In Colorado, you're generally free to choose to operate your business as a C corporation, S corporation, partnership, limited liability company (LLC), or sole proprietorship. However, the entity type you select for your business may, in some cases, decide whether you or your business pays income taxes on the business income.

Corporations. Domestic corporations (corporations organized in Colorado) and foreign corporations (corporations organized in a state other than Colorado) doing business in Colorado, are subject to a Colorado income tax. Since January 1, 2000, the income tax rate is 4.63 percent of Colorado net income.

If your corporation has limited activity in Colorado, you may pay an alternative tax instead of the regular corporate income tax. To qualify, the corporation's activity must consist only of making sales — your corporation can't own or rent real estate in the state and it must have annual gross sales in or into Colorado that do not exceed $100,000. This alternative tax is at the rate of 0.5 percent of gross receipts from sales in or into Colorado.

S corporations. If you meet the federal tax law requirements to operate as an S corporation, the IRS allows your business to "pass through" its income to the shareholders. This means that your business will not pay any IRS corporate level income tax. However, you'll have to claim your entire share of the business income on your personal federal income tax return even if you did not take any money out of the business.

In Colorado, the law extends this favorable tax treatment to state corporate income tax liability and S corporations will not be subject to the corporate income tax.

Partnerships. If you operate your business as a partnership, your partnership will not be taxed on its net income. Instead, partners must include in their Colorado taxable adjusted gross income their distributive share of partnership income.

Limited liability companies (LLCs). Colorado law recognizes businesses operating as limited liability companies (LLCs). Domestic and foreign LLCs in Colorado are classified as partnerships for Colorado tax purposes. Accordingly, your LLC will not be taxed on its net income. Instead, members must include in their Colorado taxable adjusted gross income their distributive share of LLC income.