When a Colorado resident sells an interest in a multistate pass-through and another state taxes the gain, how is Colorado's credit for taxes paid to another state figured?
Plain-English summary
A married Colorado couple sold their direct and indirect interests in a multistate LLC and made a large gain. Ohio taxed the husband on his share of the gain (but not the wife, because of an Ohio ownership threshold). As Colorado residents, all their income is taxable in Colorado — so they asked how Colorado's credit for taxes paid to another state (§ 39-22-108) works on this sale.
The Department's answer has three moving parts:
- Colorado's sourcing rules — not Ohio's — decide how much gain counts as "from Ohio." A resident's credit is for tax paid to another state "on income derived from sources within the other state." Colorado borrows its nonresident sourcing rules (§ 39-22-109) by analogy: gain from selling an interest in a pass-through is sourced to a state if the seller actively participated in the entity's income-generating activities there (a passive interest is a placeless intangible and generates no credit). Where Colorado's and Ohio's sourcing rules conflict, Colorado's govern (Rule 39-22-108).
- Use a three-year average apportionment ratio. Because selling a member's interest is really a valuation question — the price reflects where the entity's income comes from over time — Colorado (like Ohio) sources the gain using a three-year average of the entity's apportionment ratio (Colorado's single-sales-factor method) for the three years before the sale (here 2009–2011), under Rule 39-22-109(3)(e)(ii). In this case Colorado's single-factor average (18.5%) was higher than Ohio's weighted average (15%), so more gain was sourced to Ohio under Colorado's rules.
- Compute the credit, and claim it in the right year. The credit under § 39-22-108(2) is the lesser of (a) a formula amount — Colorado tax × (Colorado-modified AGI sourced to Ohio ÷ total Colorado-modified AGI) — or (b) the actual Ohio tax paid. In the Department's illustration the formula gave $243,000 but the Ohio tax was $240,000, so the allowable credit was $240,000. The credit must be claimed in the year the other state's tax accrued (here 2011, so on an amended 2011 return), and the tax must actually have been paid (a protective claim holds the statute of limitations open if not yet paid). Because the couple filed jointly, the husband's credit applies to their combined liability.
The Department stressed it was not deciding whether Ohio correctly taxed them, nor whether they applied the apportionment formula correctly — only the methodology for sourcing the gain. As a PLR, it binds the Department only for these taxpayers.
For the flip side — the same accrual-year timing rule viewed from a resident who can't line up the years — see [[gil-22-001-request-for-general-information-letter-regarding-social-security-benef]].
What this means for you
Residents selling an interest in a business that operates in several states
If another state taxes your gain, you can usually credit it against Colorado tax — but Colorado decides how much of the gain is "from" that state, using its own single-sales-factor, three-year-average method. That can source more (or less) gain to the other state than the other state itself did. Keep three years of the entity's apportionment data.
Active vs. passive owners
The credit only reaches gain from an interest you were actively involved in. A purely passive investment interest is treated as a placeless intangible — selling it doesn't generate other-state-source income, so no credit.
Accountants and tax professionals
The credit is the lesser of the § 39-22-108(2) formula or the actual tax paid, claimed in the accrual year (§ 39-22-108(4)) on an amended return if needed, and only after the other state's tax is paid (use a protective claim otherwise). Joint filers apply the credit to combined liability. Note § 39-22-329 (S-corp credit) was distinguished because the individual, not the entity, paid the Ohio tax.
Common questions
Q: Does Colorado use the other state's numbers to figure how much of my gain is taxable there?
A: No. Colorado applies its own sourcing rules — a three-year average of the entity's apportionment ratio under its single-sales-factor method — which can differ from the other state's result.
Q: How big is the credit?
A: The lesser of the § 39-22-108(2) formula amount or the actual tax you paid to the other state.
Q: What year do I claim it?
A: The year the other state's tax accrued, and only after you've paid that tax (a protective claim can preserve the deadline if you haven't paid yet).
