United States: Arizona Individual Income Taxation

Originally Published April 26, 2001

The Arizona individual income tax structure conforms generally to the federal Internal Revenue Code. It is the specific intent of the Arizona Legislature:

"To adopt the provisions of the federal Internal Revenue Code relating to the measurement of adjusted gross income for individuals, to the end that adjusted gross income reported each taxable year by an individual to the Internal Revenue Service shall be the identical sum reported to this state, subject only to modifications contained in this title [A.R.S. Section 43-101, et seq.]" A.R.S. Section 43-102.A.1

Additionally, it is the legislative objective to achieve that result by the application of the various provisions of the federal Internal Revenue Code relating to the definitions of income, exceptions, deductions, accounting methods, taxation of individuals, corporations, estates and partnerships, basis and other pertinent provisions relating to gross income as defined, resulting in an amount called "adjusted gross income for individuals." [Taxable income for corporations, trust, estates and partnership in the Internal Revenue Code] A.R.S. Section 43-102.A.3

Residents and non-residents. It is the legislative intent to impose on each resident of Arizona an income tax measured by taxable income wherever derived. As for non-residents, it is the legislative intent to impose on each non-resident and each corporation with a business situs in Arizona a tax measured by taxable income which is the result of activity within or derived from sources within the state. A.R.S. Section 43-102.A.5.

Adoption of the Internal Revenue Code of 1986. For purposes of computing the Arizona income tax for taxable years beginning from and after December 31, 1999 through December 31, 2000, Arizona refers to the Internal Revenue Code and defines that Code to mean "The United States Internal Revenue Code of 1986, as amended, in effect on January 1, 2000, including those provisions that become effective during 1999 with the specific adoption of all federal retroactive effective dates, but excluding any change to the Code enacted after January 1, 2000." A.R.S. Section 43.105.A. The Arizona Legislature annually amends this Section to define the Internal Revenue Code as the "Code in effect for that tax year."

Determining an individual’s Arizona tax liability is a several stage process, composed of the following:

These steps are detailed below.

A.R.S. Section 43-1000 and 1 provides that "Arizona gross income of a resident individual means his federal adjusted gross income for the taxable year, computed pursuant to the internal revenue code." A.R.S. Section 43-1001.2

"Arizona adjusted gross income of a resident individual means his Arizona gross income subject to the modifications specified in Sections 43-1021 [additions to income] and 43-1022 [subtractions from income]." A.R.S. Section 43-1001.1

In computing Arizona adjusted gross income, the following amounts are to be added to Arizona gross income:

