Enterprise Zone Tax Guide

The following examples illustrate the calculation of business facility employee credits.

Example 3-1. First tax year of operation

A taxpayer begins operation of its business facility on March 18^th. The taxpayer’s tax year runs from March 18^th through December 31^st. The number of employees working at the facility on the last business day of each month is:

Under the general rules for calculating the credit, discussed in Employee credit calculation, earlier in this publication, the number of business facility employees for the year is calculated by adding together the number of business facility employees on the last business day of each month of the tax year and dividing the total (180) by 12. The result is a total of 15 business facility employees for the tax year. The taxpayer is allowed a credit of $1,100 for each employee or $16,500 total ($1,100 x 15).

Example 3-2. Subsequent tax years

The taxpayer described in Example 3-1 continues operation of its business facility in the next three tax years. Using the Employee credit calculation, described earlier in this publication and in Example 3-1, the taxpayer has 15 business facility employees in the 1st year, 22 in the 2nd year, 18 in the 3rd year, and 25 in the 4th year. The following table illustrates the increase in employees over the highest preceding year and the allowable credit for each year.

Example 3-3. Health insurance credit

The taxpayer described in Examples 3-1 and 3-2 provides health insurance each year to all employees. The insurance meets the requirements to qualify for the health insurance credit.

Unlike the other enterprise zone employee credits, the health insurance credit is allowed for all employees that meet the qualifying criteria, not just the increase in those employees over the highest number in any prior year, but it is allowed only for the first two full tax years that the business facility is located in the enterprise zone.

The taxpayer’s first tax year of operation was not a full tax year, so the taxpayer cannot claim the health insurance credit for that year. Instead, the taxpayer can claim the credit for the 2nd and 3rd years of operation, since those are the taxpayer’s first two full tax years located in the enterprise zone.

The taxpayer had 22 qualifying employees in the 2nd year and 18 qualifying employees in the 3rd year. The taxpayer can claim a credit of $22,000 ($1,000 x 22) for the 2nd year and $18,000 ($1,000 x 18) for the 3rd year.

Example 3-4. Other employee credits

The business facility of the taxpayer described in Examples 3-1 and 3-2 was not in an enhanced rural enterprise zone in the year it began operations. However, beginning with the 3rd year of operation, the location of the facility was designated as an enhanced rural enterprise zone.

The taxpayer did not increase employees at the facility in the 3rd year (18 employees for the year compared with 22 in a prior year), so the taxpayer could not claim the standard employee credit or the enhanced rural employee credit for the 3rd year.

In the 4th year, the taxpayer’s 25 employees represented an increase of three employees over the highest total number of employees in any prior year. The taxpayer can claim both a standard employee credit of $3,300 ($1,100 x 3) and the enhanced rural enterprise zone credit of $6,000 ($2,000 x 3) for these three additional employees.

Example 3-5. A facility operating for less than the entire tax year

Each tax year, a taxpayer operates the same business facility in an enterprise zone seasonally from mid-May through mid-October. At all other times, there is no activity and there are no employees working at the facility. The taxpayer’s tax year runs from January 1^st through December 31^st.

Since all business activities conducted at the facility cease temporarily during the tax year and the business facility is therefore in operation for less than the entire tax year, as described earlier in this publication, the calculation of the number of business facility employees for the year includes only the full calendar months of operation. The number of employees working at the facility on the last business day of each full calendar month of operation is:

The number of business facility employees for the year is calculated by adding together the number of business facility employees on the last business day of each month of the tax year and dividing the total (40) by the number of full calendar months during which the facility was in operation (4). The result is a total of 10 business facility employees for the tax year, resulting in an increase of two business facility employees over the eight business facility employees, which was the highest number of business employees for any prior tax year. The taxpayer is allowed a credit of $1,100 for each of the two additional employees or $2,200 total ($1,100 x 2).

Example 3-6. Pre-certification after commencing operations

A taxpayer commences operations at a business facility in an enterprise zone on January 1, 2018, and is a calendar year filer whose 2018 tax year runs from January 1, 2018, to December 31, 2018. The taxpayer employs eight business facility employees at the facility at the end of each month of the 2018 tax year. However, the taxpayer does not pre-certify, as described in Part 1 of this publication, either prior to or at any time during the 2018 tax year. Consequently, for the purpose of calculating the credit allowed for the 2018 tax year, the taxpayer is deemed to have zero employees (the highest average number of employees in any prior tax year) at the end of each month during the 2018 tax year and is therefore not allowed any credit.

