The end of the Legislature’s regular session typically results in the introduction of budget bills, which may include tax-related provisions. In 2023, SB 1734 was introduced and contained three significant provisions related to taxation.

However, only one of these provisions was incorporated into the Arizona Revised Statutes, while the other two exist solely as part of the session law. This means that if you want to reference those two provisions, you will need to refer back to the original bill that was signed by the Governor (presuming the Governor signs the bill, as expected).

The bill passed both chambers of the Arizona Legislature on May 10, 2023 and is expected to be signed by the Governor.

Partnership Income Subject to the Pass-Through Tax Broadened

One significant limitation that many CPAs encountered when working with Arizona’s passthrough entity tax for 2022 tax returns was that only a narrow range of partnership income was subject to the tax. Specifically, the tax was only levied on the non-separately stated income of the partnership, while any separately stated items of income and deduction were disregarded. Despite this, the non-separately stated income was still subject to all of the Arizona additions and subtractions to partnership income that were detailed in the statute.

By contrast, S corporations were subject to the passthrough entity tax on all of their passthrough income. Given that the primary purpose of the tax was to pay Arizona tax at the entity level, rather than the individual level, most CPAs and their clients preferred the more comprehensive taxation of S corporations over the limited taxation of partnerships.

However, effective for tax years starting on or after December 31, 2022 (essentially, 2023 and beyond), the law has been modified to change the way that the income of a partnership is calculated for tax purposes. Specifically, the calculation of partnership income will now encompass a broader range of income, including separately stated items of income and deduction.  The new definition reads:

(ii) for taxable years beginning from and after December 31, 2022, the Arizona taxable income determined under chapter 14 of this title, including the items that require separate computation under section 43-1412, paragraphs 1 through 16.[1]

It’s worth noting that the previous calculation method for partnership income, which limited the taxable income to only the non-separately stated income of the partnership, will continue to apply for the 2022 tax returns. This calculation method is explicitly retained in ARS §43-1014.B.1.(a)(i).:

(i) for taxable years through December 31, 2022, the Arizona taxable income determined under chapter 14 of this title.

The definitions provision of Chapter 14 of Title 43 of the Arizona revised statutes contains the following definitions of Arizona gross income and Arizona taxable income:

43-1401. Definitions

In this chapter, unless the context otherwise requires:

1. “Arizona gross income” of a partnership means its taxable income for the year, computed according to subtitle A, chapter 1, subchapter K of the internal revenue code, exclusive of items requiring separate computation under section 43-1412, paragraphs 1 through 16. (emphasis added) For purposes of this title the provisions relating to interest on investment indebtedness contained in section 163(d) of the internal revenue code shall not apply.

2. “Arizona taxable income” of a partnership means its Arizona gross income adjusted by the modifications specified in sections 43-1021 and 43-1022 and section 43-1414, subsection A.

The Arizona Department of Revenue had interpreted that reference to exclude from the calculation all non-separately stated items of income and deduction.  The new law seeks to explicitly have those items included in the calculation.

Example

Below is the computation of an example partnership’s income subject to the PTE tax under both the 2022 and the 2023 provisions.

Under the prior law that applied in 2022:

• Ordinary business income or loss: $500,000
• Section 1231 gain: $1,000,000 (not included)
• Interest income: $1,000 (not included)
• Dividend income: $2,000 (not included)
• Charitable contributions: $25,000 (not deducted)
• Section 179 expense: $200,000 (not deducted)

Income subject to Arizona passthrough entity tax under 2022 law: $500,000

Under the law applicable to 2023 and later years:

• Ordinary business income or loss: $500,000
• Section 1231 gain: $1,000,000 (included)
• Interest income: $1,000 (included)
• Dividend income: $2,000 (included)
• Charitable contributions: $25,000 (deducted)
• Section 179 expense: $200,000 (deducted)

Income subject to Arizona passthrough entity tax: $1,278,000

Temporary Increase in Adoption Expense Subtraction to $40,000 (2023-2025)

Under Arizona’s income tax law, taxpayers are permitted to take a subtraction for adoption expenses up to a maximum of $3,000 in the year when the adoption is finalized. This provision is outlined in ARS §1022.12:

12. The amount of unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption not to exceed $3,000.  In the case of a husband and wife who file separate returns, the subtraction may be taken by either taxpayer or may be divided between them, but the total subtractions allowed both husband and wife may not exceed $3,000.  The subtraction under this paragraph may be taken for the costs that are described in this paragraph and that are incurred in prior years, but the subtraction may be taken only in the year during which the final adoption order is granted.

In a provision retained solely as session law (thus not incorporated into ARS §1022), the subtraction is revised for years 2023-2025 as follows to increase the subtraction to $40,000:

A. Notwithstanding any other law, for taxable years beginning from and after December 31, 2022 through December 31, 2025, the subtraction amount allowed under section 43-1022, paragraph 12, Arizona Revised Statutes, is the amount of unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption not to exceed $40,000. For a married couple filing separate returns, the subtraction may be taken by either taxpayer or may be divided between them, but the total subtractions allowed to each spouse may not exceed $40,000. The subtraction may be taken for the costs that are described in this subsection and that are incurred in prior years, but the subtraction may be taken only in the year during which the final adoption order is granted.[2]

Below is an example of applying the revised limit on the adoption expense deduction

Example

Assume that John and Jane, a married couple, began the process of adopting a child in 2022. They incurred adoption expenses as follows:

• Unreimbursed medical and hospital costs: $10,000
• Adoption counseling fees: $2,500
• Legal fees: $15,000
• Agency fees: $12,000

Their adoption was finalized in 2023. Under the revised law, they may take a subtraction for adoption expenses on their 2023 Arizona income tax return. The maximum subtraction amount is $40,000.

Since their total adoption expenses ($39,500) do not exceed the maximum allowed amount, they can take the full $39,500 as a subtraction on their 2023 tax return. The subtraction will reduce their Arizona taxable income for the year, likely resulting in a lower tax liability.

If John and Jane had incurred more than $40,000 in adoption expenses, they would only be able to take the maximum allowed amount of $40,000 as a subtraction on their tax return.

It’s worth noting that this subtraction may also be taken for adoption expenses that were incurred in prior years, but only in the year in which the final adoption order is granted.

Had their adoption been finalized in 2022, their deduction would have been limited to $3,000.

