Arizona’s alternative tax

Your Guide to State, Local, Federal, Estate + International Taxation

Normally, we don’t think of Arizona as being in the forefront of new changes, but they sure got creative in 2021. In June of 2021, the legislature passed into law Arizona’s alternative tax. This tax is called the Arizona Small Business Income Tax (SBI). Don’t let the title lead you down the garden path – it isn’t really about small business at all.

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The “alternative” part of this tax is that the items that qualify to be taxed this way (more on that in a moment) are taxed at a flat 3%. The top rate in Arizona is 4.5%. So that appears to be quite a savings – right?

Except the reality is that while the top Arizona rate is 4.5%, there are lower tax rates in play until you get to the top rate.  So a flat rate means losing out on the graduated nature of the tax.

In order to determine the lowest amount of Arizona tax to pay for our clients, we need to look at each return individually to see if the items that qualify for the SBI make the overall tax burden less.

Here are items that qualify for SBI treatment:

  • Interest and dividends (I told you to ignore the small business part of the name!)
  • All items on Schedule E (rental properties, royalty income, flow-through activity, such as partnership and S corporation income)
  • Gains or losses included on Form 4797
  • Certain capital gains, if they are used in a trade or business (so not sales in brokerage accounts)

What about the following items, you may ask:

  • Wages – not included in SBI
  • Retirement income, such as pensions, IRA distributions or Social Security income – not included in SBI
  • Taxable gain on the sale of your residence – not included in SBI

There are many other nuances with the filing of these returns, so it is best to reach out to see if you qualify. And it may take longer to get your return prepared, because of the analysis and preparation, so please be patient. Contact your Henry+Horne advisor for more guidance.

Donna Harmon Laubscher, CPA