Beginning in January 2019, and throughout the entirety of tax year 2019, the taxpayer employs 11 business facility employees. On August 15, 2019, the taxpayer pre-certifies with the enterprise zone administrator. For the purpose of calculating the credit for tax year 2019, the number of business facility employees for any month in 2019 commencing prior to pre-certification is deemed not to exceed the highest average number of business facility employees for any prior year. Consequently, the number of business facility employees from January 2019 through August 2019 is deemed to be eight, rather than 11.

The credit for tax year 2019 is computed by subtracting the average number of business facility employees in 2019 by the highest average number of business facility employees for any prior year and multiplying the result by $1,100. The average number of business facility employees for 2019 is calculated by adding together the number of employees at the end of each month during the tax year (eight for each month January through August and 11 for each month September through December) and dividing the sum (108) by 12, resulting in nine business facility employees for tax year 2019. The nine business facility employees for tax year 2019 is one more than the eight business facility employees that were the highest average from any prior year. Therefore, the taxpayer is allowed a credit of $1,100 ($1,100 x 1).

The taxpayer continues operation of the business facility throughout tax year 2020, employing eleven business facility employees at all times during the tax year. The credit for tax year 2020 is calculated by subtracting the average number of business facility employees for tax year 2020 (11 employees) by the highest average number of business facility employees for any prior year (11 employees, for tax year 2019). Because the average number of business facility employees for tax year 2020 is no greater than the highest average number of business facility employees for any prior year, the allowable credit for tax year 2020 is $0.

The credit a taxpayer can use for any tax year is limited to the taxpayer’s net tax liability. If the allowable credit exceeds the taxpayer’s net tax liability, the taxpayer can carry forward the excess credit for application toward the tax due for subsequent tax years. Please see Table 3-1, earlier in this publication, for the allowable carryforward period applicable to the different enterprise zone employee credits. Any credit that has not been used within the carryforward period expires and is no longer available to the taxpayer.

The following is a list of statutes, regulations, forms, and guidance relevant to enterprise zone business facility employee credits. This list is not, and is not intended to be, an exhaustive list of authorities that govern the tax treatment of every situation. Individuals and businesses with specific questions should consult their tax advisors.

Statutes and regulations

• § 39-30-105.1, C.R.S. Credit for new enterprise zone business employees – definitions.
• Rule 39-30-105.1. Enterprise zone business facility employee credits.

Forms and guidance

• Tax.Colorado.gov
• OEDIT.Colorado.gov/enterprise-zone-new-employee-tax-credit
• OEDIT.Colorado.gov/enterprise-zone-employer-sponsored-health-insurance-tax-credit
• Enterprise Zone Credit and Carryforward Schedule (DR 1366)

An income tax credit is allowed to any taxpayer who makes expenditures in research and experimental activities conducted in an enterprise zone for the purpose of carrying out a trade or business. This Part 5 provides information about qualifying expenditures and calculation of the credit.

Research or experimental expenditures that qualify for the credit are any expenditures subject to the federal income tax treatment prescribed by section 174 of the Internal Revenue Code. Eligible expenditures must be incurred in connection with the taxpayer's trade or business and represent research and development costs in the experimental or laboratory sense. These expenditures generally include all costs incident to the development or improvement of a product.

A “product” for which research and experimental expenditures are made can be a pilot model, process, formula, invention, technique, patent, or similar property. The product can be used by the taxpayer in its trade or business or developed for sale, lease, or license.

Whether expenditures qualify as research or experimental expenditures depends on the nature of the activity to which the expenditures relate, not the nature of the product or improvement being developed or the level of technological advancement the product or improvement represents. The ultimate success, failure, sale, or use of the product is not relevant to a determination of eligibility of expenditures for the credit.

Research or experimental expenditures are those made for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product. Costs may qualify for the credit if paid or incurred after production begins, but before uncertainty concerning the development or improvement of the product is eliminated.

