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
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