Don’t let the high altitude of Colorado raise your stress about the IRS and taxes.
By following my expertise and familiarizing yourself with the different business structures and entity types under the Colorado Department of Revenue, you will know what to expect and minimize your worries about Colorado business taxes.
Colorado State Income Tax
The Colorado Department of Revenue requires individuals and some businesses to pay Colorado state income taxes. Calculating your Colorado state taxes is really easy for residents and businesses.
The personal income tax rate is 4.55% regardless of income. Single taxpayers get a deduction of $12,550 and married taxpayers get a $25,100 deduction.
The Department of Revenue requires anyone who lived in Colorado or any business that conducted business in the state to file a return on their Colorado taxes.
Colorado provides the required form DR 0104 on their website.
Colorado has a great corporate tax system that promotes business in the state. The Colorado corporate income tax rate is 4.55% on your business’s Colorado taxable income.
The taxable income is calculated by taking the federal taxable income of Colorado plus state additions minus state subtractions. This total is multiplied by the Colorado corporate income tax rate of 4.55% or 0.0455, then from that total subtract the Colorado tax credits.
Thankfully the state provides an easy to read table here.
Creating a sole proprietorship in Colorado is an easy process. You will need to file a Statement of Trade Name to create a record of your Colorado business with the Secretary of State’s office.
Thankfully you can do this online.
The small business owners conduct and manage the work of the business. Selling products, such as metalwork or antique furniture, or providing a service, such as pool cleaning, are examples of possible sole proprietorship businesses. Obviously there are thousands of possibilities.
The federal government and the Internal Revenue Service (IRS) view you and your business venture as one entity under this business structure. Legally and financially they are one entity. This structure does not separate your personal assets from your business assets. Your personal assets may be vulnerable if your business is sued.
Other business structures provide legal protection and separate your business and personal assets. They may be options for your business venture.
Sole Proprietorship Taxes
Being a single entity, your business and personal income will need to be combined and reported to the IRS on your state tax and federal tax return. The federal and Colorado net income of the business and any additional income you make will need to be reported.
Total sales minus expenses will be your net income and the amount you will file on your tax return. The sales will be money your business brought in while expenses are the costs of running your business.
Calculating your personal income tax burden as a sole proprietor is easy to do. Let’s say you are a pool cleaning service provider.
If you hire employees you will need to get a tax ID (employer identification number or EIN) or file a Doing Business As.
Keeping accurate records of your sales and expenses throughout the year will make doing your taxes a lot easier and will give you confidence in the numbers you report.
In this pool cleaning example, the total of your calendar year sales was $10,000. That is step one.
The next step is going to be calculating your total expenses and deductions. These will include your pool cleaning equipment, the wear you put on your company vehicle, fuel, and possible advertising you purchased to promote your new business. For the transportation and wear on your company vehicle, the government uses an easy formula: the business miles you traveled multiplied by the vehicle mileage rate. The IRS sets this number annually. For 2021, it was $0.585.
After doing all the math, you calculate the total costs to be $5,000.
You are going to need to determine your net income, which is your sales ($10,000) minus the business expenses ($5,000) for a total profit of $5,000. This is the reportable and taxable net income for your business.
If you have a separate job, your job’s salary in addition to your business income will be reported and taxed at the federal tax rate on your tax return. Colorado will tax your net income, business and additional sources, at the state income tax rate.
You will only need a few forms to file your Colorado taxes and the federal income tax.
For Colorado, you will need to report your taxable income in the DR 0104 Book. This packet will include all the required documents, including your personal state tax return. Thankfully, a lot of tax software compiles these forms and auto-populates your information.
For your federal income tax return, you will need Form 1040 for your personal income tax return and a Schedule C Form. The Schedule C Form reports the profits and losses for your business from the taxable year.
These forms are going to be a breeze to complete if you keep accurate records and receipts of your business transactions from throughout the year.
Partnerships (Including Limited and General)
Business partnerships are a type of business structure and they come in five different forms in Colorado: general partnership, limited partnership, limited liability partnership, limited liability limited partnership, and limited partnership association. Each partnership type requires two or more people that have ownership of the business.
The general partnership pays no business taxes, but also has no liability protection. The general partners will pay Colorado state tax on their personal income tax returns where they report their share of their earnings.
Each of the partners in a general partnership can make executive decisions for the business. If the business gets sued, the personal assets of each of the partners are potential vulnerabilities.
At the establishment of a general partnership, the business is set up and organized by an official agreement, often called an operating agreement. The partners will each be responsible for their share of the tax burden of the company profits according to the operating agreement. A high level of trust between partners is necessary for this business structure, as actions your partners take may put your personal assets in a vulnerable position.
A limited partnership requires two or more partners, usually a general partner along with limited partners. The general partner manages and operates the business. The limited partners have no say in the business management aspect. The general partner is also responsible for the business debt, while the limited partners are only at risk up to the amount of money they invest into the business venture.
Limited Liability Partnership
Limited liability partnerships provide liability protection to all the partners involved. These partnerships protect each of the partners from actions taken by their partners. Under an LLP, the individual partners are protected should an individual partner be sued. This liability protection does not protect the assets of the business itself.
Limited Liability Limited Partnership
This type of partnership still includes general and limited partners. However, it grants liability protection to the general partners under the structure. Limited partners maintain their liability protection.
