Current Issues in Colorado Taxation-a Department of Revenue Perspective
| Publication year | 1979 |
| Pages | 1924 |
1979, October, Pg. 1924. Current Issues in Colorado Taxation-A Department of Revenue Perspective
In recent years the Colorado income tax has been the subject of significant legislative and administrative initiatives. This article discusses one important legislative innovation --- indexing for inflation --- and two areas where Colorado, from an administrative perspective, has been in the vanguard of state taxation --- the combined report and the business versus non-business treatment of corporate income.
In Colorado, as elsewhere, the single most important factor affecting state individual income taxes in recent years has been inflation. In 1965, the average Colorado taxpayer's adjusted gross income "AGI" was $5,588.63, with an average tax liability of $88.66. In the aggregate, Colorado taxpayers had adjusted gross income in excess of $4 billion and paid income taxes of over $63 million. This amounts to an effective tax rate of 1.6 percent of AGI. In addition, only 11 percent of total returns filed reported adjusted gross incomes in excess of $10,000.
The Colorado income tax rate schedule ranging from 2 1/2 percent on the first $1,000 in taxable income to 8 percent on taxable income in excess of $10,000, was the same in 1977 as it was in 1965. However, for 1977 returns the statistics change dramatically as compared to the 1965 figures. The average adjusted gross income for 1977 was $12,662.70 with an average tax liability of $346.61. Also, nearly 52 percent of returns filed showed an adjusted gross income in excess of $10,000.(fn1)
The cause of the increase in the effective rate of taxation is the inflation we have experienced during the last decade and, to a limited extent, the real growth in income experienced by Colorado residents. Given the same progressive tax rate schedule, an individual pays at a higher rate of tax as inflation pushes his income up the rate schedule. Absent the inflationary effect on rates, the effective rate of taxation should have remained approximately the same 1.6 percent that existed for 1965. The 69 percent increase in the effective rate (from 1.6 percent in 1965 to 2.7 percent in 1977) can generally be attributable to inflationary pressures. Not until 1978 was an allowance
made for the effects of inflation on the individual income tax liabilities of the Colorado taxpayer.
Indexing in Colorado was implemented through C.R.S. 1973, § 39-22-103.5, which provides for adjustments based on an annual inflation factor ("AIF"). The AIF is applied to the effective rates of tax, the percentage standard deduction or low-income allowance, and the personal exemptions, adjusting in relation to changes in the consumer price indexes. The AIF is determined by the General Assembly by May 1 of each year and applied for tax years commencing on or after the following January 1.
As an example, consider a married Colorado resident individual with two children, who files a joint return, uses the standard deduction, and has adjusted gross income for both federal and state purposes of $15,481 for 1977. Under these circumstances, the federal tax liability from Tax Table B would be $1,481. The Colorado liability would be $480 computed as follows: Colorado adjusted gross income of $15,481 less the Colorado standard deduction of $1,000, the exemption deduction of $3,000 (four exemptions times $750), and the federal tax deduction of $1,481, leaving a net taxable income of $10,000. The tax on $10,000 for 1977 would be $480.
If this individual receives a 6 percent raise, his adjusted gross income for 1978 would be $16,410. The federal income tax would be $1,690, for a 14 percent increase over the 1977 liability. Without the benefit of indexing, the Colorado liability would have been $537.60 ($16,410 less $3,000 in exemptions, $1,000 standard deduction, and $1,690 in federal tax for a taxable income of $10,720, and a tax of $537.60) or a 12 percent increase over the 1977 liability.
However, with the benefit of indexing the Colorado liability for 1978 would be computed as follows: adjusted gross income of $16,410 less $3,180 in exemptions, $1,060 standard deduction, $1,690 in federal tax for a taxable income of $10,480 and a tax of $499.80. This would amount to only a 4 percent increase in taxes. The Colorado tax would have increased 6 percent from 1977 to 1978, the same percentage increase as the income experienced, except for the fact that the federal tax liability which is a deduction on the Colorado return increased by 14 percent or over twice the rate that the income increased. For the purposes of this example, no consideration is given to legislation that increased the Colorado exemption from $750 in 1977 to $850 in 1978.
With the tremendous growth in personal income within Colorado, from $4 billion in 1965 to $14 billion in 1977, helped both by inflation and by the increased population, business activity within the state has increased correspondingly. Colorado has experienced a great deal of corporate growth in the form of large multinational firms moving operations into Colorado or expanding upon previously limited operations within Colorado. A great deal of the Colorado Department of Revenue's ("Department") activity has been directed toward the taxation problems revolving around business or corporate activity in the state.
The most pressing tax issues the Department has encountered over the past few years relate to the means and manner of taxing large multistate or multinational firms Simply put, these major issues have concerned whom, what and how to tax business activities conducted in Colorado.
The first issue --- whom to tax --- requires at the outset a determination of whether Colorado has a legal right to tax a particular corporation. If a corporation is foreign to Colorado and has no operations
within Colorado's borders, the answer is simple. In such a case, Colorado cannot tax any of the income of the corporation. Now suppose a corporation has no contacts within Colorado other than to send salesmen into the state to solicit sales. If the salesmen are successful in their efforts, the corporation will make delivery of its product into Colorado and there will be sales in Colorado. Can Colorado tax these sales for income tax purposes?
The answer is that Colorado cannot tax these sales because the corporation's activities within Colorado do not exceed "solicitation of sales" as contemplated by federal statute (P.L. 86-272). This law limits the power of the various states to impose net income taxes on income derived from interstate commerce. The statute fixes minimum standards of activity which a foreign corporation may "conduct" within a given state and still not establish a nexus for tax purposes.
Prior to the enactment of P.L. 86-272, the U.S. Supreme Court in Northwestern States Portland Cement Co. v. Minnesota(fn2) held that the net income of a foreign corporation from interstate operations could be subject to state income taxation if the levy was not discriminatory and was properly apportioned to local activities within the taxing state sufficient to support the tax. Within seven months of the Northwestern decision, Congress enacted P.L. 86-272 in response to the concern and apprehension voiced by the business community. There had been an apprehension among businessmen that mere solicitation would subject them to state income taxation. There was a concern that Northwestern did not adequately specify what local activities were enough to create a nexus sufficient for the state to. exercise its power to tax. Accordingly, P.L. 86-272 was viewed as legislation designed to define a lower limit for the exercise of that power to tax.
Returning now to our hypothetical corporation, suppose that the corporation's Colorado activities reach the point where it now has ten salesmen, two sales managers and one district manager working in Colorado. Is this enough activity to create a nexus sufficient to allow Colorado to tax any income of the corporation? There is no certain answer at this point. Before this determination can be made, one would need to know the extent of the activities of the various persons stationed in Colorado. Does the position of district manager perform activities in excess of solicitation of sales? Is his position one of management? Does he hire and fire the salesmen under his control? Does he maintain an office in Colorado? Is there an inventory of products maintained in Colorado?
The list of possible questions that might be asked to aid in determining whether the corporation has sufficient activities within Colorado is almost endless. Certain facts such as the maintenance of an office in Colorado would make the question of nexus easy to answer: there would be sufficient nexus to warrant taxation. However, short of the opening of an office and/or maintaining an inventory of products, the Department has the problem of determining whether nexus exists, and if it does, at what point in time did the activities exceed the guidelines set forth by P.L. 86-272.
Let us assume that a corporation does have sufficient nexus within Colorado to warrant the filing of tax returns. Now the corporation is on the tax rolls and will...
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