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New Taxpayer Guidance on Arizona Proposition 208

Prop 208 background

In November 2020, Arizona voters approved Proposition 208 with a narrow majority of 51.7%. Starting with 2021 tax returns, Prop 208 would impose a 3.5% surcharge on Arizona taxable income over $250,000 for single filers, and $500,000 for joint filers, resulting in an 8% combined top tax rate. 

Before Prop 208, Arizona’s top regular tax rate for 2021 was set at 4.5%.

Lawmakers adjust

In 2021, as part of the budget reconciliation process, Arizona statutes were revised to ensure that the combined top tax rate (regular tax rate plus the Prop 208 Surcharge) could not exceed 4.5%. Under the new law, if the combined top tax rate would otherwise exceed 4.5% (as it would have with Prop 208 in place), the regular income tax rate would be adjusted down to keep the combined rate at 4.5%. Therefore, for the 2021 tax year, Arizona taxpayers who exceeded the $250,000/$500,000 income threshold would be subject to a top regular tax rate of 1%, plus the 3.5% Prop 208 surcharge, for a combined 4.5% top tax rate.

Court Rulings

In August 2021, Prop 208 faced its first major hurdle in the Arizona Supreme Court. The Court ultimately concluded that if the funds raised by the Prop 208 surcharge did not exceed constitutional spending caps on education, then Prop 208 would stand as passed. The Court deferred back to the Maricopa County Superior Court. On March 11, 2022, Maricopa County Superior Court Judge John Hannah determined that spending limits would be exceeded and ruled Prop 208 unconstitutional. 

What does this mean for Arizona taxpayers?

2021 Arizona returns will remain effectively unchanged from a dollar perspective. With the ruling, the Prop 208 surcharge rate is now reduced to 0%, and the top regular tax rate will revert to the original 4.5% rate, resulting in the same 4.5% combined top tax rate. Taxpayers will not experience any changes to their tax due or refund received for 2021.

However, the Arizona Department of Revenue (ADOR) has noted that taxpayers who would have been affected by Prop 208 may experience delays in processing their Arizona return, as it works to implement updates to the tax forms and ensure proper allocation of tax revenues. In the meantime, ADOR has recommended that taxpayers still file their Arizona returns using current forms and instructions, stating that taxpayers’ total tax or refund due will remain the same, and taxpayers will not need to take any further action to amend their Arizona return for the Prop 208 changes.

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