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
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