Individual Income Tax General Welfare Rebate (Arizona Families Tax Rebate)

Arizona will paying a onetime individual income tax general welfare rebate (referred to as the Arizona Families Tax Rebate) to taxpayers who filed a 2021 full-year resident return, claimed a dependent credit on that return and meets one of the following qualifications:

• Had a tax liability of at least $1 on the filed full-year resident tax return for taxable year 2021.
• If the taxpayer does not meet the tax liability requirement for taxable year 2021, filed a full-year resident tax return for taxable year 2020 under the identical filing status used on the taxpayer’s taxable year 2021 full-year resident tax return and had a tax liability of at least $1 on the full-year resident tax return for taxable year 2020.
• If the taxpayer does not meet the tax liability requirement for taxable years 2021 or 2020, filed a full-year resident tax return for taxable year 2019 under the identical filing status used on the taxpayer’s full-year resident tax returns for taxable years 2020 and 2021 and had a tax liability of at least $1 on the full-year resident tax return for taxable year 2019.[3]

The rebate is calculated using the following rules:

• The Department of Revenue shall issue to a qualifying taxpayer a rebate of $250 for each dependent tax credit claimed on the taxpayer’s full-year resident tax return for taxable year 2021 who was under seventeen years of age at the end of taxable year 2021 and $100 for each dependent who was at least seventeen years of age at the end of taxable year 2021.
• The Department of Revenue shall issue a rebate for a maximum of three dependents for a qualifying taxpayer under this section. For a taxpayer who claimed more than three dependents on the taxpayer’s full-year resident tax return for taxable year 2021, the rebate will be calculated by first counting the dependents who were under seventeen years of age at the end of taxable year 2021 and then, if additional dependents may be claimed to meet the maximum number, the dependents who were at least seventeen years of age at the end of taxable year 2021.[4]

Below is an example of applying these rebate rules:

Example 1

Assume that John is a full-year Arizona resident who filed a tax return for taxable year 2021 and claimed four dependent credits on that return. Two of his dependents were under seventeen years of age at the end of taxable year 2021, and two were at least seventeen years of age at the end of taxable year 2021.

Under the newly enacted law, John qualifies for the one-time individual income tax general welfare rebate since he filed a 2021 full-year resident return, claimed a dependent credit on that return, and had a tax liability of at least $1 on that return.

Since John claimed four dependent credits on his 2021 full-year resident tax return, he is eligible to receive a tentative rebate of $700 (before applying the maximum credit limitations). Here’s how the tentative rebate amount is calculated:

• $250 for each dependent under seventeen years of age: $500 ($250 x 2)
• $100 for each dependent at least seventeen years of age: $200 ($100 x 2)
• Tentative rebate amount before limitation: $700

Since John claimed four dependents on his 2021 full-year resident tax return, the maximum number of dependents for which he can claim a rebate is three. However, since two of his dependents were under seventeen years of age, the rebate will be calculated based on those two dependents and only one of the older dependents. Therefore, John is eligible for a rebate of $600 ($250 x 2 plus $100 x 1) for his two dependents who were under seventeen years of age and one additional dependent.

If John had claimed three or fewer dependents on his 2021 full-year resident tax return, the rebate amount would have been calculated based on the actual number of dependents claimed.

Example 2

Now let’s consider another scenario. Assume that Jane is also a full-year Arizona resident who filed a tax return for taxable year 2021 and claimed a dependent credit on that return. However, Jane had no tax liability on her 2021 full-year resident tax return.

Since Jane does not meet the tax liability requirement for taxable year 2021, she must look back to her 2020 full-year resident tax return. If Jane had a tax liability of at least $1 on her 2020 full-year resident tax return, she would qualify for the rebate. However, if she did not have a tax liability on her 2020 full-year resident tax return either, she must look back further to her 2019 full-year resident tax return.

If Jane had a tax liability of at least $1 on her 2019 full-year resident tax return, she would qualify for the rebate. Assuming that the rebate amount is $600 (like John she had two dependents under age 17 and two over), Jane would receive a rebate of $600 from the state of Arizona.

If Jane did not have a tax liability for 2019 then she would not qualify to receive a rebate.

A key issue is what is considered a “tax liability” under this provision. SB1734 Section 4.N.4 provides:

4. “Tax liability” means the taxpayer’s taxable income multiplied by the taxpayer’s applicable tax rate as prescribed in section 43-1011, Arizona Revised Statutes, plus any amount of recaptured income tax credits and the taxpayer’s Arizona small business tax liability, if any, minus the sum of nonrefundable and refundable income tax credits claimed by the taxpayer under title 43, chapter 10, article 5, Arizona Revised Statutes.

Below is an example of applying the tax calculation.

Example 1:

Assume that Neal had $2,000 of Arizona tax for 2021 and had claimed an Arizona tax credit of $2,000 for contributions to a Private School Tuition Organization during the year. Under the definition of a tax liability, the calculation would be as follows:

• Neal’s Arizona tax: $2,000
• Nonrefundable income tax credits: $2,000
• Refundable income tax credits: $0

Therefore, according to the definition of a tax liability, Neal’s tax liability for 2021 is $0. Although Neal had $2,000 of Arizona tax for the year, the full amount was offset by the Arizona tax credit he claimed. Since his tax liability is $0, he would not be eligible for the Arizona income tax general welfare rebate unless he can qualify based on having a tax liability in 2020 or 2019.

Example 2:

Assume that the facts are the same as in Example 1, except that Neal was only eligible to claim $1,999 in credits in 2021. Under the definition of a tax liability, the calculation would be as follows:

• Neal’s Arizona income tax: $2,000
• Nonrefundable income tax credits: $1,999
• Refundable income tax credits: $0

Therefore, according to the definition of a tax liability, Neal’s tax liability for 2021 is $1. Although he had $2,000 of Arizona tax for the year, his tax liability is reduced to $1 due to the Arizona tax credit he claimed. Since his tax liability is (barely) greater than $0, Neal would be eligible for the Arizona income tax general welfare rebate, assuming he meets the other qualifications under the law.

The primary taxpayer’s identification number reported on the 2021 return shall be used as needed for matching and verification purposes.[5]

The bill provides that if the taxpayer is deceased, the taxpayer’s surviving spouse, personal representative or executor or another official representative of the estate designated pursuant to applicable state law may receive the rebate for the deceased taxpayer.[6]

The Department of Revenue (ADOR) is directed to pay all rebates issued pursuant to this section on or after October 15, 2023, and on or before November 15, 2023.[7]

ADOR shall attempt to pay a qualifying taxpayer’s rebate by electronic funds transfer using the routing and account information provided by the taxpayer on the taxpayer’s full-year resident tax return for taxable year 2021 or more recent routing and account information provided by the taxpayer.[8] We will have to wait to see if the Department offers a way for taxpayers to update that information easily, or if the Department will only consult any changes that may have been made when filing the taxpayer’s 2022 returns.

