A pleasant surprise awaits Coloradans when they file their taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es this spring: a reduced tax rate of 4.5 percent (rather than the usual flat rate of 4.63 percent) will apply to income earned in 2019. This temporary income tax rate reduction, which will be enjoyed by individuals, pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es, and corporations alike, was triggered because state tax collections exceeded the Taxpayer’s Bill of Rights (TABOR) revenue limit by $428 million in fiscal year (FY) 2019.
TABOR, enshrined in the state constitution since it was approved by voters in 1992 (but amended by a an increased “Referendum C” cap in 2005), places an annual limit on state revenue growth, capping it at the prior year level after adjusting for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , population growth, and any voter-approved revenue changes. Any collections above that limit, by default, are returned to taxpayers unless a majority of voters authorize the state to retain the surplus.
The Colorado Constitution does not prescribe specific refund mechanisms but instead authorizes the General Assembly to make those determinations. Under current law, TABOR surpluses can be returned to taxpayers using up to three refund mechanisms: a property tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the IRS, preventing them from having to pay income tax. reimbursement to local governments, a “sales tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. ,” and a temporary reduction in the state’s income tax rate. The income tax rate reduction is the most difficult to trigger since it requires the largest amount of revenue.
Specifically, current law requires the first dollars of any TABOR surplus be used to reimburse local governments for forgone revenue resulting from homestead property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. credits granted to qualifying seniors and disabled veterans. If the surplus is enough to provide a full reimbursement, then any remaining revenue is used to give taxpayers a “sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. refund” (which appears on a taxpayer’s individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. return and is intended to help offset sales taxes paid). However, if the TABOR surplus is enough to fully reimburse local governments for homestead credits and to reduce the state income tax rate to 4.5 percent, the rate reduction will take precedence over any sales tax refund.
This past fiscal year marks the first time since 2005 (when voters approved the income tax reduction mechanism) that a TABOR surplus has been large enough to trigger the income tax rate reduction. At 4.5 percent, Colorado’s income tax rate for tax year 2019 will be the lowest rate the state has seen since moving to a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. in 1987. After the forthcoming income tax reduction is distributed, less than $2 million in surplus revenue will remain, so it is uncertain whether any sales tax refund will be administered.
After receiving income tax relief this year, taxpayers may be in luck for the next couple years, as future surpluses of approximately $304 million and $367 million are projected for FY 2020 and FY 2021, respectively. If these projected surpluses come to fruition, Colorado taxpayers are on track to receive approximately $1.1 billion in TABOR-triggered tax relief in just a three-year period. Colorado’s surpluses are attributable to economic growth and to several of the federal Tax Cuts and Jobs Act’s base-broadening provisions flowing through to the state tax code. Colorado conforms to the Internal Revenue Code (IRC)’s individual and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. provisions on a rolling basis, so a preexisting taxpayer protection mechanism like TABOR prevented the state from being able to quietly pocket the additional revenue, as some states have done.
Notably, it’s fresh in Coloradans’ minds that their future TABOR refunds were in jeopardy as recently as this past November. When faced with the question of whether to allow the state to retain all future TABOR refunds, voters emphatically rejected Proposition CC, sending a strong signal that taxpayers continue to hold their Constitution’s taxpayer transparency and refund mechanisms in high regard.
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