Arizona conforms to federal tax regulations, delivers tax relief and simplification

Governor Doug Ducey earlier this month signed into law House Bill 2757, making Arizona the latest state to conform to the newest version of the Internal Revenue Code.

The conformity first provides tax rate reductions across the board. More specifically, the state eliminated a bracket and will now have just four tax brackets; anyone making less than $26,500 will be taxed 2.59 percent instead of the previous 2.88 percent. The top three brackets also fell from 4.54 to 4.5 percent, 4.24 to 4.17 percent, and 3.36 to 3.34 percent, as shown below:

“Although Arizona’s changes are modest, they simplify tax compliance, eliminate an unintended tax increase, and are consistent with the principle of seeking a more neutral tax code by broadening bases and lowering rates,” explains Tax Foundation senior policy analyst Jared Walczak. “Arizona is now one of eight states to have cut individual income tax rates as part of the state’s offset for new conformity revenues.”

In addition, HB 2757 increases the standard deduction from $5,312 for a single filer, to $12,200, the same as the current federal deduction. The legislation also replaces the current dependent tax exemption of $2,200 with a more progressive tax credit of $100 per child.

According to Walczak, this is more advantageous for taxpayers.

“Note here that an exemption represents a reduction in taxable income, whereas a credit is a dollar-for-dollar reduction in tax liability,” Walczak said. “Within the lowest bracket, a $2,200 deduction is equivalent to a $57 credit; within the second, $73; within the third, $92; and for the top bracket, $99. Under the new law, a $100 per-dependent credit is available for all filers.”

Overall, passage of the legislation benefits Arizona taxpayers. Tax conformity last year resulted in a one-year tax increase, but the passing of HB 2757 more than offsets the short-term effects.

“Tax conformity makes life easier for taxpayers, because calculations they make on their federal tax forms carry over to their state forms, and provisions within the two codes are more likely to complement each other than to work at cross purposes,” Walczak said. “In the wake of federal tax reform, however, updating a state’s tax conformity date means bringing in base-broadening elements of the new federal tax code without the offsetting rate reductions, yielding a net tax increase at the state level. Arizona took longer than most to reach an agreement, and ultimately wound up imposing a one-year tax increase for 2018, but under the new legislation, base broadening is offset by rate reductions for 2019 onward.”

The bill also included a provision stating that it will not conform to the federal government’s tax on Global Intangible Low-Taxed Income. This means that any income earned by a company’s foreign affiliates or subsidiaries from assets such as patents and copyrights are fully deductible at the state level.

“Policymakers also adopted language clarifying that the state will not seek to tax businesses’ international income, an assurance that is important for the state’s overall tax climate,” Walczak concludes.