If the attempt to electronically deposit the funds fails, or if the taxpayer did not provide such routing and account information, ADOR is directed to issue the rebate check by mail to the most recent home address provided by the taxpayer.[9]

A taxpayer who does not receive his or her rebate will be able to file a separate refund claim—but the taxpayer will have to wait until November 15, 2024 to do so.  Section 4.H of the bill provides:

A taxpayer who does not receive the rebate issued pursuant to this section on or before November 15, 2024 may claim the rebate by filing a claim application online in the form and manner prescribed by the department of revenue. The claim application must include the claimant’s name, address, taxpayer identification number and individual income tax filing status. The department shall review each claim application and verify the information provided. The department may request that a claimant provide evidence to verify the claimant’s eligibility for the rebate.

Given that the Legislature calls this a “general welfare” rebate, it appears they are asking the IRS to treat these payments as excludable from income under the general welfare exception.  While it likely the IRS will treat them that way, just in case the agency doesn’t the bill provides that any amount of the rebate included in federal income will be subtracted from the taxpayer’s Arizona gross income.[10]

A floor amendment adopted prior to vote on the bill in the Senate added the following provisions regarding communications from the Department of Revenue and the Governor’s office regarding this rebate:

Any notification from the department that relates to the rebate issued under this section shall state the following: “This rebate is being issued pursuant to Senate Bill 1734, as passed by the fifty-sixth legislature, first regular session, and signed into law by the governor.” No letter relating to the Arizona families tax rebate issued under this section shall be sent from the governor’s office, be sent on the governor’s letterhead or reference the governor’s office.[11]

[1] ARS §43-1014.B.1.(a)(ii)

[2] SB1734, Fifty-sixth Legislature, First Regular Session, Section 2.A

[3] SB1734, Fifty-sixth Legislature, First Regular Session, Section 3.A

[4] SB1734, Fifty-sixth Legislature, First Regular Session, Section D and E

[5] SB1734, Fifty-sixth Legislature, First Regular Session, Section C

[6] SB1734, Fifty-sixth Legislature, First Regular Session, Section F

[7] SB1734, Fifty-sixth Legislature, First Regular Session, Section G

[8] SB1734, Fifty-sixth Legislature, First Regular Session, Section G

[9] SB1734, Fifty-sixth Legislature, First Regular Session, Section G

[10] SB1734, Fifty-sixth Legislature, First Regular Session, Section H

[11] SB1734, Fifty-sixth Legislature, First Regular Session, Section G

On September 29, 2022, Governor Ducey sent a letter to Robert Woods, Director of the Arizona Department of Revenue,[1] reporting that the Joint Legislative Budget Committee and the Governor’s Office of Strategic Planning and Budgeting had issued a joint memo certifying that General Fund revenues in Fiscal Year 2022 were $16.7 billion, exceeding the thresholds in the statute that would allow the 2.5% flat tax rate to apply for tax years beginning in 2023.

ARS §43-1011.A.8 and 9 provide:

8. Subject to subsections E and F of this section, for taxable years beginning from and after December 31 of the year in which notice is provided to the department pursuant to section 43-243, subsection A or subsection B, paragraph 1 through December 31 of the year in which notice is provided to the department pursuant to section 43-243, subsection B, paragraph 2:

(a) In the case of a single person or a married person filing separately:

If taxable income is: The tax is:

$0 — $27,272 2.53% of taxable income

$27,273 and over $690, plus 2.75% of the amount over $27,272

(b) In the case of a married couple filing a joint return or a single person who is a head of a household:

If taxable income is: The tax is:

$0 — $54,544 2.53% of taxable income

$54,545 and over $1,380, plus 2.75% of the amount over $54,544

9. Subject to subsection F of this section, for taxable years beginning from and after December 31 of the year in which notice is provided to the department pursuant to section 43-243, subsection B, paragraph 2, the tax is 2.5% of taxable income.

ARS §43-1011.A.8 and 9

The tax rate triggers were found at ARS §43-243.A and B which provided:

A. On or before September 30, 2022, the director of the joint legislative budget committee and the director of the governor’s office of strategic planning and budgeting shall jointly notify the department whether the fiscal year 2021-2022 state general fund revenue, excluding the beginning balance, was $12,782,800,000 or more.

B. On or before September 30, 2023 and on or before September 30 of each year until the notice is provided as prescribed in subsection A of this section or paragraph 1 of this subsection, and paragraph 2 of this subsection, the director of the joint legislative budget committee and the director of the governor’s office of strategic planning and budgeting shall jointly notify the department whether the previous fiscal year state general fund revenue, excluding the beginning balance, was either of the following amounts:

1. More than $12,782,800,000 but less than $12,976,300,000.  The notice required pursuant to this paragraph is not required if the notice required pursuant to subsection A of this section was provided on or before September 30, 2022.

2. $12,976,300,000 or more.

ARS §43-243.A and B

Note that while ARS §43-243.B, which would trigger the first year Arizona would have a single 2.5% tax bracket found at ARS §43-1011.A.9, did not require a notification of meeting its target until September 30, 2023, at which point it would have measured the 2023 fiscal year and first impacted 2024 tax rates, nothing in the law prevented the certification being made earlier than that date.

Thus the rates found at ARS §43-1011.A.8 will never apply to any Arizona individual income tax year, but rather they will be bypassed for the lower rate at ARS §43-1011.A.9 in 2023 and later years.

This change in rate will also affect Arizona’s passthrough entity tax rate.  Under ARS §43-1014 the entity-level tax rate is the “same as the tax rate prescribed by section 43-1011” which means that rate will also drop to 2.5% for 2023 tax years.

[1] Governor Douglas A. Ducey, Letter to Robert Woods, Arizona Department of Revenue, “RE: Accelerated Tax Relief for Families,” September 29, 2022, https://azgovernor.gov/sites/default/files/accelerated_tax_relief_for_arizona_families_letter.pdf

On September 6, 2022 the Arizona Department of Revenue began allowing taxpayers to make their PTE estimated tax payments via the AZTaxes.gov website.  The Department of Revenue also sent out an email announcement and posted the same to their website announcing the development.^[1]

The announcement provides the following basic information on making the third quarter payment:

Partnership and S corporation taxpayers can now make their required third quarter pass-through entity tax payment electronically using AZTaxes.gov(link is external), under Quick Payment Links – “Make a Corporation/S-Corporation/ Partnership Payment.”^[2]

The announcement clarified that only a 25% payment is needed for the third quarter, so that taxpayers don’t need to “catch-up” and now make the first two payments along with the third quarter payment:

Estimated payments are due September 15, 2022 and taxpayers are required to pay at least 25% of the estimated tax for the 2022 tax year.^[3]

The announcement reminds taxpayers of the basic estimated tax payment rules as interpreted by the Department of Revenue for the passthrough tax:

For taxable years beginning from and after December 31, 2021, an entity that is treated as a partnership or S corporation for federal income tax purposes that elects to pay the tax under A.R.S. § 43-1014 and whose taxable income for the taxable year exceeds $150,000 in the preceding taxable year must make estimated tax payments during the taxable year in a manner consistent with how estimated individual income tax payments are made.

