Arizona PROP 208 – Big Tax Increase Possible in Arizona

On the ballot in Arizona this November is Proposition 208 (the “Proposition”). Proponents assert it will benefit students in public schools. Critics warn it sends most of the increased income tax revenue it generates into the school bureaucracy, not to teachers, as it implies, and will dissuade some businesses and taxpayers from moving to or staying in Arizona. Regardless, some polls indicate at the moment proponents of the measure have the upper hand. For reasons discussed below, there may be greater tax savings to have more Arizona businesses taxed as corporations if this initiative is passed.

Section 5 of the Proposition provides for an income tax surcharge of 3.5% on individual taxpayer. The surcharge is on top of the existing 4.5% income tax and applies to taxable income of married taxpayers above $500,000, and to single and married filing separate individuals above $250,000.

If passed, the maximum income tax rate in Arizona will rise from a middling 4.5% to 8.0%, the eleventh highest state income tax in the country, and the highest in the western continental region, excluding California.

If passed, it will be effective for tax years beginning in 2021, and then the days of Arizona’s reputation as a relatively low state may be over, with some ramifications. There would no longer be as much incentive for higher income individuals to flee to Arizona solely for income tax benefits.

For tax professionals, it is interesting that the language of the Proposition creates a separate statutory income tax section to implement the surcharge. However, the estate and trust income tax rates refer only to the regular tax rate statute, which highest rate is 4.5%, and makes no reference to the new surcharge section. So it appears that the top Arizona estate and trust income tax rate would not change. The corporate tax rates are also not affected. Taxation of flow through entities, such as limited liability companies – not electing to be taxed as corporations, will have their income taxed to their owners, who, if individuals, would be subject to the surcharge rules.

Since the Tax Cuts and Jobs Act enacted in 2017, corporations now enjoy a relatively low federal income tax rate of 21% (reduced from 35% under prior law). Arizona corporations will not be subject to the 3.5% Arizona income tax surcharge. So the rate benefit (and tax savings) for Arizona “C” corporations could now be as high as 17.5% for certain businesses.

Please contact Les Raatz in our Phoenix office (602-285-5022) or any of the other tax attorneys at Dickinson Wright if you wish to further explore this important ballot initiative and plan accordingly.