Category: Tax Law

Billy Rowland’s estate claimed $3,712,562 of exclusion inherited from his late wife, Fay, and lost all of it on summary judgment. In Estate of Rowland v. Commissioner, T.C. Memo. 2025-76 (filed July 15, 2025), Chief Judge Urda held that the Form 706 filed for Fay’s estate never made a valid portability election. The return named her assets. It never said what any of them were worth.

Colorado families have more riding on that lesson. In a separate property state, the first death resets income tax basis only on the decedent’s share of jointly owned property, while a Texas or California survivor often gets a new basis on the whole community asset. That makes the deceased spousal unused exclusion (the DSUE amount) worth more here, because it lets a Colorado survivor hold appreciated assets until her own death without estate tax.

What was actually missing from the Rowland return?

Fay Rowland, of Lorain, Ohio, died April 8, 2016. Her trust made $950,000 of specific gifts, sent 20 percent of the trust estate to a family foundation, sized her husband’s share by reference to one-fourth of her gross estate, and left the residue to trusts for grandchildren. Her executor missed the extended deadline and mailed the Form 706 in late December 2017.

The return claimed DSUE of $3,712,562 from an estimated $3 million gross estate. Its schedules listed real estate, family company shares, a note, and bank accounts with no date-of-death values. The recapitulation showed $0 in every category and put the full $3 million on the line reserved for assets estimated under the special rule.

Why did the Tax Court hold the election invalid?

Under 26 U.S.C. § 2010(c)(5)(A), no election may be made on a late return, so the statute alone defeated Fay’s election. The only rescue was Rev. Proc. 2017-34, which excused lateness for a return that was “complete and properly prepared” under Treas. Reg. § 20.2010-2(a)(7). Fay’s return met the timing test and failed the quality test. Paragraph (a)(7)(i) ties completeness to the Form 706 instructions, which require a value for each asset, and paragraph (a)(7)(ii) excuses values only for marital or charitable deduction property. The return stretched that relief to gifts for friends and grandchildren. Even the spouse’s and foundation’s shares needed values, because their size fixed the grandchildren’s residue, the exception in § 20.2010-2(a)(7)(ii)(A)(1).

The court left open whether substantial compliance can ever save a DSUE election, holding only that this return fell well short, and refused to let audit-stage valuations cure it. The docket (No. 12736-22) shows partial summary judgment entered August 22, 2025, with the remaining issues set for trial in Cincinnati on November 30, 2026.

When can a portability-only return use estimates instead of appraisals?

Only when the gross estate plus adjusted taxable gifts is under the filing threshold in 26 U.S.C. § 6018(a), and only for assets that will go to the spouse or a charity. Those assets are still listed, with a good-faith estimate reported in bands from the Form 706 instructions under penalties of perjury. The relief disappears in four cases, the most common being when that property’s value affects what another beneficiary receives. The others involve special valuation provisions, partly qualifying assets, and partial disclaimers or QTIP elections.

Why does separate property make portability matter more in Colorado?

The One Big Beautiful Bill Act, Pub. L. No. 119-21, set the basic exclusion at $15,000,000 for 2026 deaths, indexed after 2026, and Rev. Proc. 2025-32 confirms the figure. A DSUE amount is fixed at the first death and does not index. Colorado adds no second layer: the Legislative Council Staff explains that the state estate tax effectively ended for deaths after December 31, 2004.

Under 26 U.S.C. § 1014, inherited property takes its date-of-death value as basis, and § 1014(b)(6) also resets the survivor’s half of community property. Colorado is not a community property state. For spouses holding title as joint tenants, 26 U.S.C. § 2040(b) includes half the value in the first estate, and only that half is revalued. A deed creates a joint tenancy only when it says so under C.R.S. § 38-31-101; tenants in common get the same half-and-half result.

Portability makes waiting for the second step-up affordable, and lifetime workarounds are weak: a gift carries over basis under 26 U.S.C. § 1015, and § 1014(e) denies a step-up when appreciated property given to a spouse who dies within one year passes back to the donor.

What does the math look like for a Boulder County family?

Hypothetical. Tom and Ellen Marsh of Louisville own their home as joint tenants; it cost $700,000 in 2003 and is worth $2.4 million. Tom’s revocable trust holds a Berthoud horse property worth $3.1 million. Tom has a $1.9 million IRA, Ellen a $1.2 million 401(k), and they share a $1.4 million brokerage account. Tom dies in February 2026; his trust leaves 10 percent of the trust estate to his daughter from a first marriage and the rest to Ellen.