Qualifying expenditures

Qualifying expenditures generally include all costs incident to the development or improvement of a product. Examples of qualifying expenditures include:

• salaries for those engaged in research or experimentation efforts;
• amounts incurred to operate and maintain research facilities (e.g., utilities, depreciation, rent, etc.);
• expenditures for materials and supplies used and consumed in the course of research or experimentation (including amounts incurred in conducting trials);
• the costs of obtaining a patent, such as attorneys' fees expended in making and perfecting a patent application; and
• expenditures paid or incurred for research or experimentation conducted on the taxpayer’s behalf by another person or organization (such as a research institute, foundation, engineering company, or similar contractor).

The credit is allowed only for the amount of research and experimental expenditures that is reasonable under the circumstances. In general, the amount of an expenditure for research or experimental activities is reasonable if the amount would ordinarily be paid for like activities by like enterprises under like circumstances. Amounts supposedly paid for research that are not reasonable under the circumstances may be characterized as disguised dividends, gifts, loans, or similar payments.

Please see section 174 of the Internal Revenue Code and 26 CFR § 1.174-2 for additional information about research and experimental expenditures.

Non-qualifying expenditures

The credit is not allowed for any expenditures for:

• the acquisition or improvement of land or depreciable property;
• the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral (including oil and gas);
• the ordinary testing or inspection of materials or products for quality control (quality control testing);
• efficiency surveys;
• management studies;
• consumer surveys;
• advertising or promotions;
• the acquisition of another's patent, model, production, or process; or
• research in connection with literary, historical, or similar projects.

Any taxpayer who intends to claim a credit must first pre-certify with the applicable enterprise zone administrator. No credit is allowed with respect to any activity undertaken by the taxpayer prior to the taxpayer’s pre-certification with the enterprise zone administrator for the tax year. If expenditures are made in multiple tax years, the taxpayer must submit a separate pre-certification form for each year, prior to making any expenditures for that year. Please see Part 1 of this publication for additional information about pre-certification.

The allowable credit is based upon an increase in the taxpayer’s research and experimental expenditures in an enterprise zone over the two prior years. The credit is equal to 3% of the amount by which the taxpayer’s research and experimental expenditures in an enterprise zone exceed the average of the taxpayer’s research and experimental expenditures in the same enterprise zone over the two preceding tax years.

The credit calculated as described above is not allowed entirely for the tax year in which the expenditures were made. Instead, the credit is divided evenly over four tax years. Twenty-five percent of the credit is allowed for the tax year in which the expenditures were made and 25% of the credit is allowed for each of the subsequent three tax years.

Credit carryforward

If the credit allowed exceeds the income tax the taxpayer otherwise owes for the tax year, the excess credit may be carried forward and applied toward the taxpayer’s tax liability for the following tax year. Any excess credit after application toward tax for the subsequent year may be further carried forward until the full amount of the credit has been used.

The following examples illustrate the calculation of the credit and carryforwards.

Example 5-1

A taxpayer incurs $140,000 in expenditures for research and experimental activities conducted in an enterprise zone in tax year 2017. The taxpayer’s research and experimental expenditures in the same enterprise zone for tax years 2015 and 2016 were $0 and $100,000, respectively, for an average of $50,000. The $140,000 of expenditures in 2017 is $90,000 more than the taxpayer’s average expenditures in the same enterprise zone over the two preceding tax years.

The total allowable credit is $2,700 (3% x $90,000). The credit is divided evenly over the current tax year and the three following tax years. The taxpayer can claim a credit of $675 (25% of the total credit) for tax year 2017 and for each of the three subsequent tax years.

Example 5-2

The taxpayer from Example 5-1 incurs $200,000 in expenditures for research and experimental activities conducted in the same enterprise zone in tax year 2018. The taxpayer’s average expenditures in the same enterprise zone in the two prior tax years were $120,000 ($100,000 for tax year 2016 and $140,000 for tax year 2017). The $200,000 of expenditures in 2018 is $80,000 more than the taxpayer’s average expenditures in the same enterprise zone over the two preceding tax years.

The total allowable credit is $2,400 (3% x $80,000). The total allowable credit is divided evenly over the current tax year and the three following tax years. The taxpayer can claim a credit of $600 (25% of the total credit) for tax year 2018 and for each of the three subsequent tax years.

Example 5-3

The taxpayer from Examples 5-1 and 5-2 had a tax liability of $400 for tax year 2017. The taxpayer applied $400 of the $675 credit allowed for tax year 2017 to offset the entire tax amount due. The remaining $275 of credit is carried forward to tax year 2018.

