Previous luminescence and absorption experiments in Co-doped ZnO revealed two ionization and one intrashell transition of d(Co 2+ ) electrons. Those optical properties are analyzed within the generalized gradient approximation to the density functional theory. The two ionization channels involve electron excitations from the two Co 2+ gap states, the t 2↑ triplet and the e 2↓ doublet, to the conduction band. The third possible ionization channel, in which an electron is excited from the valence band to the Co 2+ level, requires energy in excess of 4 eV, and cannot lead to absorption below the ZnO band gap, contrary to earlier suggestions. We also consider two recombination channels, the direct recombination and a two-step process, in which a photoelectron is captured by Co 3+ and then recombines via the internal transition. Finally, the observed increase the band gap with the Co concentration is well reproduced by theory.The accurate description of ZnO:Co is achieved after including +U corrections to the relevant orbitals of Zn, O, and Co. The +U (Co) value was calculated by the linear response approach, and independently was obtained by fitting the calculated transition energies to the optical data. The respective values, 3.4 and 3.0 eV, agree well. Ionization of Co induces large energy shifts of the gap levels, driven by the varying Coulomb coupling between the d(Co) electrons, and by large lattice relaxations around Co ions. In turn, over ∼ 1 eV changes of Co 2+ levels induced by the internal transition are mainly caused by the occupation-dependent U (Co) corrections.