Q: I was a passive investor. Do I get a credit on the sale gain?
A: Generally no. A passive interest is treated as a placeless intangible, so its sale doesn't produce other-state-source income.
Q: Can I rely on this ruling?
A: No. A private letter ruling binds the Department only for the taxpayer and facts it was issued to and cannot be relied upon by anyone else.
Citations and references
Statutes and rules:
- § 39-22-108, C.R.S. (credit for taxes paid to another state); (2) (computation/limit); (4) (accrual-year claim)
- § 39-22-109, C.R.S. (sourcing rules applied by analogy); (2)(a)(V) (gain from intangible used in business)
- § 39-22-303.5, C.R.S. (single-sales-factor apportionment)
- § 39-22-329, C.R.S. (S-corporation credit provision — distinguished)
- 1 CCR 201-2, Rule 39-22-108 (Colorado sourcing governs); Rule 39-22-108(3)(a)(i) (credit fraction)
- 1 CCR 201-2, Rule 39-22-109(3)(e)(ii) (three-year average ratio; active vs. passive interest)
- 1 CCR 201-1, Rule 24-35-103.5 (private letter ruling procedure)
Source
- Landing page: https://tax.colorado.gov/all-letter-rulings
- Original PDF: https://tax.colorado.gov/sites/tax/files/documents/PLR-16-006.pdf
Original ruling text
Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]
PLR-16-006
April 12, 2016
XXXXXXXXXXX
Attn: XXXXXXX
XXXXXXXXXXX
XXXXXXXXXXX
Re: Credit for Taxes Paid to Another State
Dear XXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXXXXX ("Taxpayers") a request for a private
letter ruling to the Colorado Department of Revenue ("Department") pursuant to
Department Rule 24-35-103.5. This ruling is binding on the Department to the extent set
forth in Department Rule 24-35-103.5. It cannot be relied upon by any taxpayer other than
the taxpayer to whom the ruling is made.
Issues
1. Are Taxpayers entitled to a credit for taxes paid to another state?
2. How is the credit for taxes paid to another state computed and what is the amount of
the credit under the assumptions given?
3. In what tax year do Taxpayers claim the credit on the Colorado income tax return?
Conclusions
1. Taxpayers are entitled to a credit for taxes paid to Ohio on income that Colorado
sources to Ohio. Taxpayers determine the amount of income sourced to Ohio by using
an average of the limited liability company's apportionment ratios using Colorado's
apportionment methodology set forth in 39-22-303.5, C.R.S. for the three tax years
immediately preceding the tax year in which the husband's interest in the limited
liability company was sold. That apportionment will determine whether husband has
income derived from sources in Ohio. Income from the sale of the wife's interest does
not generate a credit because such income was not subject to Ohio income tax.
However, because Taxpayers filed a joint 2011 Colorado income tax return, then the
credit, if any, will be applied to the net income tax liability of both husband and wife.
2. The credit for taxes paid to another state is the lesser of (1) the amount computed by
multiplying the husband's capital gain by the limited liability company's average sales
factor for the prior three years, dividing it by Taxpayers'1 total modified federal adjusted
1
The husband and the wife.
DR 4010A (06/11/14)
gross income derived from sources inside and outside Colorado multiplied by the
tentative Colorado tax or (2) the tax paid to Ohio.
3. The credit is claimed by filing an amended 2011 Colorado individual income tax return.
Background
Taxpayers provided a lengthy description of the facts. For purposes of this ruling, the
following is a summary of those facts. Taxpayers formed and were initially the sole
members of a limited liability company which provided services both inside and outside
Colorado. The percentage of their membership interests varied over time. They also
transferred their membership interests to other pass-through entities, and created and
owned by them, in whole or in part, at different times. Taxpayers eventually sold their direct
and indirect interests in the limited liability company and realized substantial gain. Ohio
assessed the husband income tax liability on gain from the sale of his interest in the limited
liability company. Because of certain ownership threshold requirements in Ohio law, Ohio
did not assess the wife Ohio tax on the gain from the sale of her interest in the limited
liability company. Ohio calculated the tax based on a three year average of the limited
liability company's apportionment ratio.2 Ohio's apportionment ratio is computed based on
a weighted average of the payroll, property and sales factors. In this case, the limited
liability company's sales apportionment factor is the highest of the three factors.
