from sources outside of Colorado. Section 39-22-202, C.R.S.

GIL 22-003
April 25, 2022
Page 2
allocated pursuant to section 39-22-303.6, C.R.S.4 Rule 39-22-109 provides considerable guidance regarding the determination of Colorado-source income under section 39-22-109, C.R.S. More specifically, Rule 39-22-109(3)(c) offers direction regarding the sourcing of a nonresident partner’s distributive share of partnership income. However, the rule does not explicitly prescribe the method for sourcing a nonresident partner’s distributive share of ordinary business income. Under section 39-22-109(2)(a)(II), C.R.S., income derived from a business, trade, profession, or occupation carried on in Colorado is considered Colorado source income. Although Rule 39-22109 does not explicitly address the sourcing of a nonresident partner’s distributive share of ordinary business income, the rule does prescribe the method for sourcing the business income of an independent contractor derived from activities other than the performance of purely personal services.5 Under the rule, such business income is apportioned under the apportionment rules for corporations set forth in section 39-22-303.6, C.R.S., and the rules promulgated thereunder. The character of a nonresident partner’s distributive share of any income item is determined as if the item was realized or incurred directly by partner.6 Therefore, under section 39-22-109, C.R.S., a nonresident partner’s share of ordinary business income is apportioned pursuant to section 39-22-303.6, C.R.S. This apportionment method applies even if the partnership did not elect, under section 39-22-203(1)(a), C.R.S., to apportion or allocate the entirety of the partner’s distributive share of the items of partnership income, gain, and loss pursuant to section 39-22-303.6, C.R.S. Sourcing of the nonresident partner’s distributive share of other items of partnership income Other items of income, such as gain, loss, rents, and royalties, that may flow through from a partnership to its nonresident partners are sourced separately under section 39-22-109, C.R.S. (unless the partnership has made an election under section 39-22-203(1)(a), C.R.S., to apportion all items of income pursuant to section 39-22-303.6, C.R.S.). For example, any gain or loss realized from the sale of real or tangible personal property is Colorado-source income if the property is located in Colorado.7 Income, including gain and loss, earned from intangible property employed in a business, such as patents, trademarks, and copyrights, are Coloradosource income if the intangible property is employed in a business, trade, profession, or occupation carried on in Colorado.8 Sourcing of the nonresident partner’s distributive share of the gain when the partnership sells its ownership interest in a single-member LLC that is a disregarded entity for federal tax purposes In determining the source of income under section 39-22-109, C.R.S., each item of partnership income, gain, loss, deduction, or credit has the same character for the nonresident partner for Colorado income tax purposes as for federal income tax purposes.9 The Internal Revenue Service has provided guidance regarding the sale of all or a part of an ownership interest in a single member domestic limited liability company (LLC) that is disregarded for federal tax 4 Section 39-22-203, C.R.S. 5 1 CCR 201-2, Rule 39-22-109(3)(b)(ii)(B) 6 1 CCR 201-2, Rule 39-22-109(3)(c)(ii); sections 39-22-202(2) and -203(5)(a), C.R.S.; and 26 USC sec. 702(b). 7 Section 39-22-109(2)(a)(I), C.R.S., and 1 CCR 201-2, Rule 39-22-109(3)(a)(ii) and (iii). 8 Section 39-22-109(2)(a)(V), C.R.S., and 1 CCR 201-2, Rule 39-22-109(3)(e). 9 Sections 39-22-202(2) and 39-22-203(5)(b), C.R.S.

GIL 22-003
April 25, 2022
Page 3
purposes as an entity separate from its owner under 26 CFR § 301.7701-3.10 The Internal Revenue Service treats this transaction as a sale of the LLC’s assets, which are treated as held directly by the single member—here the partnership—for federal tax purposes. Any gain realized by a nonresident partner from such a sale, treated for federal income tax purposes as a sale of the LLC’s assets held directly by the partnership that was the LLC’s single member, will be sourced under section 39-22-109, C.R.S., as though such assets had been sold directly by the nonresident partner.11 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 on any of the issues raised and the Department is not bound by this general information letter. Thank you for your request. Sincerely,

Office of Tax Policy
Colorado Department of Revenue

10 IRS Rev. Rul. 99-5, 1999-1 CB 434.
11 26 U.S.C. sec. 702(b). Gain or loss from the sale of a pass-through entity (as defined in Rule 39-22-109(2)(e)) that

is not disregarded for federal income tax purposes is sourced pursuant to Rule 39-22-109(3)(e)(ii).