1. A beneficiary’s share of trust or estate income includable under § 43-1344.
2. A beneficiary’s share of trust or estate deductions allowable under the internal revenue code.
3. An amount equal to the "ordinary income portion" of a lump sum distribution that was excluded from federal adjusted gross income pursuant to § 402(d) of the internal revenue code.
4. The amount of interest income received on obligations of any state, territory or possession of the United States, or any political subdivision thereof, located outside the state of Arizona, reduced, for tax years beginning from and after December 31, 1996, by the amount of any interest on indebtedness sand other related expenses that were incurred or continued to purchase or carry those obligation sand that are not otherwise deducted or subtracted in arriving at Arizona gross income.
5. Annuity income received during the taxable year to the extent that the sum of the proceeds received from such annuity in all taxable years prior to and including the current taxable year exceeds the total consideration and premiums paid by the taxpayer. This paragraph applies only to those annuities with respect to which the first payment was received prior to December 31, 1978.
6. The excess of a partner’s share of partnership taxable income required to be included under chapter 14, article 2 of this title over the income required to be reported under § 702(A)(8) of the internal revenue code.
7. The excess of a partner’s share of partnership losses determined pursuant to § 701(a)(8) of the internal revenue code over the losses allowable under chapter 14, article 2 of this title.
8. The amount by which the adjusted basis of property described in this paragraph and computed pursuant to the internal revenue code exceeds the adjusted basis of such property computed pursuant to this title and the income tax act of 1954, as amended. This paragraph shall apply to all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year, except depreciable property used in a trade or business.
9. The amount of depreciation or amortization of costs of any capital investment that is deduction pursuant to § 167 of 179 of the internal revenue code by a qualified defense contractor with respect to which an election is made to amortize pursuant to § 43-1024.
10. The amount of gain from the sale or other disposition of a capital investment which a qualified defense contractor ha selected to amortize pursuant to § 43-1024.
11. The amount of depreciation or amortization of costs of child care facilities deducted pursuant to § 167 or 188 or the internal revenue code for which a credit is taken under § 43-1075, subsection A. paragraph 1.
12. Amounts withdrawn from the Arizona state retirement system, the corrections officer retirement plan, the public safety personnel retirement system, the elected officials’ retirement plan or a county or city retirement plan by an employee upon termination of employment before retirement to the extent they were deducted in arriving at Arizona taxable income in any year.
13. That portion of the net operating loss included in federal adjusted gross income which has already been taken as a net operating loss for Arizona purposes or which is separately taken as a subtraction under the special net operating loss transition rule.
14. Any nonitemized amount deducted pursuant to § 170 of the internal revenue code representing contributions to an educational institution which denies admission, enrollment or board and room accommodations on the basis of race, color or ethnic background except those institutions primarily established for the education of American Indians.
15. The amount of depreciation or amortization of costs of recycling equipment deducted pursuant to the internal revenue code for which an election is made pursuant to § 43-1076.
16. The amount paid as taxes on property in this state with respect to which a credit is claimed under §43-1078.
17. Amounts withdrawn from a medical savings account by the individual during the taxable year computed pursuant to § 220(f) of the internal revenue code and not included in federal adjusted gross income.
18. Any amount of agricultural water conservation expenses that were deducted pursuant to the internal revenue code for which a credit is claimed under § 43-1084.
19. The amount by which the depreciation or amortization computed under the internal revenue code with respect to property for which a credit was taken under § 43-1080 exceeds the amount of depreciation or amortization computed pursuant to the internal code on the Arizona adjusted basis of the property.
20. The amount by which the adjusted basis computed under the internal revenue code with respect to property for which a credit was claimed under § 43-1080 and which is sold or otherwise disposed of during the taxable year exceeds the adjusted basis of the property computed under § 43-1080.
21. The amount by which the depreciation or amortization computed under the internal revenue code with respect to property for which a credit was taken under either § 43-1081 or 43-1081.01 exceeds the amount of depreciation or amortization computed pursuant to the internal revenue code on the Arizona adjusted basis of the property.
22. The amount by which the adjusted basis computed under the internal revenue code with respect to property for which a credit was claimed under either § 43-1081 or 43-1081.01 and which is sold or otherwise disposed of during the taxable year exceeds the adjusted basis of the property computed under §43-1081 or 43-1081.01, as applicable.
23. The deduction referred to in § 1341(a)(4) of the internal revenue code for restoration of a substantial amount held under a claim of right.
24. The amount by which a net operating loss carryover or capital loss carryover allowable pursuant to § 1341(b)(5) of the internal revenue code exceeds of the net operating loss carryover or capital loss carryover allowable pursuant to § 43-1029, subsection F.
25. Any amount deducted pursuant to § 170 of the internal revenue code representing contributions to a school tuition organization or a public school for which a credit is claimed under § 43-1089 or 43-1089.
26. Any amount deducted in computing Arizona gross income as expenses for installing solar stub outs or electric vehicle recharge outlets in this state with respect to which a credit is claimed pursuant to § 43-1090.
27. Any wage expenses deducted pursuant to the internal revenue code for which a credit is claimed under § 43-1087 and representing net increases in qualified employment positions for employment of temporary assistance for needy families recipients.
28. Any amount deducted pursuant to § 170 of the internal revenue code representing the contribution of a motor vehicle for which a credit is claimed pursuant to § 43-1090.
29. Any amount deducted for conveying ownership or development rights of property to an agricultural preservation district under §48-5702 for which a credit is claimed under §43-1081.02.

Step 3. Subtractions from Arizona Gross Income.