For purposes of illustrating our ruling, we make the following assumptions: The Colorado
taxable income is $34,800,000 and the Colorado tax amount is $1,600,000. The average
of the Colorado sales factor for 2009 through 2011 is 18.5 percent and the average of the
Ohio Weighted Apportionment Factor for 2009 through 2011 is 15 percent. The total
capital gain generated by the husband's sale of his limited liability company interests is
$28,700,000. The total capital gain sourced to Ohio under O.R.C. § 5747.212(8) is
$4,300,000.
Structure of Analysis
To determine whether Taxpayers are entitled to a credit for taxes paid to another state, the
Department will examine the following questions:
1. Do Taxpayers derive income from sources within the other state?
a. If so, how do Taxpayers apportion such income?
2. How is the credit for tax paid to another state calculated?
3. In which tax year is the credit applied?
Discussion
1. Determination of Source of Income.
Colorado allows residents to claim a credit for tax paid to another state "on income derived
from sources within the other state."3 Colorado statutes do not directly define when the
2
We do not rule here whether Ohio correctly imposed or calculated the Ohio income tax on
Taxpayers. To reach the question posed in the ruling request, we assume Ohio correctly
imposed and calculated the tax.
3
§ 39-22-108, C.R.S. Taxpayers represent that the limited liability company elected to be treated
as a S-corporation. § 39-22-329, C.R.S. addresses when a tax credit is paid by a S-corporation
and the tax is not measured by the income of the shareholder, which is not the case here
because company did not pay Ohio income tax - the husband paid the tax. In the absence of
2
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income of an individual is derived from sources within another state.4 To resolve this
issue, the Department traditionally looks to§ 39-22-109, C.R.S., which sets forth rules for
determining whether a nonresident has income derived from sources within Colorado.
Although section 109 addresses the income of nonresidents, the sourcing rules do provide
legislative guidance for determining the source of income for residents claiming the credit
for taxes paid another state. For example, § 39-22-109(2)(a)(II), C.R.S. states that income
derived from a trade or business carried on in Colorado by a nonresident is Coloradosource income. Applying this principle to the converse case, a resident derives income
from another state if he or she carries on a trade or business in that state.
Colorado's rules for determining the source of an individual's income are typically the same
or similar as other states' sourcing rules and, therefore, there is consistency in the
application of credit for tax paid another state. However, there are instances, such as in
the case described in this ruling request, when the sourcing rules of another state are
different from Colorado's sourcing rules. Both Colorado's and Ohio's law treat, in principle,
the gain or loss from the sale of a member's active5 interest in a pass-through entity that
engages in a trade or business in the other state as income derived from sources within
that other state. In particular,§ 39-22-109(2)(a)(V), C.R.S. states that the gain from the
sale of an intangible is Colorado-source income to the extent the intangible was used in the
trade or business conducted in Colorado. A member's interest in a pass-through entity is
an intangible property interest, and that interest is used in the conduct of a business in the
state where such business operates if the member is actively engaged in the pass-through
entity's income generating activities.6 Thus, Colorado income tax applies to the sale of a
nonresident member's interest in a pass-through entity that conducts business in Colorado
if the member actively participates in the income-generating activities of the pass-through
entity. Conversely, Colorado sources, for purposes of determining the credit, the gain from
the sale of a resident's membership interest to a state where the pass-through entity
conducted business if the member actively participated in the pass-through entity's
business.7
Colorado statutes do not provide guidance on how to apportion the gain on the sale of a
member's interest between or among states in which the pass-through entity operates.