Tom’s $6.9 million gross estate requires no return. Assuming no lifetime taxable gifts and ignoring expenses, a correct portability-only return shows a $310,000 taxable estate (the daughter’s share) and DSUE of $14,690,000. The house, IRA, and brokerage account can be estimated. The Berthoud property cannot, because a percentage gift and a partial marital interest trigger two exceptions. That is Rowland in Colorado.

Tom’s half of the house steps up to $1.2 million while Ellen’s half stays at $350,000. If she sells for $2.4 million within two years, while unmarried, her $850,000 gain is reduced by the $500,000 exclusion in 26 U.S.C. § 121(b)(4), leaving $350,000 taxable. A community property home would have had no gain, and the IRA gets no step-up under § 1014(c).

If Ellen instead keeps the house and land and dies in 2040 with a $19.5 million estate, and her own exclusion is still $15 million (indexing will raise it by an unknown amount), the tax without DSUE is 40 percent under 26 U.S.C. § 2001(c) on $4.5 million, or $1.8 million. With the DSUE amount the tax is zero, and her heirs still get a new basis in everything outside the retirement accounts.

What if the deadline has passed, and what will the IRS check later?

Rev. Proc. 2022-32 replaced the procedure Fay’s executor used and gives an estate not otherwise required to file until the fifth anniversary of death, with a header statement on the return. The Rowland condition carries over: relief covers only a complete and properly prepared return. After five years, the remaining path is a private letter ruling request under Treas. Reg. § 301.9100-3. For the Marsh estate, the window closes in February 2031.

Section 2010(c)(5)(B) lets the IRS examine the first spouse’s return whenever the DSUE amount is used, even after that return’s limitations period has run, and reduce or eliminate the DSUE amount. In Rowland, the examiner raised the issue more than five years after Fay died. A Colorado survivor should keep the filed return, its appraisals, and proof of mailing with her own estate plan.

Frequently Asked Questions

Does Colorado have an estate tax or an inheritance tax?

No. Colorado’s estate tax was tied to the federal state death tax credit and effectively ended for deaths after December 31, 2004, and the inheritance tax was replaced in 1980. A Colorado estate’s transfer tax exposure is federal only, which makes the portability election more important.

Do we need to file Form 706 if the estate owes no tax?

Not to pay tax, but a return is the only way to elect portability. A surviving spouse can use the unused exclusion only if the executor files a return that computes the DSUE amount. In 2026 that amount can reach $15 million.

Can a portability-only return use estimates for every asset?

Only in simple cases. Estimates are permitted for assets going to the surviving spouse or a charity when the estate is under the filing threshold. Property going to children needs a real value, as does marital property whose value affects another beneficiary’s share.

How long does an executor have to file a late portability return?

Under Rev. Proc. 2022-32, an estate not otherwise required to file can elect portability with a complete and properly prepared Form 706 filed by the fifth anniversary of death. After that, the remaining option is a private letter ruling request under Treasury Regulation section 301.9100-3.

Does remarriage cost a surviving spouse the DSUE amount?

Remarriage alone does not. The DSUE amount comes from the survivor’s last deceased spouse, and remarriage does not change that designation. If the new spouse dies first, though, that spouse becomes the last deceased spouse, and the earlier DSUE amount can no longer be applied.

Does joint tenancy give a full basis step-up in Colorado?

No. When spouses own property as joint tenants with right of survivorship, federal law includes half its value in the first spouse’s estate, and only that half gets a new basis. The survivor’s half keeps its original basis until her own death.

How North Star Law Firm Can Help

North Star Law Firm works with Colorado executors and surviving spouses on the federal side of portability, from complete Form 706 portability returns and late elections to IRS examinations of DSUE claims. Phillip Zagotti, JD/CPA, is an attorney and CPA admitted to practice before the U.S. Tax Court, and co-author with Ashley Burdette of Trusted: The Essential Guide for Trustees. The firm’s trust and estate tax planning, real estate tax strategy, and Tax Court litigation practices cover these issues. Phillip Zagotti is not licensed by the Colorado Supreme Court; for Colorado state-law questions the firm works alongside Colorado-licensed counsel.

If a spouse died in the last five years and no portability return was filed, or the return that was filed looks thin, review it before the window closes. Contact North Star Law Firm to schedule a consultation.

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.

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.