In computing Arizona adjusted gross income, the following amounts are to be subtracted from Arizona gross income:

1. The amount of exemptions allowed by § 43-1023.
2. Benefits, annuities and pensions in an amount totaling not more than two thousand five hundred dollars received from one or more of the following:
   
   (a) The United States government service retirement and disability fund,
   retired or retainer pay of the uniformed services of the United States, the United States foreign service retirement and disability system and any other retirement system or plan established by federal law.
   (b) The statement retirement system, the state retirement plan, the corrections officers retirement plan, the public safety personnel retirement system, the elected officials’ retirement plan, an optional retirement program established by the Arizona board of regents under § 15-1628, an optional retirement program established by a community college district board under §15-1451, or a retirement plan established for employees of a county, city or town in this state.
3. A beneficiary’s share of trust or estate income recognized pursuant to the internal revenue code.
4. The amount of any distributions from an individual retirement account as provided for in § 408 of the internal revenue code or from a qualified retirement plan of a self-employed individual as provided for in § 401 of the internal revenue code to the extent that total adjustments made pursuant to this paragraph in all tax years do not exceed the total of all contributions made by the taxpayer to such plans prior to December 31, 1975, which were included in computing Arizona taxable income.
5. The amount of income on an installment receivable which is recognized pursuant to the internal revenue code and which has already been recognized on the death of the taxpayer for purposes of this title for tax years ending before January 1, 1990.
6. Interest income received on obligations of the United States, less any interest on indebtedness, or other related expenses, and deducted in arriving at Arizona gross income, which were incurred or continued to purchase or carry such obligations.
7. The amount of any income tax refunds which were received from states other than Arizona and which were included as income in computing federal adjusted gross income.
8. Annuity income included in federal adjusted gross income pursuant to § 72 of the internal revenue code if the first payment with respect to such annuity was received prior to December 31, 1978.
9. The excess of a partner’s share of income required to be included under § 702(1)(8) of the internal revenue code over the income required to be included under chapter 14, article 2 of this title.
10. The excess of a partner’s share of partnership losses determined pursuant to chapter 14, article 2 of this title cover the losses allowable under § 702(a)(8) of the internal revenue code.
11. The amount by which the adjusted basis of property described in this paragraph and computed pursuant to this title and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the internal revenue code. This paragraph shall apply to all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade of business.
12. The amount allowed by § 43-1024 for amortization, by a qualified defense contractor certified by the department of commerce under § 41-1508, of a capital investment for private commercial activities.
13. The amount of gain included in federal adjusted gross income on the sale or other disposition of a capital investment that a qualified defense contractor has elected to amortize pursuant to § 43-1024.
14. The amount allowed by § 43-1025 for contribution during the taxable year of agricultural crops to charitable organizations.
15. The portion of any wages or salaries paid or incurred by the taxpayer for the taxable year that is equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips and the Indian employment credit that the taxpayer received under §§ 45A, 45B, 51(a) and 1396 of the internal revenue code.
16. The amount of prizes or winnings less than five thousand dollars in a single taxable year from any of the state lotteries established and operated pursuant to title 5, chapter 5, article 1, except that all such winnings before March 22, 1983, and including periodic distributions from such winnings made after March 22, 1983, may be subtracted.
17. The amount of exploration expenses that is determined pursuant to § 617 of the internal revenue code, that has been deferred in a taxable year ending before January 1, 1990 and for which a subtraction has not previously been made. The subtraction shall be made on a ratable basis as the units of produced ores or mineral discovered or explored as a result of this exploration are sold.
18. The amount included in federal adjusted gross income pursuant to § 86 of the internal revenue code, relating to taxation of social security and railroad retirement benefits.
19. To the extent not already excluded from Arizona gross income under § 112 of the internal revenue code, compensation received for active service as a member of the armed forces of the United States for any month during any part of which the member served in a combat zone as determined under § 112 of the internal revenue code or in an area given the same treatment as a combat zone for purposes of § 112 of the internal revenue code.
20. The amount of unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption not to exceed three thousand dollars. In the case of a husband and wife who file separate returns, the subtraction may be taken by either taxpayer or may be divided between them, but the total subtractions allowed both husband and wife shall not exceed three thousand dollars. The subtraction under this paragraph may be taken for the costs that are described in this paragraph and that are incurred in prior years, but the subtraction may be taken only in the year during which the final adoption order is granted.
21. The amount authorized by § 43-1027 for the taxable year relating to qualified wood stoves, wood fireplaces or gas fired fireplaces.
22. With respect to a medical savings account established pursuant to § 43-1028:
    
