Arizona Poised to Move to a Flat Tax Rate

Background

After being ruled unconstitutional, the Arizona Department of Revenue recently issued Guidance on Proposition 208. While Prop 208 was working its way through the court system, the Arizona legislature passed several other bills.

Bills, Bills, Bills

H.B. 2838 was signed into law on July 9, 2021. It allows partnerships, LLCs, and S Corporations to pay a 4.5% tax at the entity level in lieu of passing business income through to be taxed at the owner/shareholder level. H.B. 2838 was not affected by the court’s ruling on Prop 208 and will remain in effect for tax periods beginning after December 31, 2021.

Another bill, S.B. 1783, was also signed into law on July 9, 2021. It allows taxpayers to elect to report Arizona small business income on a separate return and taxed at a flat rate. For 2021, this rate was 3.5% and would decrease to 3% in 2022, 2.8% in 2023-2024, and 2.5% for 2025 and thereafter.  

Before Prop 208 was ruled unconstitutional, Arizona individual taxpayers potentially faced an 8% top marginal tax rate. In response, S.B. 1827 was passed to cap the combined top marginal rate at 4.5 percent. However, with Prop 208’s 3.5% surcharge no longer in effect, the bill’s cap is redundant since Arizona’s top marginal rate reverted to the 2020 top rate, which is already 4.5%.

The final bill, S.B. 1828, is poised to have the most significant long-term impact on Arizona taxpayers. S.B. 1828 was successfully petitioned to be on the November 2022 ballot as Proposition 307. However, while the Maricopa County Superior Court ruled that the bill was referable as a ballot measure (and could be voted on by the taxpayers), the Arizona Supreme Court reversed the lower court’s decision in April, allowing the bill to be implemented immediately. Thus, no vote is needed in November.

The Future of Arizona Tax Rates

Beginning in the 2022 tax year, the bill establishes two marginal tax rates for individuals. Single taxpayers would pay 2.55% tax on taxable income up to $27,272 ($54,544 for joint filers), and 2.98% on taxable income exceeding $27,272 ($54,544 for joint filers). The bill also provides for two revenue triggers, the first of which would reduce the 2.55% and 2.98% rates to 2.53% and 2.75%, respectively. After the first trigger is met, the second would enact a flat 2.5% tax.

Arizona looks to be joining several states that have already moved to tax income at a single rate. Some critics are concerned that the tax cuts provide greater benefit to the wealthiest of taxpayers, while others argue that additional deductions and credits will still offer greater benefits to low and middle-income taxpayers. In either case, Arizona taxpayers can expect significant changes to their income tax bills in the coming years.

We Can Help

Contact BeachFleischman if you would like more information or require assistance with your tax planning needs.

Brad Nicholas
Brad Nicholas

Brad Nicholas is a Supervisor at BeachFleischman. He has more than fifteen years of public accounting experience working with privately-held businesses.