Individuals subject to estimated tax payments in Arizona must make quarterly payments by April 15, June 15, and September 15 of the current year and January 15 of the following year. However, the first and second quarter Arizona estimated tax payments were not required in 2022 for partnerships or S corporations making the pass-through entity election under A.R.S. § 43-1014.^[4]

The Department, apparently recognizing how close to the September 15 deadline they finally made this option available, does provide for relief for taxpayers who are unable to get the electronic deposit option to work:

Please Note: If taxpayers experience technical difficulties making their pass-through entity tax payment electronically on AZTaxes.gov, they may use Arizona Form 120/165ES to make a payment by paper and include the EIN on the check to ensure the payment is accounted for correctly. See forms instructions for information on making online and paper payments.^[5]

^[1] 2022 Pass-Through Estimated Payment Guidance for Partnerships and S Corporations, Arizona Department of Revenue Website, September 6, 2022,  https://azdor.gov/media-center/latest-press-releases/news/2022-pass-through-estimated-payment-guidance-partnerships (retrieved September 6, 2022)

^[2] 2022 Pass-Through Estimated Payment Guidance for Partnerships and S Corporations, Arizona Department of Revenue Website, September 6, 2022

^[3] 2022 Pass-Through Estimated Payment Guidance for Partnerships and S Corporations, Arizona Department of Revenue Website, September 6, 2022

^[4] 2022 Pass-Through Estimated Payment Guidance for Partnerships and S Corporations, Arizona Department of Revenue Website, September 6, 2022

^[5] 2022 Pass-Through Estimated Payment Guidance for Partnerships and S Corporations, Arizona Department of Revenue Website, September 6, 2022

Included in one of the budget bills that passed the Arizona Legislature on June 23, 2022 is a revision to the Arizona elective passthrough entity tax (PTET) that reduces the rate from its previous 4.5% to one tied to rates found in ARS §43-1011^[1] that apply for Arizona individual income taxes.

The revised ARS §43-1014.A reads as follows:

A. For taxable years beginning from and after December 31, 2021, the partners or shareholders of a business that is treated as a partnership or S corporation for federal income tax purposes may consent to be taxed at the entity level at a tax rate that is the same as the tax rate prescribed by section 43-1011 applicable to the entire portion of its taxable income that is attributable to its resident partners or shareholders and the portion of its taxable income derived from sources within this state that is attributable to its nonresident partners or shareholders for that taxable year.  The election under this subsection must be made on or before the due date or extended due date of the business’s return under this title.

ARS §43-1014.A

Unfortunately, there is a bit of ambiguity in that reference, as ARS §43-1011 for the current taxable year provides two different rates, one for each of two brackets that apply for each filing status.  ARS §43-1011.A.7 provides that:

Subject to subsections E and F of this section, For taxable years beginning from and after December 31, 2021 through December 31 of the year in which notice is provided to the department pursuant to section 43-243, subsection A or subsection B, paragraph 1:

(a) In the case of a single person or a married person filing separately:

If taxable income is:         The tax is:

$0 – $27,272                 2.55% of taxable income

$27,273 and over            $695, plus 2.98% of the amount over $27,272

(b) In the case of a married couple filing a joint return or a single person who is a head of a household:

If taxable income is:         The tax is:

$0 – $54,544                 2.55% of taxable income

$54,545 and over            $1,391, plus 2.98% of the amount over $54,544

ARS §43-1011.A.7

Presumably the intent is to set the rate at the highest marginal tax rate (2.98%) under ARS §43-1011 for the year in question, but either the Legislature will need to adopt a clarification (likely in the first session of the new legislature in 2023) and/or (more likely due to timing) the Department of Revenue will need to issue guidance clarifying the proper rate to be used.

But no matter whether the rate used is 2.55% or 2.98%, the lower rate makes it far less likely that a taxpayer’s credit for the passthrough entity tax under ARS §43-1075 will exceed the taxpayer’s Arizona income tax for 2022 or later years, something that could easily happen when the PTET rate was well above the maximum individual income tax rates that would apply for those years.

Currently the bill is on the Governor’s desk awaiting is signature. Presumably he plans to sign this bill before the state’s fiscal year ends on June 30, 2022 and the state’s authority to spend funds ends.

^[1] HB 2871, Fifty-fifth Legislature Second Regular Session 2022, Section 15, June 23, 2022

The Arizona Supreme Court has issued an order blocking the referendum on 2021’s SB1828 from going to a vote this November and instead is now treated as enacted and effective.  While the Court has not issued its opinion (that has been promised to come later), the Order stated:

The Court en banc has considered the briefs, authorities, and arguments in this appeal. The Court finds that §§ 13 and 15 of S.B. 1828 do fall within the support and maintenance exception to the Arizona Constitution, and thus may not be referred to the voters.

Impact on 2022 Tax Rates – Regular Income Tax

The most immediate impact of the decision is that now the rates are set for the 2022 income tax returns.  Under SB1838, Arizona’s regular income rates for 2022 will be as follows:

Single Person or Married Filing Separately

A rate of 2.55% will apply on taxable income up to $27,272, with a rate of 2.98% that applies to taxable income in excess of that amount.

Married Couple Filing a Joint Return or Head of Household

A rate of 2.55% will apply on taxable income up to $54,544, with a rate of 2.98% that applies to taxable income in excess of that amount.

In the future the rates will drop depending on the meeting revenue targets in the bill, with the top rate dropping first to 2.75% and then to a pure flat rate of 2.5%

Impact on the Arizona Small Business Income Tax

With the maximum rate of 2.98% applying for 2022, the Arizona Small Business Income Tax now becomes a virtually irrelevant tax for 2022 as it will apply a flat rate of 3.0% to Small Business Income which is 0.02% higher than the top rate applicable under the regular tax.  Thus, there is no reason to elect to pay tax at 3.0% with very limited deductions when, if the election is not made, the highest possible rate is 2.98% for a tax that comes with many more deductions.

And the situation does not improve in the future.  For 2023 and 2024 the SBI rate drops to 2.8%, but it’s very likely the regular rate will fall to 2.75% for that year and then 2.5% for 2024.  Finally, in 2025 the Small Business Income Tax will fall to a 2.5% rate, but that will simply make the rate equivalent to the regular rate and the SBI tax still does not allow nearly as many deductions as the regular tax.

