Worldwide Combined Reporting with Water’s Edge Election (HB 26-1289)

• Beginning with tax years on or after January 1, 2027, worldwide combined reporting becomes the default method.
• Taxpayers may elect water’s-edge treatment by making the election on a timely filed original return. However, the election is binding for ten consecutive years and renews automatically at the end of that period unless the taxpayer affirmatively withdraws it.
• Taxpayers may petition the Colorado Department of Revenue (“Department”) for a withdrawal of the water’s edge election or reinstatement of a previous withdrawal prior to the expiration of the 10-year period but are required to show reasonable cause based upon extraordinary hardship due to unforeseen changes in state tax statues, law, or policy. The Department may further impose conditions with the grant of this petition.
• Under the water’s-edge election, the combined group must include: (a) all domestic members; (b) foreign corporations with at least 20% of their property and payroll attributable to U.S. sources; (c) Domestic International Sales Corporations (DISCs) and export trade corporations; (d) the apportionable income of any foreign corporation in the affiliated group that is effectively connected with the conduct of a trade or business in the U.S. (or treated as effectively connected with the conduct of a trade or business in the U.S. for federal income tax purposes); (e) certain income and apportionment factors of corporations resident in countries that do not have a comprehensive income tax treaty with the U.S. that derive more than 20% of their net income, directly or indirectly, from intangible property or service-related activities that are deductible from the apportionable income of one or more members of the combined group and (f) any corporations in the affiliated group that are incorporated in designated tax-haven jurisdictions.
• The bill eliminates duplicative income inclusions; specifically, intercompany dividends, Subpart F income (certain passive and related-party income of controlled foreign corporations), and net CFC tested income (commonly known as NCTI) for members of the combined group.
• The bill also disallows deductions claimed by affiliates included in the combined group for amounts paid to affiliates excluded from the group in exchange for services or the use of intangible property. This provision is designed to prevent base erosion through intercompany payments to low-tax foreign affiliates.
• The list of designated tax-haven jurisdictions was expanded last year to include Hong Kong, Ireland, the Netherlands, and Singapore and Liechtenstein. This legislation removes Liechtenstein from the list.

Opportunity Zone Restriction (HB 26-1289)

For tax years beginning on or after January 1, 2027, taxpayers must add back to Colorado taxable income any capital gain or appreciation that is excluded at the federal level under IRC § 1400Z-2, unless the gain is attributable to an investment in a “Colorado Qualified Opportunity Fund.” To qualify, such a fund must hold at least 90% of its assets in qualified opportunity zone (“QOZ”) property located within Colorado.

Enterprise Zone and Other Tax Expenditure Reforms (HB 26-1289)

The bill makes significant changes to several enterprise zone credits. The enterprise zone health insurance credit is now restricted to employers with fewer than fifty employees. The enterprise zone research and experimental expenditure credit is also restructured. The credit is now available only for persons that satisfy a $150,000 minimum spending threshold, and the credit is calculated based only on to incremental expenditures that exceed a two-year average baseline. In addition, the bill eliminates the commercial vehicle investment credit for heavy vehicles and repeals the state deduction under IRC § 280C, which previously reduced otherwise allowable wage deductions by the amount of certain tax credits claimed.

 Software Sales Tax Expansion (HB 26-1223)

Effective January 1, 2027, all computer software (including downloaded software, software as a service (SaaS), and mobile applications) becomes subject to Colorado sales and use tax. The new law preserves a narrow exemption for custom software or software governed by a genuinely negotiated license agreement (i.e., one that is individually bargained and executed by authorized representatives of each party). Standard click-wrap and browse-wrap agreements do not qualify for this exemption.

Implications & Recommendations

• Worldwide Combined Reporting: Multinational groups should begin modeling the financial impact of the new worldwide combined reporting regime and evaluate whether to make the water’s-edge election on their 2027 return. Given the ten-year binding period, the entities requiring mandatory inclusion, and the expanded list of tax-haven jurisdictions, this election requires a comprehensive analysis of the group’s entire worldwide structure before a decision is made.
• Opportunity Zone Investments: Investors in Qualified Opportunity Funds should confirm that their funds meet the Colorado Qualified Opportunity Fund standard (i.e., at least 90% of assets are QOZ property located in Colorado). Funds that do not meet this standard will trigger a state-level add-back of federally excluded gains.
• Enterprise Zone Credits: Companies currently benefiting from enterprise zone credits should confirm their continued eligibility under the new employee-count thresholds, spending minimums, and restructured credit methodologies.
• Potential for OB3 Decoupling: Two related bills—HB 26-1221 (executive compensation limits and net operating loss restrictions) and HB 26-1222 (decoupling from federal business deductions)—passed the House but did not advance in the Senate. However, considering Governor Polis’s statements denouncing the provisions of the One Big Beautiful Act, there is a strong likelihood that similar legislation will be reintroduced at some point in the future.
• Software Transactions: Technology companies and software purchasers should audit their Colorado transactions to identify newly taxable software sales. Companies should also evaluate whether any existing agreements may qualify for the narrow negotiated-license exemption.

Client Alert 2026-124