When Congress enacted the One Big Beautiful Bill Act in July 2025, Colorado’s revenue took an automatic hit, because Colorado’s income tax starts from federal taxable income. The General Assembly answered in an August 2025 special session, and on August 28 Governor Polis signed five revenue bills whose main provisions first apply to 2026 returns.
This post is for S corporation shareholders, partners in operating LLCs, sole proprietors, and Colorado retailers. It prices the now-permanent QBI addback for a hypothetical Grand Junction owner, then turns to the corporate provisions, one of which a June 2026 statute has already rewritten.
Why does a federal deduction change what you owe Colorado?
Under C.R.S. § 39-22-104, Colorado taxes federal taxable income, adjusted by state additions and subtractions, at 4.40 percent. A temporary TABOR rate cut under C.R.S. § 39-22-627 needs a surplus, and Legislative Council Staff’s September 2026 revenue forecast reports that FY 2025-26 revenue fell $175.9 million short of the TABOR cap, so 4.40 percent applies to 2025 and 2026 income.
Section 70105 of Pub. L. No. 119-21 removed the sunset on the 26 U.S.C. § 199A deduction, which on its own would have cut Colorado revenue. Colorado’s response was HB 25B-1001. Its legislative declaration calls the addback “a continuation of existing tax policy,” the General Assembly’s basis for skipping a TABOR vote; for other bills it relied on the de minimis rule of TABOR Found. v. Reg’l Transp. Dist., 2018 CO 29.
Who has to add back the QBI deduction on a Colorado return?
The addback sits in C.R.S. § 39-22-104(3)(o). It began with 2021 under HB 20-1420; HB 25B-1001 deleted its 2025 end date and left the thresholds alone. A single filer adds back the entire federal 199A deduction when adjusted gross income is greater than $500,000, and a joint filer when it is greater than $1,000,000. The Department of Revenue’s 2025 filing guide agrees. One exception matters in Weld County and on the Western Slope: taxpayers required to file Schedule F are excluded.
Under Rev. Proc. 2025-32, the 2026 joint-filer phase-in for the 199A wage and property limits ends at $553,500. A couple with AGI above $1 million is nearly always past it, so owners of specified service businesses like medical practices and law firms get no 199A deduction and have nothing to add back. The addback falls on non-service businesses that pay real W-2 wages or hold depreciable property: contractors, manufacturers, distributors, restaurant groups. The final fiscal note puts the revenue at $95.5 million for FY 2026-27.
What does the addback cost a Grand Junction S corporation owner?
Hypothetical: a married couple in Grand Junction owns a commercial HVAC contractor organized as an S corporation. For 2026 the company pays one spouse a $220,000 salary, pays $1.1 million of total W-2 wages, and reports $900,000 of ordinary income on the K-1. The couple also earns $40,000 of interest, so AGI is $1,160,000. Assume $60,000 of itemized deductions and no other Colorado modifications.
Federally, 20 percent of $900,000 is $180,000. Neither the wage limit nor the taxable income cap binds, so federal taxable income is $920,000. At a 37 percent marginal rate, which begins at $768,700 for joint filers in 2026, the deduction saves $66,600 of federal tax. Colorado then adds the $180,000 back. Colorado taxable income becomes $1,100,000 and the tax is $48,400, compared with $40,480 if Colorado followed the federal figure. The addback costs this family $7,920 a year.
Why does the $1 million line matter so much?
Section 39-22-104(3)(o) has no phase-in. At $1,000,000 of joint AGI the addback is zero; one dollar more and the whole deduction comes back. Suppose the same S corporation earns $760,000. AGI is $1,020,000, the 199A deduction is $152,000, and Colorado tax is $42,240. Had the company made an extra $20,000 employer contribution to the owners’ retirement plan, AGI would be exactly $1,000,000, not “greater than” the threshold, and the Colorado bill would fall to $34,848. That is $7,392 of state tax saved on a $20,000 contribution.
A gain on a Montrose rental can push a family over the line just as easily. Itemized deductions do not help, because they come after AGI. Retirement contributions do, and so can the SALT Parity Act election under C.R.S. § 39-22-343: under IRS Notice 2020-75, the electing entity deducts the Colorado tax it pays, which lowers the owners’ AGI.
Should the permanent addback change entity choice or owner salary?
Above the threshold, the addback costs 4.40 percent of the 199A deduction, or 0.88 percent of QBI. That rarely justifies converting a profitable S corporation into a C corporation, where Colorado’s 4.40 percent corporate tax is followed by a second layer on dividends. The salary question does change. Under 26 U.S.C. § 199A(c)(4), reasonable compensation is not QBI, but above the Colorado line salary and K-1 income produce identical Colorado taxable income. The owner’s pay becomes a purely federal calculation, and a low salary chosen to enlarge QBI earns nothing from Colorado while the IRS still tests S corporation compensation for reasonableness. Below the line, Colorado follows the federal deduction and adds 4.40 percent to the savings.
What does a Colorado retailer lose now that the vendor fee is gone?
Under C.R.S. § 39-26-105(1)(d), a timely filer kept 4 percent of the state tax it reported, capped at $1,000 per filing period, and since 2022 retailers with over $1 million of taxable sales in a period got nothing. HB 25B-1005 ends all retention of state tax beginning January 1, 2026.
