The Arizona Legislature is currently moving two identical bills, HB 2153 and SB 1106, which propose substantial modifications to the Arizona Revised Statutes (A.R.S.) regarding income taxation in reaction to the enactment of the One Big Beautiful Bill Act. But despite rapid movement this week, it make take quite a while before we get a complete answer to how Arizona will deal with conformity this year.

While introduced separately, the legislature intends to merge these provisions into a single enactment. The legislation updates Arizona’s conformity date with the Internal Revenue Code (IRC), overhauls the standard deduction calculation, and introduces significant new subtractions from gross income for retirement and labor-related income. However the proposal would add a new nonconformity provision related to itemized deductions for state and local taxes.

While the bill is likely to receive approval from both the House Ways and Means Committee and the Senate Finance Committee in a rare joint committee meeting on January 14, the Arizona Capitol Times reported on January 13 that the bill faces a likely veto when it arrives at the Governor’s desk, while the publication also reported Senate President Warren Petersen stated the bill should arrive on her desk in days.

The Governor does not want to deal with conformity to provisions other than the ones she discussed in her Executive Order released in November until an agreement is reached on the budget for this session. So both the Executive Order and this bill appear to be opening proposals in what seems likely to become an extended battle over budget issues this session.

Even if the bill is vetoed, it is likely that eventually the parties will agree to some form of compromise that includes many of these details, so it is helpful to understand what is in this bill. Just don’t be surprised if we don’t get a bill passed and signed into law until well after the April 15 deadline.

Technical Analysis of the Bill

The following technical analysis details the additions, deletions, and modifications contained in the legislation.

I. Internal Revenue Code Conformity (A.R.S. §§ 42-1001, 43-105)

The legislation updates the definition of the “Internal Revenue Code” for Arizona income tax purposes.

• Updated Reference Date: For taxable years beginning from and after December 31, 2025, the definition of the IRC is updated to mean the Code as in effect on January 1, 2026.
• Retroactive Provisions: The bills incorporate provisions that became effective during 2025 with the specific adoption of their retroactive effective dates.
• Historical Conformity: The bills strike out the specific conformity definition for the 2014–2015 period (Subsection K), effectively rolling the historical window forward.

II. Standard and Itemized Deductions (A.R.S. §§ 43-1041, 43-1042)

Perhaps the most structural change involves the decoupling of the Arizona standard deduction from fixed state-statutory dollar amounts.

A. Standard Deduction Coupling (A.R.S. § 43-1041(A))

Practitioners should note that the specific statutory amounts (e.g., $12,200 for single filers) and the accompanying inflation adjustment mechanisms have been deleted.

Instead, the Arizona standard deduction is now statutorily defined as “the amount of the federal basic standard deduction determined pursuant to section 63 of the internal revenue code for the taxpayer’s filing status”. This creates an automatic lockstep with federal inflation adjustments, removing the need for separate state-level inflation calculations previously mandated under the now-repealed Subsection H.

B. Charitable Contribution Adjustment (A.R.S. § 43-1041(H))

For taxpayers electing the standard deduction, the “charitable add-on” calculation (the additional amount allowed beyond the standard deduction) changes significantly for taxable years beginning from and after December 31, 2025:

• Old Law: 25% of total charitable deductions allowed, with the percentage annually adjusted by a factor determined by the rate of inflation.
• New Law: The add-back is equal to 100% of the taxpayer’s charitable contributions as defined in IRC § 170©, but it is subject to a strict statutory cap:
  • $1,000 for single or married filing separately.
  • $2,000 for married couples filing jointly.

C. Itemized Deduction for SALT (A.R.S. § 43-1042(D))

A new provision is added regarding the deduction for state and local taxes (SALT). In lieu of the federal itemized deduction amount allowed under IRC § 164(b)(7), an Arizona taxpayer may deduct up to $10,000 of that amount for state and local taxes. If the bill is enacted into law, Arizona is effectively keeping the “old law” (TCJA) version of the state and local tax deduction, deciding not to conform to the temporary higher deduction allowed on the federal return.

III. Subtractions from Gross Income (A.R.S. §§ 43-1022, 43-1030)

The legislation introduces several new subtractions from Arizona gross income, generally effective for taxable years beginning from and after December 31, 2024. These provisions implement two of the four deductions added to IRC §63 available regardless of whether or not a taxpayer itemizes deductions, but which do not reduce a taxpayer’s federal adjusted gross income. The law provides a substitute for one other of the deductions and quietly declines to adopt the fourth.

