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Get ready for market-based sourcing in Colorado

Beginning January 1, 2019, sourcing of sales in Colorado should be moving to a market-based sourcing system. Both chambers of the state of Colorado passed legislation (HB18-1185) to change market sourcing for business income tax. The governor is expected to sign the legislation, enacting a change that will:

1) Require out-of-state service providers to have Colorado sourced revenue, and

2) Minimize the tax burden for in-state service providers with out of state customers.

The bill generally replaces the sales-sourcing method for apportioning taxpayer income, which uses income from sales, lease, license, or rental of intangible property receipts in both Colorado and other states, with a market-based sourcing system. Both the cost-of-performance test in the case of services and the commercial domicile test in the case of intangible property are replace by a market-based sourcing system. Under this new system, receipts are apportioned to Colorado based not on where the service is performed, but where the service is delivered.

Sourcing for apportionment purposes

The ruling will alter how businesses allocate their federal income to the various states in which they operate. Colorado-based service companies will no longer assign receipts from services based on in-state costs. Under the new ruling, companies will assign receipts based on delivery, typically viewed as the location of the customer.Previously, out-of-state service companies with in-state customers did not have costs and revenue sourced to Colorado for income tax purposes.

An example of how this is applied is a Colorado-based service company with $1,000,000 of revenue that does all the work here but all of their customers are in California. Under the old rule, both Colorado and California will have $1,000,000 of revenue sourced to each state (paying state tax on 200% of your federal income). Using the same facts under the new rule, however, California reports the $1,000,000 of revenue to California and Colorado reports $0 because none of the services were delivered to a Colorado location, all to California.

Effective dates

The bill indicates market-based sourcing will commence January 1, 2019. Assuming Governor Hickenlooper signs the bill, taxpayers would need to account for the change to their 2019 tax returns due in 2020 and, potentially, their deferred income tax rate for tax provisions beginning with the time of enactment. Let us know if you'd like to discuss within the context of your business.

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Meredith Smith can be reached at msmith @taxops.com or 720.227.0064. Follow Meredith on LinkedIn.

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