For tax year 2018, the taxpayer will have available credits totaling $1,550, consisting of the following:

• $675, equal to 25% of the total credit allowed for expenditures made during 2017;
• $600, equal to 25% of the total credit allowed for expenditures made during 2018; and
• $275 allowed in the prior year and carried forward to the 2018 tax year.

The taxpayer’s 2018 tax liability is $500. After applying $500 of the available credit to offset the tax due, the taxpayer has $1,050 credit remaining to carry forward to tax year 2019.     

The following is a list of statutes, regulations, forms, and guidance pertaining to the enterprise zone research and experimental activities credit. This list is not, and is not intended to be, an exhaustive list of authorities that govern the tax treatment of every situation. Individuals and businesses with specific questions should consult their tax advisors.

Statutes and regulations

• § 39-30-105.5, C.R.S. Credit…for research and experimental activities.
• I.R.C. § 174. Research and experimental expenditures.
• 26 CFR § 1.174-2. Definition of research and experimental expenditures.

Forms and guidance

• Tax.Colorado.gov
• OEDIT.Colorado.gov/enterprise-zone-research-and-development-tax-credit
• Enterprise Zone Credit and Carryforward Schedule (DR 1366)

Machinery, machine tools, and parts thereof used solely and exclusively in an enterprise zone are exempt from state and state-administered local sales and use taxes if all four of the following conditions are met. This Part 7 discusses the qualifying criteria and requirements for the exemption.

To qualify for exemption, machinery, machine tools, or parts thereof must:

1. be purchased for more than $500;

2. be used solely and exclusively in an enterprise zone in Colorado;

3. satisfy certain requirements prescribed by federal law; and

4. be used directly and predominantly in the manufacturing of tangible personal property for sale or profit, as “manufacturing” is defined by law for the enterprise zone exemption.

The exemption also applies to materials for the construction or repair of machinery, machine tools, and parts thereof.

The enterprise zone exemption for machinery and machine tools applies to state sales and use taxes, as well as all state-administered local sales and use taxes.

Colorado law defines machinery, eligible for exemption, as any apparatus consisting of interrelated parts used to produce an article of tangible personal property. The exemption applies to both the basic unit and any adjunct or attachment necessary for the basic unit to accomplish its intended function.Requirements prescribed by federal law

With one notable exception, machinery, machine tools, and parts thereof qualify for the enterprise zone exemption only if they are of such nature that they would have qualified for the federal investment tax credit under section 38 of the Internal Revenue Code of 1954, as amended. The Internal Revenue Code of 1954, as amended, was replaced by the Internal Revenue Code of 1986. Consequently, eligibility for the exemption cannot be determined based upon the Internal Revenue Code as it exists today, but rather is governed by the version of the Code in effect immediately prior to the 1986 change. 

In defining “section 38 property” that was eligible for the credit, section 48 of the Internal Revenue Code of 1954, as amended, established many requirements and exceptions that also apply in determining eligibility for the exemption from Colorado sales and use taxes. For example, section 48 establishes special conditions for leased property and limits on used property, which are discussed below.

While section 48 establishes depreciability and useful life requirements, these requirements do not apply to the enterprise zone exemption for machinery and machine tools. Provided that all other requirements are met, machinery and machine tools qualify for the enterprise zone exemption regardless of whether they are capitalized or expensed.

Limitations for used property

The federal investment tax credit allowed for used property was allowed only for the first $150,000 of all used property purchased during a tax period. As the excess over $150,000 could not qualify for credit, the excess also does not qualify for the sales tax exemption. Therefore, annually, only the first $150,000 of all purchases of used machinery to be used directly and predominantly in manufacturing in Colorado can qualify for the exemption. All purchases of used property in excess of that amount are subject to sales or use tax.

For machinery or machine tools to qualify for exemption, they must be used directly and predominantly in manufacturing tangible personal property. Importantly, the term “manufacturing” is defined, for the purpose of the enterprise zone exemption, to include a number of activities.

The following four sections discuss the exemption requirements related to:

1. the definition of “manufacturing”;

2. the manufacture of “tangible personal property”;

3. the use of machinery “directly” in manufacturing; and

4. the use of machinery “predominantly” in manufacturing.