Arizona Passthrough Entity Tax

The flat tax’s lower rate will also impact the elective Arizona Passthrough Entity Tax.  The passthrough entity tax is applied at a rate of 4.5% of taxable income attributable to eligible and electing partners.  As should be clear, that rate is over 50% higher than the maximum rate that will apply in 2022, and the rates are scheduled to go lower over time.

But Arizona’s version of the passthrough entity tax has another “feature” that will make this problem far worse for most partners and S corporation shareholders.  Unlike most states that use the tax credit structure to give the partners and shareholders a reduced tax burden to compensate for the tax paid at the entity level, Arizona’s credit is not refundable.  

Rather the taxpayer must carry any amount of this credit in excess of the tax due on the regular tax return forward for up to five years.  If the taxpayer is unable to absorb the credit over that five year period, the taxpayer will have paid more in tax to the state of Arizona than would otherwise be due.  And even if it can be absorbed, there are time value of money issues that also must be considered.

The nonrefundable nature of the credit also poses problems for taxpayers that regularly have wiped out most or even all of their Arizona tax liabilities by claiming the various Arizona charitable tax credits.

For taxpayers with large amounts of passthrough income compared to their taxable income, the only realistic option to use up the credit may be to skip the federal benefit of the passthrough entity tax in certain years, or hope the federal benefit of the above the line deduction for the entity level tax will be higher than the extra cash sent to the state of Arizona.

The Arizona Department of Revenue announced that it would waive penalties on the first two estimated tax payments due for the 2022 Arizona elective passthrough income tax.[1]  The agency is not yet able to accept electronic payments for this tax but expects to be able to receive such payments by September 15, 2022, the date the third estimated payment is due.

The Arizona elective passthrough entity tax is Arizona’s version of the state and local tax (SALT) workaround that the IRS blessed in Notice 2020-75 in November 2020.  The passthrough entity elects to pay a tax at the entity level on all or a portion of the entity’s income, which results in a non-separately stated deduction that passes out to the shareholders on Schedule K-1 as a reduction of non-separately stated income, effectively deducting these taxes in full in computing the equity holder’s adjusted gross income.

The equity holder then gets a dollar for dollar credit against his/her Arizona income taxes, so no extra tax would be paid in the best case.[2]  Arizona’s version of the tax first applies for 2022.

The announcement begins by indicating the relief being granted:

First and second quarter Arizona estimated tax payments are not required in 2022 for partnerships or S corporations making the pass-through entity election under A.R.S. § 43-1014.[3]

The page notes that, generally, estimated tax payments are due under the law for partnerships and S corporations making the passthrough entity tax election whose taxable income for a year exceeds $150,000:

A.R.S. § 43-1014(B)(3) requires partnerships and S corporations to pay estimated tax pursuant to  A.R.S. § 43-581.  A.R.S. § 43-581(C) provides that, for taxable years beginning from and after December 31, 2021, an entity that is treated as a partnership or S corporation for federal income tax purposes that elects to pay the tax under A.R.S. § 43-1014 and whose taxable income for the taxable year exceeds $150,000 in the preceding taxable year must make estimated tax payments during the taxable year in a manner consistent with how estimated individual income tax payments are made. Individuals subject to estimated tax payments in Arizona must make quarterly payments by April 15, June 15, and September 15 of the current year and January 15 of the following year.[4]

But the page notes that the Department itself does not expect to be able to accept these estimated tax payments in time for taxpayers to make those timely first two estimated tax payments:

Because ADOR is currently unable to process electronic estimated tax payments for the new pass-through entity tax, the first two estimated tax payments of 2022 due in April and June will be waived for partnerships and S corporations subject to estimated tax payments under A.R.S. § 43-581(C).  Partnership and S corporations that do not make the April and June estimated tax payments will not incur a penalty under A.R.S. § 43-1125(Q): ADOR will notify affected taxpayers of any required action needed to request abatement.[5]

The page concludes by noting that for the third payment in September, taxpayers are only going to be required to pay 25% of their proper estimate for the year (that is, the agency is not asking taxpayers to catch up at that time):

ADOR anticipates being able to accept electronic estimated payments in time for the third quarter payment due on September 15, 2022, at which time a minimum payment of 25% of the entity’s estimated tax for the 2022 tax year will be due.[6]

Presumably taxpayers could wait and pay the amounts that would have been due for the first two estimates with their tax returns in March of 2023 without facing a penalty from the state of Arizona.  However, that may not be a smart move under federal law.  Under Notice 2020-75, the above the line deduction for these entity level taxes is only allowed for taxes paid during the year in question.[7]

[1] “Arizona Estimated Tax Notice for Partnerships and S Corporations Making the Pass-Through Entity Tax Election,” Arizona Department of Revenue website, March 2, 2022, https://azdor.gov/news-events-notices/news/arizona-estimated-tax-notice-partnerships-and-s-corporations-making-pass (retrieved March 9, 2022)

[2] There are issues with how Arizona handles this tax and credit that raises a real risk that some or all equity holders may find that the system doesn’t actually work to achieve this break-even result.  But that is a topic for another day.

[3] “Arizona Estimated Tax Notice for Partnerships and S Corporations Making the Pass-Through Entity Tax Election,” Arizona Department of Revenue website, March 2, 2022

[4] “Arizona Estimated Tax Notice for Partnerships and S Corporations Making the Pass-Through Entity Tax Election,” Arizona Department of Revenue website, March 2, 2022

[5] “Arizona Estimated Tax Notice for Partnerships and S Corporations Making the Pass-Through Entity Tax Election,” Arizona Department of Revenue website, March 2, 2022

[6] “Arizona Estimated Tax Notice for Partnerships and S Corporations Making the Pass-Through Entity Tax Election,” Arizona Department of Revenue website, March 2, 2022

[7] Notice 2020-75, Section 3.02(2), https://www.irs.gov/pub/irs-drop/n-20-75.pdf

In the Tax Cuts and Jobs Act (TCJA) Congress imposed a $10,000 cap for deductions of state and local taxes not related to a trade or business or a §212 activity on Schedule A.  Effective in 2022 the state of Arizona will allow partnerships and S corporations to elect to pay an entity level tax for which each partner or S corporation shareholder will receive a credit against their Arizona taxes.  The entity level tax was first enacted as a SALT cap workaround by the state of Connecticut shortly after the passage of the TCJA.  Despite initial statements from the IRS that they agency would issue guidance rendering the workaround ineffective, the agency issued no such guidance and, in fact, in late 2020 announced Treasury would be issuing regulations that would recognize these workarounds as effective.