In Colorado, limited partnerships can convert into limited liability limited partnerships and extend the liability protection to the general partner.
Limited liability limited partnerships are a fairly new partnership and not recognized by some other states in the United States.
Limited Partnership Association
Limited partnership associations are a new partnership type in Colorado. They require at least two people to create the partnership. The partners are called members, much like under a limited liability company.
This partnership allows members to directly participate in the business and still provides liability protection to its members.
Partnership Tax Information
Partnerships report taxes similarly to sole proprietorships. The business’s profits and losses are passed through to the partners and members of the business.
The partners will report their business income on their state tax and federal tax returns along with any other income, including jobs or other businesses. The net income will account for the business expenses and deductions from throughout the tax year, much like the sole proprietorship example.
Partners do not receive W-2 forms because they are not employees.
The partnership will need to file and submit a Form 1065, Return of Partnership Income when reporting their federal taxes. This is a partnership version of the Schedule K form. Additional documents will be required for the taxes collected throughout the year. These forms can be found on the IRS partnership website.
Each partner of a partnership will need to file Form 965, for tax liabilities, and Schedule E, for supplemental income. The partners will also need to fill the standard Form 1040 for the federal income return.
The Colorado Department of Revenue provides the documents you need to file your forms and additional resources here.
The DR 0106 Book is the comprehensive collection of partnership filing forms that you will be required to file for state taxes.
Limited Liability Companies (LLC)
Limited liability companies (LLCs) are pass-through entities, a unique business entity type. The profits and losses of the business are passed through to each of the LLC members. Individually, they will be taxed for their portion of the LLC's profits.
Business owners choose to structure their companies as LLCs for the liability protection they provide to their members. By separating personal and business assets, only the business may be a target of lawsuits.
For more information, read my comprehensive guide to starting your own LLC.
Colorado allows single-member LLCs created by an individual, but the risk is the legal interpretation of where the individual ends and business begins, similar to a sole proprietorship. This may expose the personal assets to settling the company’s debts and obligations.
Since LLCs are pass-through entities, the members of the LLC pay taxes on their individual tax returns. The LLC owners will be taxed federally for their profits after accounting for their expenses and deductions.
In Colorado, the members will pay taxes at the Colorado state tax rate of 4.55% on their portion of the company’s federal taxable income.
The required federal tax documents for an LLC are similar to the other pass-through entities.
Members of an LLC will file the standard Form 1040 to the IRS. The partners will also be required to file Form 1065 and a Schedule K-1 form that reports their share of the income, losses, and deductions.
If your LLC has employees, you will need to file additional forms to pay the payroll taxes. You should familiarize yourself with Forms 940, filed annually, and 941, filed quarterly.
Colorado requires that any LLC that files a federal income tax return must file a Colorado income tax return. The taxable income will be based upon the percentage of taxable income for the appropriate net income derived from each state. The Colorado corporate income tax applies to the business income that came from Colorado sales.
C corporations are typically large companies that have formal requirements, such as company operating rules. Corporations are required to formally choose directions and maintain the Articles of Incorporation and company bylaws.
The requirements of creating and running a C corporation are extensive. They are required to have shareholder meetings and keep minutes. C Corporations can quickly become complicated.
C Corporation Tax Information
A C corporation pays federal and Colorado’s corporate income tax on its profits, calculated just like our sole proprietorship example. They are likely to be more complex due to their scale, real estate, the associated employee taxes, and insurances involved.
The profits of a C corporation may be subject to double taxation or being taxed twice. This happens when corporations pay out a dividend to their shareholders. The shareholders are then responsible for paying the taxes on those dividends.
Colorado’s corporate income tax is 4.55% on the taxable income made within Colorado. If the company conducts business in multiple states, the taxable income will be divided to reflect the income that occurred in the different states.
If the C corporation distributes a dividend, the shareholders receiving dividend income will be responsible for reporting that income on their personal income tax returns.
C corporations are usually required to file and make quarterly estimated payments in Colorado.
C Corporations can have complicated taxes, so I recommend hiring an accountant. The corporation will need to file a Form 1120 for their federal tax return.
In Colorado, you will need to file the C Corporation Income Tax Booklet, DR 0112 Book. This booklet will include forms that will report your income tax, credits, and extension of time requests.
S corporations are viewed as corporations, just like C Corporations, when it comes to Colorado state tax. The difference is that S corporations pass their income, losses, credits, and deductions to their shareholders when filing their federal tax returns.
S Corporation Tax Information
S corporations pay the Colorado state business tax like all businesses at the rate of 4.55%.
When filing the federal income tax returns, that is where it makes a difference. The IRS will require the shareholders of the company to pay their share of the business income taxes.
An S corporation files a Form 1120-S when reporting federal income taxes annually. The shareholders and those that benefit from the pass-through business income are required to file Schedule K-1 form along with the standard Form 1040.
Colorado requires S Corporations to file the same booklet of forms as required for partnerships. The filing forms can be found on the Colorado Department of Revenue site.
When starting a business in Colorado, taxes can be an intimidating topic. Hopefully I have eased that stress by explaining the type of business structure types.
By keeping accurate records, contacting a business attorney when necessary, and using the correct state and federal tax forms, stressing over state and federal taxes won’t be a barrier to success.
Colorado is a great state for starting a business and supports business owners when possible. Here is a link to business tax classes that the state offers.
Good luck with your business endeavors!