A. Labor and Compensation

The two federal Section 63 deductions proposed for adoption into Arizona tax law pertain to compensation.

• Qualified Tips: Taxpayers may subtract the amount of qualified tips received that are deducted under IRC § 224. (ARS §43-1022(31))
• Overtime Compensation: Taxpayers may subtract qualified overtime compensation deducted under IRC § 225. (ARS §43-1022(32))

B. Retirement Income (A.R.S. §§ 43-1022(36) and 43-1030)

The bills introduce a complex subtraction matrix for retirement income involving Roth IRAs and pension distributions.

1. Roth IRA Contributions: A subtraction is allowed for contributions to a Roth IRA (IRC § 408A) made during the taxable year, provided they were not deducted from federal AGI.
2. Pension/Retirement Distributions (New § 43-1030): Taxpayers aged 60 or older may subtract distributions from qualified pension or retirement accounts.
3. Aggregate Limits: The combined subtraction for Roth contributions and pension distributions is capped at:
   • $6,000 for single/head of household/MFS.
   • $12,000 for married filing joint.
4. Means Testing (Phase-out): The subtraction under § 43-1030 (distributions) is reduced by 6% of the amount the taxpayer’s Arizona gross income exceeds:
   • $75,000 (Single/HOH/MFS).
   • $150,000 (MFJ).

This appears to be in lieu of Arizona adopting the over 65 subtraction that the Governor had proposed in her Executive Order.

C. No Tax on Car Interest Deduction Not Adopted

The bill contains no text related to the no tax on car interest deduction added as part of the One Big Beautiful Bill, which serves to decouple Arizona’s taxable income computation from this federal provision.

Arizona tax law starts with federal adjusted gross income and allows itemized deductions by reference to the federal itemized deductions, which means simply updating the IRC conformity date would not bring in a provision that allows a deduction solely in the computation of taxable income as part of IRC §63, such as the deduction for qualified business income under IRC §199A.

So by its silence on the issue, the bill provides that Arizona law will not conform to the federal deduction for certain interest paid to acquire a qualified vehicle.

D. Family and Education

• Dependent Care: Taxpayers may subtract child and dependent care expenses (IRC § 21) that exceed the federal credit amount received. (ARS §43-1022(34))

• Adoption Costs (Post-2025): For taxable years beginning after December 31, 2025, the subtraction limit for adoption costs increases from $3,000 to:

  • $5,000 (Single/HOH).
  • $10,000 (MFJ).

  This provision is already part of Arizona tax law, enacted in 2025’s session to take into account the expiration of a higher temporary increase in the allowable adoption expense.

• 529A/530A Distributions: A subtraction is added for distributions from accounts established pursuant to IRC § 530A (Trump Accounts). (ARS §43-1022(33))

IV. Credits and Other Provisions

A. Dependent Tax Credit (A.R.S. § 43-1073.01)

The bills amend the dependent tax credit amounts. For dependents under seventeen years of age, the credit increases from $100 to $125. The credit for dependents 17 and older remains $25. The phase-out thresholds remain unchanged.

B. Scholarship Granting Organizations (New Chapter 18)

The legislation adds Chapter 18, titled “Scholarship Granting Organizations”.

• Federal Election: Arizona elects to participate in the federal tax credit established by IRC § 25F.
• Certification: The Department of Revenue must certify SGOs that meet IRC § 25F requirements.
• Effective Date: Participation and scholarship issuance under this chapter begin for taxable years from and after December 31, 2026.

V. Summary of Effective Dates

• Retroactive to Tax Years Beginning After Dec 31, 2024:
  • New subtractions for tips, overtime, dependent care, and retirement (Roth/Pension).
  • IRC Conformity update (Jan 1, 2026 reference).
  • Standard Deduction coupling to IRC § 63.
• Effective for Tax Years Beginning After Dec 31, 2025:
  • Charitable contribution standard deduction adjustment.
  • Revised adoption cost subtraction.
  • IRC § 530A (Trump Accounts) (This is the practical effective date, as federal law does not allow any funds to be deposited into a Trump account until July 4, 2026, thus no distributions are possible before that date. Technically this provision takes effect for tax years beginning after December 31, 2024 but it simply could not apply to 2025 returns.)
• Effective for Tax Years Beginning After Dec 31, 2026:
  • Scholarship Granting Organization provisions. (Another practical effective date exists, as the related federal tax credit will not take effect until 2027. Technically, all of these provisions are effective immediately, with the exception of ARS §43-1803, which pertains to organizations issuing SGO scholarships.)

Prepared with assistance from NotebookLM.