Arizona Entity Level Tax (ARS §43-1014)

In House Bill 2832, Chapter 425, July 9, 2021 the Arizona Legislature adopted its version of the passthrough entity tax described in Notice 2020-50.[10]  The bill takes effect from and after December 31, 2021.[11]

Computation of the Tax

The law provides that “the partners or shareholders of a business that is treated as a partnership or S corporation for federal income tax purposes may consent to be taxed at the entity level” for the tax described at ARS §43-1014.[12]

The tax is imposed at a 4.5% rate on:

• The entire taxable income for the year that is attributable to its Arizona resident partners or shareholders and
• The portion of its taxable income for the year derived from sources within Arizona that is attributable to its Arizona nonresident partners or shareholders.[13]

Example 1

ABC is an S corporation that is filing an Arizona S corporation income tax return.  ABC has $100,000 of income in 2022, $75,000 of which is from Arizona sources and $25,000 of which is not Arizona source. 

There are two shareholders of ABC – Al, who is an Arizona resident holding 75% of the stock and Wilma who is not an Arizona resident and holds the other 25% of the stock.

The shareholder consent and ABC elects to pay the Arizona entity-level tax for 2022.  The total income ABC will pay the entity level tax on is computed as follows:

• 100% of income allocated to Al, Arizona resident (75% of 100,000) or $ 75,000
• 25% of Arizona source income allocated to Wilma, non-resident (25% of $25,000) or $18,750
• Total taxable income for Arizona entity-level income tax is therefore $ 93,750
• ABC’s Arizona entity-level income tax is 4.5% of $93,750, or $ 4,219.

If the election described in the next section is made, the taxable income of the entity is calculated using the standard Arizona income tax rules for individuals (under Chapter 10 of Title 43) or partnerships (under Chapter 14 of Title 43).[14]

If the entity fails to pay the entity-level tax, the Department of Revenue “may collect the amount from the partners or shareholders based on the proportionate share of income that is attributable to each partner or shareholder for Arizona tax purposes.”[15]

Election

The law seems to require two steps for this tax to apply:

• The partners or shareholders must consent to be taxed at the entity level and
• An election must be made by the entity on or before the due date (including extensions) of the business’s Arizona income tax return.[16]

The law does not provide any details on either how the partners’ or shareholders’ consents are to be documented, if there must be unanimous consent, if corporate and tax-exempt partners must also consent, nor any other specifics on how the entity will make this election.  Rather such details will have to come from the Department of Revenue under the authority granted to the Department in this section.[17]

Equity Holders to Whom the Election Does Not Apply

The election does not apply to:

• Partners or shareholders that are not individuals, estates or trusts and
• Partners or shareholders who are individuals, estates or trusts and who opt out or waive the right to opt out of the election.[18]

Analysis

The inclusion of partners or shareholders who waive the right to opt out of the election in the list of those to whom the election does not apply appears to be a drafting error.  The provision is at odds with what would appear to be the intent of a partner or shareholder who formally waives the right to opt out and also directly at odds with the language found at ARS §43-1014.D that requires that a partner or shareholder who waives the right to opt out to be included in the election.

Example 2

Continuing with the facts in Example 1, assume that Wilma decides to opt-out.  In that case, the $18,750 that represents her Arizona source income would not be included in taxable income in computing the entity’s entity-level tax.  Only the $75,000 of income allocated to Al would be subject to the tax, resulting in an entity-level tax of $3,375.

Opting Out of the Election

A single partner or shareholder can decide that while the entity may be making this election, they don’t want the election to apply to them, perhaps because they will not have any Arizona tax liability or would lose a credit for the tax paid to Arizona on their home state income tax return.  Under the law such an option to opt-out must be made available to each shareholder.

A partnership or S corporation that intends to make this election:

• Shall notify all partners or shareholders who are individuals, estates or trusts that they have the right to opt out of the election for their share of the income and
• Shall allow at least 60-days to each such partner or shareholder to make the opt-out election.[19]

If a partner or shareholder fails to respond within 60 days or waives the right to opt out, the partner or shareholder will be included in the election per ARS §43-1014.D.

Analysis

As was noted in the section describing the equity holders to whom this election does not apply, ARS §43-1014.C provides an exactly opposite treatment for partners or shareholders who waive the right to opt-out of the election.  While that appears to be a drafting error, it is part of the law as enacted and, unless changed by the Legislature, at best creates ambiguity as to the status of such a partner or shareholder.  

Unless the Department of Revenue provides a clarification on how the agency will apply that text (or the text is changed by the Legislature), it would appear that partners and shareholders should be advised not to specifically waive their right to opt out, but rather just let the 60-day time period expire if they wish to be part of the election.

Although less of an issue, the law appears to first require a consent from the partners or shareholders to make the election, but then they must be offered the ability to opt-out.  Hopefully the Department of Revenue will allow using a single form to consent to the entity’s election and, at the same time, indicate if the individual equity holder plans to opt out.

Estimated Taxes for Electing Entities (ARS §43-581.C)

Entities making the entity-level tax election will be required to have made payments of estimated taxes under the estimated tax rules found at ARS §43-581.[20]

Estimated taxes will be required for an entity making the entity-level election:

• If the entity’s taxable income exceeded $150,000 in the prior year and
• The payments shall be made in a manner that is consistent with rules that apply to individuals.

Analysis

The Department will need to clarify if the $150,000 is measured based on the taxable income reported on the Form 165 or 120S for the prior year even if no election is made, or if the $150,000 is solely the taxable income computed for the entity-level tax only.  But, presumably, the relief available for individuals who owed no tax the prior year should apply even if the entity is deemed to have income in excess of $150,000 in the prior year unless the election to pay the entity-level tax was made in that prior year.

Addition to Income on the Individual Return (ARS §43-1021.16)

The key to getting a full federal tax deduction for the state taxes is that the tax is deducted in computing non-separately stated income from the partnership or S corporation, reducing the amount of income that would flow onto Schedule E and be included in adjusted gross income.

Because of that, the law provides for adding back the partner’s or shareholder’s share of the taxes deducted to Arizona gross income for Arizona income tax purposes.  But it goes further and also requires adding back “similar” taxes imposed by other states—a concept that will appear again in the credit for taxes paid to other states.[21]

The add-back provision concludes with the following sentence:

This amount shall be reflected in the partner’s or shareholder’s Arizona gross income and the Partnership’s or S corporation’s Arizona taxable income.[22]

Analysis

The intent of that sentence is not completely clear.  The Department of Revenue may shed some light on what impact that sentence would have on the amount that is added back to income.

As well, this add-back may serve to put the taxpayer in worse shape than without the election if the taxpayer is both able to itemize on the Arizona return and does not have other state and local taxes of at least $10,000.