    (a) An eligible individual may subtract:
    
    (i) The amount of contributions made by the individual’s employer during the taxable year to the individual’s medical savings account pursuant to § 43-1028 to the extent that the employer contributions are included in the individual’s federal adjusted gross income.
    (ii) the amount deposited by the individual in the account during the taxable year to the extent that the individual’s contributions are included in the individual’s federal adjusted gross income.
    
    (b) The individual’s employer may subtract the amount of contributions made by the employer to a medical savings account established on the individual’s behalf to the extent that the contributions are not deductible under the internal revenue code.
23. The amount by which a net operating loss carryover or capital loss carryover allowable pursuant to § 43-1029, subsection F exceeds the net operating loss carryover or capital loss carryover allowable pursuant to § 1341(b)(5) of the internal revenue code.
24. Any amount of qualified educational expenses that is distributed from a qualified state tuition program determined pursuant to § 529 of the internal revenue code and that is included in income in computing federal adjusted gross income.
25. Any item of income resulting from an installment sale that has been properly subjected to tax in another state in a previous taxable year and that is included in Arizona gross income in the current taxable year.
26. Any item of income resulting from an installment sale that has been properly subject to income tax in another state in a previous year and that is included in Arizona gross income in the current taxable year.
27. The amount authorized by § 43-1030 relating to holocaust survivors.
28. The amount authorized by § 43-1031 for constructing an energy efficient residence. A.R.S. § 43-1011

The taxpayer is allowed the following exemptions:

1. If the taxpayer or spouse is blind - $1,000.
2. 2. Dependents - $2,300.
3. Persons aged 65 or older regardless of the person’s relationship to the taxpayer if the taxpayer pays more than one-fourth of the cost of maintaining that person in a nursing case institution, residential care institution or an assisted living facility.
4. Parents. For taxable years beginning from and after December 31, 1998, a resident taxpayer is allowed an exemption of $10,000 for each parent or ancestor of a parent who was aged 65 or older which requires assistance with activities of daily living and who lives in the taxpayer’s principal residence for the entire taxable year, if the taxpayer pays more than one-half of the person’s support.
5. If taxpayer is age 65 or older - $2,100.

Additionally, the following adjustments are to be taken into account in determining Arizona adjusted gross income:

1. Amortization of private commercial Capital investment by qualified defense contractor. A.R.S. § 43-1024.
2. Subtraction for agricultural crops contributed to charitable organizations. A.R.S. § 43-1025.
3. Subtraction for alternative fuel vehicles and equipment (repealed effective May 5, 1999). A.R.S. § 43-1026.
4. Subtraction for wood stoves, wood fireplace or gas fired fireplaces. A.R.S. § 43-1027.
5. Subtraction for contribution to medical savings accounts. A.R.S. § 43-1028.
6. Subtraction for restoration of a substantial amount held under claim of right. A.R.S. § 43-1028.

After the above additions, subtractions, other adjustments and exemptions for blind and over 65 are made, the result is Arizona adjusted gross income. See A.R.S. § 43-1001.1.

The next step in the process for determining taxable income is the subtraction of deductions, either the optional standard deduction, or itemized deductions.

Optional standard deduction. A taxpayer, at his or her election may take the standard deduction as follows:

Itemized deductions. A taxpayer that his or her election in computing taxable income may take the amount of itemized deductions allowable for the taxable year pursuant to subtitle A, chapter 1, subchapter B, plus V and VII of the internal revenue code (subject to the limitations prescribed by § 66, 68 and 274 of the internal revenue code.

Medical expenses. In lieu of the amount of the federal itemized deduction for medical expenses, an Arizona taxpayer may deduct the full amount of such medical expenses (without regard to federal adjusted gross income). A.R.S. § 43-1042.

The next calculation is the subtraction of the taxpayer’s personal exemptions.