The Department has recently adopted revisions to Department Rule 1 CCR 201-2, 39-22109 that provides the guidance needed to resolve this issue. Specifically, the rule uses a
three year average apportionment ratio rule, which is very similar to Ohio's rule. The
Department uses a three year average apportionment ratio, as opposed to, for example,
using only the current tax year apportionment ratio, because, unlike income generated in
the regular conduct of a business (which is apportioned on only the current tax year
apportionment ratio), the sale of a member's interest is an issue of valuation. The valuation
any express provision in subpart 3 (S corporations), we look to the more general provision of
39-22-108, C.R.S. for guidance on how to compute the tax credit.
4
This is in large part because determining the source of income of a resident individual is not an
issue: all income of the resident individual is subject to Colorado tax. § 39-22-104, C.R.S.
5
In 1 CCR 201-2, Department Rule 39-22-109(3)(e)(ii), adopted in December of 2015, the
Department distinguishes between active and passive interests in pass-through entities: the
interests of a passive ownership interest is treated as an intangible which has not acquired a
business situs in the state in which the income-generating activity occurs.
6
Ibid. See, e.g., Arizona Tractor Co. v. Arizona State Tax Com'n., 566 P.2d 1348, 1350 (Ariz.
App. 1997}
7
See discussion supra regarding 1 CCR 201-2, Rule 39-22-109.
3
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is a reflection not only of the amount of income that the interest will generate but also the
sources from which the income will be generated. For example, the pass-through may
have had an usually successful year in making sales in Colorado. If only that year is used
to determine the appropriate ratio of Colorado income attributable to the sale of the interest,
then the apportionment ratio will be skewed toward Colorado. Therefore, the Department
believes a three year average will, in general, better reflect the sources of income giving
rise to the value of the member's interest. Ohio, as we noted above, uses the same
approach.
The difference between Colorado's sourcing rule and Ohio's sourcing rule is found in the
methodology for determining how much of the gain (or loss} is attributable to each state.
Ohio's sourcing rule states that the amount of gain or loss from the sale of the member's
interest attributable to Ohio is determined using an apportionment formula that considers a
variety of factors. Colorado also has a similar rule but Colorado uses a single sales factor
apportionment formula that is not used in Ohio. These may produce different results.8 In
cases of conflicting sourcing rules, 1 CCR 201-2, Department Rule 39-22-108 states that
Colorado's sourcing rules govern.9
Therefore, the husband must use Colorado sourcing rules to determine the amount of gain
from the sale of the husband's membership interest in the limited liability company that is
attributable to Ohio. The husband must use a three year average of the limited liability
company's apportionment ratios using Colorado's single sales factor apportionment
methodology for the three tax years immediately preceding the tax year in which the
interest was sold (i.e. 2009-2011). Because the limited liability company's sales factor is
the highest of the three apportionment factors Ohio considers, the total gain sourced to
Ohio, under Colorado's sourcing rules, is greater than the total gain sourced to Ohio under
Ohio's sourcing rules. This larger total gain sourced by Colorado to Ohio is used to apply
the limits set forth in§ 39-22-108(2), C.R.S. Income from the sale of the wife's interest
does not generate a credit because such income was not subject to Ohio tax.10 However,
because the Taxpayers filed a joint Colorado income tax return for tax year 2011, the credit
generated from the Ohio tax on the husband's income from the sale of his interest is
applied to the Taxpayers' net income tax liability.