Prior to TCJA, the taxpayer would have gotten a deduction for all Arizona taxes paid as an itemized deduction.  That would still be true if the taxpayer’s total state and local taxes are less than $10,000.  In such a case, the taxpayer should consider opting-out of the election by giving notice to the entity during the 60-day period allowed for opting out.

Credit for Entity-Level Tax Against Title 43 Taxes (ARS §43-1075)

A credit is allowed against “taxes imposed by this title” for a partner or shareholder of an entity that elects to pay the entity-level tax.  The credit is initially the amount of tax paid by the entity that is attributable to the partner’s or shareholder’s share of income taxable in Arizona.[23]

The taxes potentially imposed that are apparently eligible to be offset with the credit would include:

• The regular income tax (ARS §43-1011 for individuals, ARS §43-1301 for estates and trusts)
• The income tax surcharge for public education (ARS §43-1013)
• The small business income tax (ARS §43-1711)[24]

Analysis

The law does not provide any order in which these taxes are offset, although the credit appears available to offset all of the taxes.  Whether the Department of Revenue will provide for an ordering of the offset or if the taxpayer will be allowed to select the amount of credit used against each tax remains to be seen.

If the credit exceeds the taxes due under those provisions, the excess is carried forward for up to five years against the subsequent years’ income tax liability.[25]

Analysis

Presumably the “income tax liability” refers to all of the taxes under Title 43, though it is interesting that previously the section referred to all taxes under this title (Title 43).  Again, we will need to wait and see how the Department of Revenue interprets this provision.

The fact that the credit is not refundable and has a limited life of five years means care must be taken to opt-out by an equity holder who has insufficient tax due to be offset.  Even if the credit could be used in later years, the taxpayer is accelerating the payment of the tax if they don’t have a sufficiently large tax liability.

Given the large number of Arizona tax credits available, taxpayers should be asked about their intent to make tax credit donations and warned about the issues that can take place if they reduce the taxes too much.  In that situation, paying the entity-level tax would be counterproductive.

Credit for Other States’ Similar Passthrough Taxes

A problem that arises with passthrough taxes involves the credit given for taxes paid by other states, as to pass muster under Notice 2020-50 (and thus accomplish the goal of working around the limit on the deduction of state and local taxes on Schedule A), the tax must be imposed on the entity.  However, state provisions granting a credit for taxes paid to other states generally look only to taxes imposed upon and paid by the individual.  This has the effect for out of state interest holders paying taxes to each state (directly to their home state and indirectly via the entity to the state where the passthrough entity is located) without obtaining a credit to offset either tax.

Example 3

Wayne, an Arizona resident, holds a minor interest in XYZ, Inc., an S corporation operating in New Jersey.  All other partners are New Jersey residents.  The S corporation elects to participate in New Jersey’s optional entity level tax, the Business Activity Income Tax (BAIT).  Wayne’s share of the income of the S corporation is $100,000 and his share of the BAIT is $10,000.

While Wayne gets a $10,000 tax credit against his New Jersey income tax, he pays tax on the entire $100,000 to Arizona with no tax credit for taxes paid to New Jersey.  We will assume his New Jersey tax computed to be $10,000, thus is entirely offset by the tax credit.  Wayne pays a 4.5% tax rate to Arizona on the income (we’ll assume he uses only the cap on combined rates), paying $4,500 to Arizona.

Had the New Jersey S corporation not made this election, Wayne’s income would have been $110,000.  We’ll assume Wayne’s tax to New Jersey would have still been $10,000.

Given that the Arizona rate was well below New Jersey’s, in this scenario Wayne would have received a full credit against the $4,500 increase in Arizona tax.  Even considering the extra benefit for the federal deduction at the 37% rate, Wayne is still $800 worse off than if the New Jersey S corporation had not made the BAIT election.  However, the other shareholders don’t face this problem, so for them it’s a major reduction in federal taxes with no negative state tax impact.

Beginning in 2022, Arizona law will now allow a credit for taxes that the Department of Revenue considers “similar” to that imposed under the Arizona elective entity-level tax found at ARS §43-1014 (such as the New Jersey BAIT) that is subject to tax for Arizona income tax purposes.[26] 

The credit will be no more than the credit that would have been allowed had the income been taxed at the individual level and not taxed at the entity level.[27]

Analysis

Since Arizona is not taxing this income at the entity level, this appears to refer to the tax that would have been due if the income had been taxed on the other state return at the individual level.

As was mentioned earlier, these similar taxes will have to be added back to Arizona income.[28]

[1] Notice 2020-75, November 9, 2020, https://www.irs.gov/pub/irs-drop/n-20-75.pdf (retrieved November 9, 2020)

[2] Notice 2020-75, Section 2.02(3)

[3] Notice 2020-75, Section 3.01

[4] Notice 2020-75, Section 3.02(2)

[5] Notice 2020-75, Section 3.02(1)

[6] Notice 2020-75, Section 3.02(1)

[7] Notice 2020-75, Section 3.02(3)

[8] Notice 2020-75, Section 3.02(4)

[9] Notice 2020-75, Section 4

[10] HB 2828, Chapter 425, Fifty-fifth Legislature, First Regular Session, July 9, 2021, https://www.azleg.gov/legtext/55leg/1R/laws/0425.htm (retrieved July 15, 2021)

[11] HB 2828, Chapter 425, Fifty-fifth Legislature, First Regular Session, July 9, 2021, Section 8

[12] ARS §43-1014.A

[13] ARS §43-1014.A

[14] ARS §43-1014.B.1

[15] ARS §43-1014.B.2

[16] ARS §43-1014.A

[17] ARS §43-1014.D

[18] ARS §43-1014.C

[19] ARS §43-1014.D

[20] ARS §43-1014.B.3 and §43-581.C

[21] ARS §43-1021.16

[22] ARS §43-1021.16

[23] ARS §43-1075.B

[24] ARS §43-1075.A

[25] ARS §43-1075.C

[26] ARS §43-1071.G

[27] ARS §43-1071.G

[28] ARS §43-1021.16

Proposition 208, on the ballot in the 2020 general election, would add a new surcharge to Arizona income taxes that is set to take effect for tax years beginning from and after December 31, 2020—or, for most taxpayers, calendar year 2021 individual tax returns.[1]

As of the early morning following the election, the Proposition held a 135,856 vote lead with the Arizona Republic website showing 85.02% reporting (presumably election day votes in addition to the majority of the early voting ballots).  While not an insurmountable lead, it is very possible that Proposition 208 will pass and thus clients will be calling about its impact. 