1. Single individual - $2,100
2. Head of household of married individual - $4,200
3. Husband and wife to receive one personal exemption of $4,200 and if the husband and wife make separate returns, the personal exemption may be taken by either or divided between them.
4. A married couple claiming at least one dependent - $6,300. If the husband and wife make separate returns, the personal exemption may be taken by either of them or divided between them. This exemption is in lieu of the $4,200 exemption.

After subtraction of deductions and personal exemptions from Arizona adjusted gross income, the result is Arizona taxable income. A.R.S. §43-1001.11

Taxable income is then multiplied by the applicable tax rate and the result is one’s Arizona tax liability. The tax rates follow:

Single person or a married person filing separately:

Married couple filing a joint return or a single person who is a head of a household:

Optional tax table. For individuals who have been a resident of Arizona for the entire taxable year and whose taxable income is less than $50,000, regardless of filing status, may compute his or her tax based on the rates prescribed by § 43-1011 (see above) as shown in optional tax tables developed by the Arizona Department of Revenue. The tables prescribed by the tax liability amounts, based on filing status, in $50 increments of taxable income. The optional tax tables cannot be used by an individual filing a return for a period of less than 12 months because of the change in accounting period. Additionally, a married individual whose spouse files a return and computes the tax without regarding to the optional tax tables may not use the optional tax table. An individual who is not a head of a household or married person will be treated as a single person. A.R.S. § 43-1012.

Step 11. Minus tax credits. Arizona has a multitude of tax credits for individuals. They are:

1. Credit for income taxes paid to other states. A.R.S. § 43-1071.
2. Earned credit for property taxes for residents 65 years of age or older. A.R.S. § 43-1072.
3. Credit for increased excise taxes paid. A.R.S. § 43-1073.01.
4. Family income tax credit. A.R.S. § 43-1073.
5. Credit for increased employment in enterprise zones. A.R.S. § 43-1074.
6. Credit for increased research activities. A.R.S. § 43-1074.01.
7. Credit for dependent daycare facilities. A.R.S. § 43-1075.
8. Recycling equipment tax credit (recapture provisions). A.R.S. § 43-1076.
9. Credit for employment of qualified defense contractor. A.R.S. § 43-1077.
10. Credit for property taxes paid by qualified defense contractor. A.R.S. § 43-1078.
11. Credit for increased employment in military reuse zones. A.R.S. § 43-1079.
12. Credit for construction costs of qualified environmental technology facilities. A.R.S. § 43-1080.
13. Credit for pollution control equipment. A.R.S. § 43-1081.
14. Credit for agricultural pollution control equipment. A.R.S. § 43-1081.01.
15. Credit for taxpayers participating in agricultural preservation districts. A.R.S. § 43-1081.02.
16. Credit for construction materials incorporated into qualifying facility. A.R.S. § 43-1082.
17. Credit for solar energy devices. A.R.S. § 43-1083.
18. Credit for alternative fuel vehicles [note: repealed effective December 1, 2000]. A.R.S. § 43-1086.
19. Credit for vehicle refueling apparatus and infrastructure [note: repealed effective December 1, 2000]. A.R.S. § 43-1086.01.
20. Credit for alternative fuel delivery systems [note: repealed effective December 1, 2000]. A.R.S. § 43-1086.02.
21. Credit for employment of temporary assistance for needy families recipients. A.R.S. § 43-1087.
22. Credit for contribution to charitable organization that provides assistance to the working poor. A.R.S. § 43-1088.
23. Credit for technology training. A.R.S. § 43-1088.01.
24. Credit for contributions to school tuition organizations [for scholarships to be given to students at private schools]. A.R.S. § 43-1089.
25. Tax credit for public school fees and contributions. A.R.S. § 43-1089.01.
26. Credit for donation of school site [effective January 1, 2001]. A.R.S. § 43-1089.02.
27. Credit for solar hot water heater plumbing stub outs and electric vehicle recharge outlets installed in houses constructed by a taxpayer. A.R.S. § 43-1090.
28. Credit for donation of motor vehicle to Wheels to Work program. A.R.S. § 43-1090.01.

After subtracting all applicable credits, the result is an individual’s Arizona income tax liability that must be paid.

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