Can a Colorado business subtract, from its federal taxable income, the wages that federal law disallowed as a deduction because it claimed the COVID-19 employee retention credit?

Plain-English summary

This ruling addresses a tax wrinkle from the COVID-19 employee retention credit (ERC). A Colorado S corporation claimed the federal ERC under IRC § 3134(a) for the 2020 and 2021 tax years. Federal law (IRC § 3134(e)) requires an employer who claims the ERC to reduce its federal deduction for wages and salaries by the amount of the credit. That reduction increased the company's federal taxable income for those years.

Because Colorado income tax starts from federal taxable income, that federal add-back of wages also flowed into the company's Colorado starting point. The company asked whether it could subtract those disallowed wages from federal taxable income on its Colorado return. The Department concluded: yes — "under the specific circumstances at issue here, Colorado will allow a subtraction... of wages that were disallowed for federal tax purposes under IRC Section 3134(e)."

A candid note on scope: the Department's published discussion is unusually brief — essentially a one-sentence conclusion expressly limited to "the specific circumstances at issue here," with no extended statutory analysis in the released text. Treat it as a fact-specific allowance, not a broadly reasoned rule.

What this means for you

Businesses that claimed the COVID-19 ERC

If you claimed the federal ERC and had to shrink your federal wage deduction under § 3134(e) — which pushed up your federal taxable income — this ruling shows the Department allowing the affected taxpayer to subtract those disallowed wages on its Colorado return, neutralizing the state-level effect of the federal add-back. Your facts may differ, so this isn't a guarantee for your return.

Accountants and tax professionals

The mechanism: ERC claimed → § 3134(e) reduces the federal wage deduction → federal taxable income rises → Colorado, which builds on federal taxable income, picks up that increase → the Department allowed a Colorado subtraction to offset it. The released discussion is sparse and explicitly fact-bound, so don't read it as a general published position. For a client in the same posture, consider whether a private letter ruling (binding only for that taxpayer) is warranted rather than relying on this one.

Common questions

Q: Did Colorado let the taxpayer subtract the ERC-disallowed wages?
A: Yes, under the specific circumstances of this ruling, the Department allowed a subtraction from federal taxable income for the wages disallowed federally under IRC § 3134(e).

Q: Why were the wages added back in the first place?
A: IRC § 3134(e) requires an employer claiming the ERC to reduce its federal wage/salary deduction by the credit amount, which increases federal taxable income.

Q: Why does that affect Colorado tax?
A: Colorado income tax is computed starting from federal taxable income, so a federal increase carries into the Colorado calculation unless a subtraction offsets it.

Q: Can my business 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 on by anyone else — and here the Department expressly limited its conclusion to the specific circumstances presented.

Citations and references

Statutes and rules:
- I.R.C. § 3134(a) (COVID-19 employee retention credit)
- I.R.C. § 3134(e) (reduction of the federal wage/salary deduction by the credit amount)
- 1 CCR 201-1, Rule 24-35-103.5 (private letter ruling procedure)

Related Colorado income-tax rulings building on federal taxable income: [[plr-25-006-electing-settlement-trust-s-taxable-income-and-withholding-of-distribu]].

Source

• Landing page: Colorado Letter Rulings
• Original PDF: PLR-24-004.pdf

Original ruling text

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

PLR 24-004
May 21, 2024
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Re: Subtraction of wages disallowed under I.R.C. § 3134(e)
Dear XXXXXXXXXX:
You submitted a request for a private letter ruling on behalf of XXXXXXXXXX (the “Company”),
to the Colorado Department of Revenue (“Department”) pursuant to 1 CCR 201-1, Rule 24-35103.5. This letter is the Department’s private letter ruling. This ruling is binding on the
Department to the extent set forth in 1 CCR 201-1, Rule 24-35-103.5. It cannot be relied upon
by any taxpayer other than the taxpayer to whom the ruling is made.
Issue
Whether wages, the deduction of which was disallowed under section 3134(e) of the Internal
Revenue Code, may be subtracted from federal taxable income.
Conclusion
Wages, the deduction of which was disallowed under section 3134(e) of the Internal Revenue
Code, may be subtracted from federal taxable income.
Background1
Company is a Colorado S corporation that manages several XXXXXXXXXX in Colorado. For
the tax years ending December 31, 2020, and December 31, 2021, Company claimed an
employee retention credit for employers subject to closure due to COVID-19 under section
3134(a) of the Internal Revenue Code. Pursuant to I.R.C. section 3134(e), Company reduced
its federal deduction for wages and salaries by $XXXXXXXXXX for tax year 2020, and by
$XXXXXXXXXX for tax year 2021 on its federal form 1120-S. This reduction increased
Company’s federal taxable income.

1 Paragraph (4)(b)(ii) of 1 CCR 201-1, Rule 24-35-103.5 requires the request for a private letter ruling to include a

statement of facts. This section generally recites the statement of facts provided in the request, which is not an
indication that the Department found such facts relevant to its analysis. Some relevant facts may be omitted to
ensure confidentiality as required by section 24-35-103.5(5), C.R.S. The terms used in this section to describe the
factual background are generally those of the requester.

PLR 24-004
May 21, 2024
Page 2

Discussion
Under the specific circumstances at issue here, Colorado will allow a subtraction for taxpayer of
wages that were disallowed for federal tax purposes under IRC Section 3134(e).
Miscellaneous
This ruling is premised on the assumption that Company has completely and accurately
disclosed all material facts, that all representations are true and complete, and that Company
has otherwise complied with the requirements of section 24-35-103.5, C.R.S., and the rules
promulgated pursuant thereto. The Department reserves the right, among others, to
independently evaluate Company’s facts, representations, and assumptions. The ruling is null
and void if any such fact, representation, or assumption is incorrect and has a material bearing
on the conclusions reached in this ruling. This ruling is binding on the Department and is subject
to modification or revocation, in accordance with 1 CCR 201-1, Rule 24-35-103.5.
Thank you for your request.
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.