2. Computation of the Credit for Taxes Paid to Another State
After applying the sourcing rules to determine the amount of the gain that will generate a
credit for taxes paid to another state, the amount of the credit for taxes paid to another
state is computed under§ 39-22-108(2), C.R.S. Applying the limits set forth in§ 39-22108(2}, C.R.S., because the total gain sourced by Colorado to Ohio exceeds the total gain
sourced by Ohio to Ohio, the numerator of the fraction determined under 1 CCR 201-2,
Rule 39-22-108(3)(a)(i} is the amount determined under 1 CCR 201-2, Rule 39-22109(3)(e)(ii), rather than the amount apportioned to Ohio under Ohio law. Thus, for
illustrative purposes, based on the assumptions presented above, the creditfor taxes paid
8
In fact, in this case, the two sourcing rules product different apportionment factors of 18.5
percent versus 15 percent
9
1 CCR 201-2, Department Rule 39-22-108 states that Colorado will apply its sourcing rules to
determine the source of income.
10
Again, we do not rule that the wife does or does not owe tax in Ohio; we accept Taxpayers'
representation for purposes of addressing the issue set forth in the ruling request. The source
of the wife's income has no bearing on the credit calculation because such income was not
subject to Ohio tax.
4
DR 4010A (06/11/14)
to another state is computed as follows:
(1) Colorado tax
1,600,000
(2) Modified Colorado Adjusted Gross Income Sourced to Ohio11
5,300,000
(3) Total modified Colorado adjusted gross income
34,800,000
(4) Line (2) divided by line (3)
.152
(5) Line (1) multiplied by line (4)
243,000
(6) Ohio tax liability
240,000
(7) Allowable credit (smaller of line (5) and line (6))
240,000
- Credit Claimed in the Tax Year the Other State's Tax Accrued.
The credit allowed for tax paid another state must be taken in the tax year that the other
state's tax accrues, regardless of the accounting method used by the taxpayer.12 In
addition, Taxpayers must have already paid the tax to the other state in order to claim the
credit.13 In general, a tax accrues when it becomes due and payable rather than when the
liability is actually paid.14 Taxpayers represent that Ohio's tax accrued in 2011. Therefore,
the credit must be claimed by filing an amended 2011 Colorado income tax return. The
Taxpayers filed a joint federal income return for 2011. As a result, the credit will be applied
to the combined income tax liability of husband and wife on the amended 2011 Colorado
income tax return. If the husband filed a separate federal income tax return in 2011, then
only the husband may claim the credit on an individual state income tax return.
This ruling addresses only the narrow issue of the methodology for determining amount of
gain, if any, that was derived from sources in Ohio for purposes of claiming the Colorado
credit for tax paid to Ohio. This ruling does not address, among other things, whether
Taxpayer correctly applied the apportionment formula described in §39-22-303.5, C.R.S.,
whether Taxpayer correctly calculated the credit; and whether both taxpayers correctly
reported their Colorado income tax liability for tax year 2011 or any other tax year.
Miscellaneous
This ruling is premised on the assumption that Taxpayers have completely and accurately
disclosed all material facts. The Department reserves the right, among others, to
independently evaluate Taxpayers' representations. The ruling is null and void if any such
representation is incorrect and has a material bearing on the conclusions reached in this
ruling and is subject to modification or revocation in accordance to Department Rule 24-35103.5.
11
Husband's total capital gain of $28,700,000 multiplied by average Ohio sales factor for 20092011 of .185.
12
§39-22-108(4). C.R.S.
13
If Taxpayers have not yet paid the tax, Taxpayers may file a Protective Refund Claim in the
form of a Protective Amended 2011 Return. This will hold the statute of limitations open until
Taxpayers finally pay this tax.
14
See, e.g., IRS Publication 538 (accrual method).
5
DR 4010A (06/11/14)
This ruling is binding on the Department to the extent set forth in Department Rule 24-35103.5. It cannot be relied upon by any taxpayer other than the taxpayer {husband) identified
in this ruling.
Enclosed is a redacted version of this ruling. Pursuant to statute and rule, this redacted
version of the ruling 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 version of the ruling.
Sincerely,
Office of Tax Policy
Colorado Department of Revenue
This ruling cannot be relied upon by any other taxpayer other than the taxpayer to whom the
ruling is made.
6
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