Colorado recently enacted legislation that eliminates a combined reporting exclusion and allows some domestic C corporations to use water’s edge reporting. These changes will take effect for tax years beginning on or after Jan. 1, 2027.

Prior law

Beginning in 2026, Colorado introduced combined reporting. However, a domestic corporation would not be included in a combined group if at least 80% of its property and payroll are assigned to locations outside the United States.

New legislation

HB26-1289 makes worldwide combined reporting the default filing methodology and provides the option to make a water's edge election on a timely filed original return. The water’s edge group must include all domestic members of the affiliated group, including domestic 80/20 corporations. Foreign corporations will be included if at least 20% of their property and payroll is in the United States. Domestic International Trade Corporations (DISCs) and export trade corporations will also be included. Additionally, any corporation in the group that is incorporated in specifically state-designated tax haven jurisdictions listed in Colo. Rev. Stat. 39-22-303(12)(b) must be included.

The water’s edge return will include the following items of income and apportionment:

• Apportionable income of any foreign corporation that is effectively connected to the conduct of a U.S. trade or business (or treated as such for federal income tax purposes)
• Certain income and factors of corporations in countries that do not have tax treaties with the U.S. and derive more than 20% of their income (directly or indirectly) from intangible property or service-related activities that are deductible from apportionable income of at least one member of the combined group

Once made, the election will be binding for 10 years. If not affirmatively withdrawn on a timely filed original return for the first year after the period’s end, the election renews and is binding for a new 10-year period. Notably, if the election is withdrawn, the withdrawal is also binding for 10 years. Withdrawals or renewals during the binding 10-year periods will be permitted only based on extraordinary hardship from unforeseen changes in state tax law or policy.

The water’s edge return would include income and apportionment factors of other otherwise excludable affiliates to a limited extent. The new rules would bring in effectively connected income (and related factors) of excluded members. Another provision would disallow deductions taken by includable affiliates for amounts paid to excludable affiliates for services and intangibles.

Impact of the new rules

For clients who file combined returns in Colorado, it is important to take note of the election rules and factor timing into the planning process. The binding election period should be carefully considered when making these decisions.