So I’ve decided to take the risk and detail how the provision would work, assuming it actually does pass and become law. If that doesn’t happen, treat this as an analysis of a proposed law that never became law–but right now it looks like it will pass (we’ll see if we know more by later in the week).

The details of the provision are outlined below.

New ARS §43-1013.A.1 and 2 provide for the new tax.  The tax applies at a rate of 3.5% on taxable income in excess of

• $250,000 for single individuals or those filing married filing separately[2] or
• $500,000 for those filing as head of household or a married couple filing a joint return.[3]

The new section reads as follows:

43-1013. Income tax surcharge for public education

A. In addition to any other tax imposed by this chapter, for taxable years beginning from and after December 31, 2020, there shall be levied, collected and paid an income tax surcharge to advance public education in this state as follows:

1. In the case of a single person or a married person filing separately, a surcharge at the rate of three and one-half percent of taxable income in excess of $250,000.

2. In the case of a married couple filing a joint return or a single person who is a head of household, a surcharge at the rate of three and one-half percent of taxable income in excess of $500,000.

B. Notwithstanding sections 42-1116 and 43-206, the department shall separately account for revenues collected pursuant to the income tax surcharge imposed by this section, and shall deposit those revenues in the student support and safety fund established by section 15-1281.

C. The income tax surcharge levied by this section must be collected regardless of whether the income tax rate brackets in this chapter are changed, replaced or eliminated by an act of the legislature.[4]

EXAMPLE 1, MARRIED COUPLE FILING JOINT RETURN, BELOW EXEMPTION LEVEL

Wayne and Susan are a married couple filing a joint return.  Their Arizona taxable income for 2021 is $450,000.  Since their taxable income is less than $500,000 (the surtax level found at ARS §43-1013.A.2 for the married filing joint status), they will not face an addition to their Arizona income tax for 2021 under ARS §43-1013.

EXAMPLE 2, SINGLE INDIVIDUAL

Wilma, an unmarried individual who has a filing status of single, has Arizona taxable income of $600,000 for 2021.  In addition to the regular Arizona income tax due on Wilma’s 2021 Arizona income tax return, Wilma will owe an additional surcharge under ARS §43-1013 of $12,250 (3.5% of ($600,000 – $250,000)).

EXAMPLE 3, HEAD OF HOUSEHOLD

Assume the same facts as in Example 2, except that Wilma qualifies to file as head of household.  In that case, Wilma’s additional tax under ARS §43-1013 will be $3,500 (3.5% of ($600,000 – $500,000)).

EXAMPLE 4, MARRIAGE CREATING A TAX REDUCTION UNDER ARS §43-1013

Robert and Cynthia are considering getting married before the end of 2021.  Robert’s Arizona taxable income if he remains unmarried at year end and files as a single individual will be $400,000, while Cynthia’s Arizona taxable income as a single individual will be $75,000.  If they are married before year end their joint Arizona taxable income will be $475,000 (note, this would not have to be the case, but we will assume that for purposes of this illustration).  If they are married they plan to file a joint return.

If they do not marry before the end of 2021, Robert will face a §43-1013 surcharge of $5,250 while Cynthia will not have any surcharge applied to her return.

If the couple does marry before year end, there will be no surcharge on their joint return as their taxable income will be below the surcharge level.  Thus, in this case a marriage would reduce their combined surcharge.

EXAMPE 5, MARRIAGE CREATING A TAX INCREASE UNDER ARS §43-1013

The impact of marriage is a bit different in certain cases where one or both of the individuals considering marriage qualify for head of household filing status.

If we assume that Robert has a dependent that would qualify him for head of household filing status, and that Cynthia’s Arizona taxable income is $250,000 the results are a bit different.  We will again assume that the couple’s joint Arizona taxable income would the total of their individual filing status taxable incomes, or $725,000 in this case.

If they do not marry before the end of 2021 there will be no §43-1013 surcharge imposed on either tax return. Robert’s taxable income of $475,000 is below the $500,000 level at which the surcharge begins to be imposed on head of household filing status taxpayers, while Cynthia’s taxable income is at the maximum level she could have as a single individual without triggering the tax.

But if the couple marries, they now will see their combined income tested against a single $500,000 Arizona taxable income level before they begin to pay a surcharge—that is, exactly the same amount as Robert was granted when filing head of household status.  The joint return would see a §43-1013 tax imposed on $225,000 ($725,000 – $500,000), for a surcharge of $7,875 (3.5% of $225,000).

Special rules apply to the Department of Revenue’s rulemaking for this provision, found in Section 7 of the Proposition:

Section 7. Exemption from rulemaking

For the purposes of adopting rules to implement this act, and for twenty-four months after the effective date of this act, the department of education, the state board of education and the department of revenue are exempt from both of the following:

1. Any executive order or other directive purporting to limit or restrict the ability of the department of education, the state board of education and the department of revenue to adopt new rules.

2. The rulemaking requirements of title 41, chapters 6 and 6.1, Arizona Revised Statutes, except that each department shall provide the public with a reasonable opportunity to comment on proposed rules and shall publish otherwise-exempted rules.[5]

[1] ARS §43-1013, Added by Proposition 208, 2020 General Election, November 3, 2020

[2] ARS §43-1013.A.2

[3] ARS §43-1013.A.3

[4] Proposition 208, 2020 General Election, Section 5, November 3, 2020

[5] Proposition 208, 2020 General Election, Section 7, November 3, 2020

The Arizona Department of Revenue announced that the agency is now accepting electronically filed corporate and partnership income tax returns.[1]  Arizona had been one of the few states, if not the only one, that could not accept electronically filed entity returns.

The news release on the website notes that while the program is voluntary for 2019 returns, beginning with 2020 returns these entities will be required to file return electronically.  The statement provides:

Legislation signed into law in 2017 gives companies an e-file option in 2020 for tax year 2019 and becomes mandatory for corporations starting in 2021 for tax year 2020 returns.
The 2017 legislation also initiated a multi-year phase-in period for businesses required to file and pay transaction privilege tax (TPT) electronically. In 2019, the e-filing threshold was $10,000 with 77 percent of the more than 2.1 million TPT returns filed electronically. For 2020, businesses with an annual transaction privilege tax and use tax liability of $5,000 or more during the prior calendar year, will be required to file and pay electronically. In 2021, the threshold is reduced to $500 or more during the prior calendar year.

Arizona Department of Revenue News Release – January 6, 2020

[1] “Electronic Filing Now Available for Corporate Taxpayers in 2020,” Arizona Department of Revenue website, January 6, 2020, (https://azdor.gov/news-events-notices/news/electronic-filing-now-available-corporate-taxpayers-2020  Retrieved January 7, 2020)