Manufacturing

Manufacturing is the operation of producing a new product, article, substance, or commodity different from and having a distinctive name, character, or use from raw or prepared materials. The manufacturing process for items normally manufactured from inventoried raw materials begins at the point that raw material is moved from plant inventory on a contiguous plant site and ends at the point at which manufacturing has altered the raw material to its completed form. Manufacturing includes the process of packaging the finished product, if applicable.

For the purpose of the enterprise zone exemption, “manufacturing” also includes refining, blasting, exploring, mining and mined land reclamation, quarrying for, processing and beneficiation, or otherwise extracting from the earth or from waste or stockpiles or from pits or banks any natural resource.

Manufacturing tangible personal property

To qualify for exemption, machinery, machine tools, or parts thereof must be used in the manufacturing of tangible personal property. Machinery, machine tools, and parts thereof do not qualify for exemption if they are used to produce something other than tangible personal property. For example, machinery used in the generation of electricity does not qualify for exemption because electricity does not constitute tangible personal property for the purpose of the exemption. However, please see Department publication Sales & Use Tax Topics: Renewable Energy Components for information about the exemption for components used to produce energy from renewable sources.  

Direct use in manufacturing

To qualify for exemption, machinery, machine tools, or parts thereof must be used directly in manufacturing. Any individual component of a larger system is used directly in manufacturing if it is a constituent part of machinery that is used directly in manufacturing. Machinery used directly in manufacturing includes:

• machinery that cleans or prepares raw or prepared materials for production on the manufacturing line, after manufacturing has begun and before it has stopped;
• machinery that performs testing of a particular pro-duct during the manufacturing process or as a step in a continuous manufacturing line process;
• machinery that moves material from one direct production step to another in a continuous flow, such as loaders, forklifts, conveyor belts, and valves that are adjuncts or attachments to qualifying machinery; and
• pipelines and fittings used to gather and deliver natural gas from wells to a processing facility.

The following types of machinery are not used directly in manufacturing and do not qualify for exemption:

• machinery used to clean facilities or machinery;
• machinery used to repair or maintain facilities, machines, or other items; and
• machinery used in managerial, sales research and development, or other non-operational activities.

Predominant use in manufacturing

To qualify for exemption, machinery, machine tools, or parts thereof must be used predominantly in manufacturing. If a machine has other uses in addition to its manufacturing use, the manufacturing use must be greater than 50% of all use for the machine to qualify for the exemption. In determining predominant use, machinery is not considered to be in use if it is shut off, even if it is being repaired or maintained.

Anyone seeking to claim the exemption for machinery or machine tools must complete a Declaration of Wholesale or Entity Sales Tax Exemption (DR 5002) to provide to the seller.

If tax was paid on a purchase that qualifies for exemption, the purchaser may request a refund for the tax paid. Please see form DR 0137B, Claim for Refund of Tax Paid to Vendors, and the associated instructions for information regarding sales and use tax refund claims.

The following is a list of statutes, regulations, forms, and guidance pertaining to sales and use tax exemptions allowed for machinery and machine tools used in enterprise zones. This list is not, and is not intended to be, an exhaustive list of authorities that govern the tax treatment of every situation. Individuals and businesses with specific questions should consult their tax advisors.

Statutes and regulations

• § 39-26-709, C.R.S. Machinery and machine tools – definitions.
• § 39-30-106, C.R.S. Sales and use tax – machinery and equipment exempted.
• 1 CCR 201-4, Rule 39-26-709.

Internal Revenue Code of 1954, as amended

• 26 U.S.C. § 38. General business credit
• 26 U.S.C. § 46. Amount of [investment] credit
• 26 U.S.C. § 48. Definitions; special rules [for the investment tax credit]
• 26 CFR § 1.48-1. Definition of section 38 property
• 26 CFR § 1.48-2. New section 38 property
• 26 CFR § 1.48-3. Used section 38 property
• 26 CFR § 1.48-4. Election of lessor of new section 38 property to treat lessee as purchaser

Forms and guidance

• Tax.Colorado.gov
• Tax.Colorado.gov/sales-use-tax-forms 
• Declaration of Wholesale or Entity Sales Tax Exemption (DR 5002)
• Claim for Refund of Tax Paid to Vendors (DR 0137B)
• OEDIT.Colorado.gov/enterprise-zone-sales-and-use-tax-exemption-for-manufacturing-and-mining