PROPOSITION 208 APPROVED BY VOTERS; INCREASES TOP INDIVIDUAL RATE TO 8%; CHALLENGED IN COURT

In the November 2020 election, Arizona voters approved Proposition 208, the "Tax on Incomes Exceeding $250,000 for Teacher Salaries and Schools Initiative," a controversial education-funding proposition. The law would impose a 3.5% surcharge on annual taxable income over $250,000 for single persons or married persons filing separately, or $500,000 for married persons filing jointly or heads of households. The top marginal rate for individuals is 4.5%, and with the 3.5% surcharge, the top rate becomes 8%, which is one of the higher state rates, whereas before, Arizona's top rate was one of the lower state top rates. The revenues from the tax are to be used to increase funding for public education. The tax surcharge is effective beginning with the 2021 income tax year.

On November 30, 2020, the Goldwater Institute, a free-market public policy research and litigation organization, filed a lawsuit on behalf of several members of the Arizona Legislature in Arizona Superior Court, alleging that Prop 208 violates the Arizona Constitution. The suit argues that because Prop 208 authorizes a tax, which pursuant to the state constitution can only be enacted by a two-thirds vote of the state legislature, makes the law thus unconstitutional. The plaintiffs further argue that Prop 208 is unconstitutional because the state constitution prohibits citizens from enacting laws which the legislature cannot itself enact. Finally, the suit alleges that Prop 208 "seeks to exempt itself from the expenditure limitations for school districts specified in the Arizona Constitution," that it violates the Revenue Source Rule because the tax revenue raised would not cover the mandated appropriations, and that it restricts "the legislature's ability to exercise its constitutional authority to appropriate general funds."

Judge John Hannah heard arguments in late December 2020. On January 14, 2021, he issued a ruling rejecting the claim that Prop 208 illegally constrains the ability of the state legislature to control the state budget. He did not rule on the other claims at issue in the suit. It is expected that the Plaintiffs will appeal this ruling.

INCOME TAX

2020 Legislation

House Bill 2494, Chapter 24; Senate Bill 1296, Chapter 40. Annual Internal Revenue Code Conformity; Incorporates the Federal Changes Made in 2019. This bill updates Arizona's federal income tax conformity date for tax years starting after December 31, 2019 to the version of the Internal Revenue Code in effect on January 1, 2020, with the specific adoption of all retroactive effective dates for 2016 through 2019. For tax years beginning between December 31, 2018 and December 31, 2019, the bill updates Arizona's conformity to include the provisions of the Taxpayer First Act (P.L. 116-25) and the Consolidated Appropriations Act of 2020 (P.L. 116-94) that were adopted with retroactive effective dates.

House Bill 2771, Chapter 7. Extends the Credit for Qualified Facilities and the Eligibility Date for the Credit for Renewable Energy Investment and Production for Self Consumption by International Operations Centers. This bill amends the deadline for capital investments in qualifying manufacturing, research, and headquarters facilities. In order to be included in the computation of the tax credit, the capital investment must be made not more than 36 months before submitting the application for pre-approval; previously, investments could be made any time on or after July 1, 2012 to be included. Additionally, net new full-time positions with job duties associated with the qualifying facility are now counted for purposes of determining eligibility for the credit; previously, such jobs were required to be located at the facility. The bill also specifies that international operations centers that qualify for utility relief under A.R.S. § 41-1520 cannot also claim the credit for energy generated for self-consumption under A.R.S. § 43-1164.05. Finally, the bill amends the credit for increased research activity to provide for a 10-year carry over period starting in tax years beginning on or after December 31, 2021.

Senate Bill 1100, Chapter 60. School Tuition Organization Annual Reports to be Posted on the Department of Revenue's Website by March 31. This bill requires the Department of Revenue to post the annual reports received from school tuition organizations ("STO") online by March 31 each year. The annual report is to contain information about the STO, including the total number and amount of contributions received and the total number and amount of scholarships awarded.

Senate Bill 1348, Chapter 43. Annual Tax Corrections Act; Makes Several Substantive Income Tax Changes. This bill makes primarily technical, but some substantive, corrections and changes to Arizona's tax laws. The substantive changes applicable to income tax laws include: (1) updating the requirement for when Arizona tax returns must be filed when income is greater than the amount of the standard deduction; (2) eliminating several additions to Arizona income for individual and corporate tax purposes; (3) eliminating two deductions from Arizona income for individual and corporate tax purposes; (4) clarifying that a taxpayer cannot claim an itemized deduction for a charitable contribution if the taxpayer also claims a credit for the same contribution, even if the contribution is treated as a payment of state income tax; and (5) limiting certain credits to co-owners of a business, including individual partners in a partnership, but not shareholders, of an S-corporation.

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