The Disappearing Deduction for Colorado State Income Tax Purposes
On June 23, 2021, Governor Polis signed Colorado House Bill 21-1311 into law. The Bill makes significant changes to a number of Colorado state income tax laws. One change of note is an amendment to C.R.S. § 39-22-104. The amendment limits the amount of itemized deductions under Section 63(d) of the Internal Revenue Code that a high-income taxpayer may claim for Colorado state income tax purposes. The law is effective for tax years beginning on January 1, 2022. The limit applies to taxpayers who have a federal adjusted gross income of $400,000 or more in the tax year. For a taxpayer who files a single return, the taxpayer’s itemized deductions are capped at $30,000 for state income tax purposes. For taxpayers who file a joint return, the taxpayers’ itemized deductions are capped at $60,000. This limitation does not apply to taxpayers who take the standard deduction for federal income tax purposes.
This means that if taxpayers file jointly, earn over $400,000 in income in a year and itemize deductions for federal income tax purposes, the taxpayers’ itemized deductions will be limited (or reduced) to $60,000 regardless of the amount that the taxpayers can deduct for federal purposes. This could be especially significant for gifts to charity. For example, assume two spouses have a combined adjusted gross income of $600,000 and make a gift of $200,000 to charity. If they itemize their deductions for federal income tax purposes, their deductions for Colorado state income tax purposes will be limited to $60,000. They will pay Colorado state income tax on an additional $140,000 of their assets despite the gift to charity, resulting in an additional tax of $6,370 compared to prior law. Moreover, they will lose the benefit of any other federal deductions to which they may have been entitled.
To the extent that taxpayers expect to have income in excess of $400,000 in 2022 and may have substantial itemized deductions for federal income tax purposes, they may wish to accelerate their deductions into 2021. For example, if they intended to make a large charitable gift in 2022, they may wish to make that gift in 2021 in order to take full advantage of the charitable deduction for Colorado state income tax purposes. For example, a taxpayer could bunch their charitable deduction into 2021 by funding a Donor Advised Fund with a qualified charity. The taxpayer could claim the full charitable deduction for Colorado state income tax purposes in 2021, assuming the taxpayer itemizes his or her deduction for federal purposes this year, while recommending distributions to specific charities from the fund over the coming years.