With the state rate at 2.9 percent under C.R.S. § 39-26-106, a hypothetical Pueblo hardware store with $150,000 of monthly taxable sales used to keep $174 a month, or $2,088 a year. The largest loss, $1,000 a month, falls on monthly filers with taxable sales between roughly $862,000 and $1 million. The Department of Revenue’s sales and use tax page says local service fees may still be retained where they apply.
What changed for C corporations with foreign income or affiliates?
OBBBA section 70321 set the deduction under 26 U.S.C. § 250 at 33.34 percent of foreign-derived deduction eligible income. HB 25B-1002 added C.R.S. § 39-22-304(2)(l), which adds that deduction back before apportionment. It also presumed, for 2026, that a group member incorporated in Hong Kong, Ireland, Liechtenstein, the Netherlands, or Singapore exists for tax avoidance and belongs in the combined report, absent economic substance. HB 26-1289, signed June 3, 2026, drops Liechtenstein for 2027 and creates a ten-year water’s-edge election. HB 25B-1004 sold tax credits to C corporations and insurers only, at no less than 80 percent of face.
What should owners and retailers do before the 2026 filing season?
Most of these steps carry a year-end deadline, because AGI is largely fixed once December 31 passes.
| Your situation | What changed for 2026 | Step to consider before filing | Authority |
|---|---|---|---|
| Pass-through owner well above $500,000 AGI (single) or $1,000,000 (joint) | QBI addback is now permanent | Budget 4.40 percent of the 199A deduction in Colorado estimates | C.R.S. § 39-22-104(3)(o); HB 25B-1001 |
| Owner projected within about $50,000 of the threshold | All-or-nothing cliff at the AGI line | Model retirement contributions, gain timing, and the SALT Parity Act election before December 31 | C.R.S. §§ 39-22-104(3)(o), 39-22-343 |
| Farm or ranch owner filing Schedule F | Exception carried forward unchanged | Confirm Schedule F is required for the year the 199A deduction is claimed | C.R.S. § 39-22-104(3)(o) |
| Retailer filing Colorado sales tax | State vendor fee ended January 1, 2026 | Review 2026 returns for improper state retention and keep local service fees where allowed | C.R.S. § 39-26-105(1)(d)(V); HB 25B-1005 |
| C corporation exporter or group with foreign affiliates | FDDEI addback; five jurisdictions added; Liechtenstein removed for 2027 | Recompute the combined group and document economic substance for listed-country members | C.R.S. §§ 39-22-303, 39-22-304(2)(l); HB 26-1289 |
Frequently Asked Questions
Does Colorado’s QBI addback apply to every business owner?
No. It applies only when adjusted gross income exceeds $500,000 on a single return or $1,000,000 on a joint return, and never to a taxpayer required to file Schedule F for the year. Owners below those lines keep the federal section 199A deduction on their Colorado returns.
Is the Colorado addback phased in as income rises?
No. It is a cliff. A joint filer with AGI of exactly $1,000,000 adds back nothing, while one with $1,000,001 adds back the entire 199A deduction. Itemized deductions do not lower AGI, so owners near the line look at retirement contributions and entity-level tax elections.
What Colorado income tax rate applies to 2026 income?
The statutory rate is 4.40 percent. A temporary TABOR rate reduction requires a surplus, and Legislative Council Staff reported in September 2026 that none was collected in FY 2025-26. Under current law, individuals should plan on 4.40 percent of 2026 Colorado taxable income.
Can a Colorado retailer still keep part of the sales tax it collects?
Not for state sales tax on sales made on or after January 1, 2026. HB 25B-1005 ended the 4 percent state vendor fee, which had been capped at $1,000 per filing period. The Department of Revenue says retailers may still keep local service fees where they apply.
Could an S corporation or LLC buy the tax credits Colorado sold?
No. HB 25B-1004 limited corporate credit buyers to C corporations authorized to do business in Colorado, with a parallel program for insurers. The credits sold for at least 80 percent of face, are not refundable, and cannot be carried to a tax year beginning after December 31, 2033.
Is Liechtenstein still on Colorado’s tax haven list?
For 2026 tax years, yes. HB 25B-1002 added Hong Kong, Ireland, Liechtenstein, the Netherlands, and Singapore beginning with 2026. HB 26-1289 removes Liechtenstein for tax years beginning on or after January 1, 2027, and requires a periodic outside review of every listed jurisdiction.
How North Star Law Firm Can Help
North Star Law Firm advises Colorado pass-through owners on the federal side of these decisions, including section 199A planning, S corporation compensation, retirement plan design, and entity selection, and coordinates that work with the Colorado state tax and DOR consequences described above. When the IRS questions an owner’s salary or deduction, the firm handles IRS audit defense. Phillip Zagotti, JD/CPA, is an attorney and CPA admitted to practice before the U.S. Tax Court. Phillip Zagotti is not licensed by the Colorado Supreme Court; for Colorado state-law questions the firm works alongside Colorado-licensed counsel.
If your 2026 income is close to the Colorado addback threshold, or you are rethinking your structure before year end, contact North Star Law Firm to talk through the numbers.