Colorado’s “Tax Fairness” Reform Set to Eliminate Capital Gains Exclusion, Possible Impact on QSBS

Colorado QSBS

Colorado is on the precipice of the state’s biggest tax reform in many years. The state’s House of Representatives recently approved two major bills comprising a “tax fairness” initiative. The bill will provide increased tax benefits for low-income workers and families and will include a cut back on tax credits for businesses and wealthy Coloradans. 

The combined bills aim to generate about $375 million a year, primarily by eliminating tax breaks for capital gains, “pass-through” income (from businesses that pass their profits to owners or members so that they are taxed under individual income tax), and other industry-specific credits for insurance, oil and gas, and coal mining companies. 

Of this revenue, about $250 million will be spent on lower-income tax benefits, including a Child Tax Credit that pays up to $1,080 for each child under the age of 6 for families with joint incomes under $85,000 (up to $75,000 for single parents). The reform also includes an Earned Income Tax Credit, which expands the refundable federal credit. The federal credit is offered to people making less than about $60,000, depending on how many children they have. The state of Colorado would provide a 20 percent increase to that credit. 

The reform may also benefit small businesses. The “tax fairness” initiative includes an exemption for business personal property taxes, which are based on assets such as computers and furniture. Businesses with up to $50,000 of assets would be exempt from this tax. A new tax incentive will also be introduced for employee-owned businesses. 

What stock holders should be concerned about surrounding Colorado’s Tax Reform

For stockholders, one of the most significant aspects of the reform is the elimination of the capital gains deduction. Previously, Colorado taxpayers had the option of excluding capital gains of up to $100,000 on qualifying property (depending on the type of property, when it was acquired, and how long it had been held). Under the new law, this deduction would disappear. 

The question for investors in qualified small business stock (QSBS) is whether these changes will result in taxation for QSBS specifically. The new laws, which are still awaiting sign-off by the governor, don’t outline a clear answer. QSBS has been an exception to the rule on a federal level and in many states, in part because the tax exemption is intended to encourage investment in small businesses. To-date, Colorado has mimicked federal tax rules and allowed up to 100% exclusion of capital gains tax on the sale of QSBS.

Whether the elimination of Colorado’s capital gains tax exclusions will impact QSBS is yet to be clarified, but federal tax rules still currently provide a significant tax break for investors. Check our QSBS News page for ongoing updates on state-level QSBS laws.

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.

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