Small Business Income and Surcharge Guidance

2022 Small Business Income Tax (SBI) Estimated Tax Payments

First, second, third, and fourth quarter Arizona SBI estimated tax payments are not required of taxpayers who make the SBI tax election on their tax year 2022 returns.

Arizona's Small Business Income Tax (SBI) is a new tax that allows individual taxpayers to report their small business income on a separate return at a flat 3.0% tax rate for tax year 2022. Arizona taxpayers are currently unable to determine if making the SBI election will be beneficial or detrimental to their overall 2022 tax liability due to uncertainty surrounding Arizona's 2022 individual income tax rates¹.

Arizona Revised Statutes (A.R.S.) § 43-583 requires that taxpayers who are subject to SBI to make estimated tax payments if their SBI tax liability for the taxable year is at least $1,000. A.R.S. § 43-583(B) provides that the amount of the required annual estimated tax payment is the lesser of

• 90% of the tax shown on the return for the current tax year, or
• 100% of the tax shown on the SBI return for the preceding tax year.

While Arizona's 2022 individual income tax rates will be known at some point later this year, it is unlikely the rates will be known before the 1st quarter estimated due date of April 18, 2022. As a result of this uncertainty, ADOR is waiving all four SBI estimates for tax year 2022. Arizona taxpayers who do not make SBI estimates for tax years 2022 will not incur a penalty under A.R.S. § 42-1125(Q). Arizona taxpayers are welcome to make voluntary SBI estimated tax payments using Arizona Form 140ES-SBI.

Nothing in this notice should be construed as waiving 2022 Arizona individual income or corporate income estimated tax payments.

This guidance will be amended or superseded as needed by future legislative action.

For further questions, please contact [email protected].

Taxpayer Guidance on Prop 208

Responding to an order of remand from the Arizona Supreme Court, on Friday, March 11, 2022, Maricopa Superior Court judge John R. Hannah Jr. issued a ruling that permanently enjoins the Arizona Department of Revenue from administering or collecting the income tax surcharge levied by 2020’s Arizona Proposition 208 (the “Prop 208 Surcharge”).

What Was the Prop 208 Surcharge?

Proposition 208 added a 3.5% individual income tax surcharge for public education on the portion of taxable income over $250,000 ($500,000 in the case of married couples filing jointly).  The surcharge was in addition to the top regular income tax rate of 4.5%, which would have resulted in a top combined rate of 8% had further action not been taken. 

2021 Tax Law Changes Prevented an Increase in Overall Individual Income Tax Liability

As part of the 2021 budget reconciliation process, statutory changes were enacted to ensure that the combined rate of the Prop 208 Surcharge and top regular income tax rate could not exceed 4.5%.  The changes further required that, if the combined rate exceeded 4.5%, the top regular income tax rate would be adjusted downward to bring the combined rate to 4.5%.   Therefore, with the 3.5% Prop 208 surcharge, the top income tax rate was reduced to 1% to bring the combined rate to 4.5%. 

There Will Be No Net Change to Individual Income Tax Liability from the Injunction of the Surcharge

With Proposition 208 voided as unconstitutional, the Prop 208 Surcharge due from taxpayers drops to 0%.  Under current law, this means that the top income tax rate will return to 4.5%. Arizona taxpayers will neither owe more tax nor receive a larger refund due to the voiding of the Prop 208 Surcharge. Instead, the monies that taxpayers have paid toward the Prop 208 Surcharge will be applied to satisfy taxpayers’ regular Arizona individual income tax liabilities for the same tax year.

Taxpayers Who Have Already Filed Don’t Need to Amend Their Returns

Because the change will not impact individuals’ overall individual income tax liability and only affects the distribution of monies paid, taxpayers who file their Arizona individual income tax returns before changes are incorporated will not need to amend their returns.  The Department held these returns in suspense and has been processing them correctly since modifying its tax system to remove the surcharge and amend the tax bracket rates. ADOR is automatically adjust the returns to provide for the correct distribution of monies.

What If I Haven't Filed?

As noted, despite the fact that this late-breaking change is occurring in the midst of tax season, ADOR corrected the individual income tax forms by eliminating the Prop 208 Surcharge line and adjusting the individual income tax brackets to the proper rates. ADOR is also working with its tax software vendor partners to change their individual tax forms and tax brackets.

Because of the 2021 tax law changes, the total amount you owe in taxes will remain the same, and you will not have to take any further action to amend your return.  

Regardless of the tax form you ultimately use, your return were due on Monday, April 18, 2022, unless you request an extension on or before that date.

Forms

Updated forms and tax table have been posted to eliminate the Prop 208 Surcharge line and adjust the individual income tax brackets to the proper rates.

Small Business Income

The Arizona Department of Revenue (ADOR) administers Arizona’s tax system based on laws passed and signed by the governor. Like other initiatives, ADOR analyzes the legislation and the administrative and technical impact to the Department.

As it pertains to new tax laws, the Department of Revenue is committed to working with individual taxpayers to provide a smooth experience filing and paying income tax.

Senate Bill 1783 - Small Business Income

Senate Bill 1783 allows individual taxpayers to elect to have their “Arizona small business adjusted gross income” removed from their regular individual income tax return and taxed on a separate “Arizona small business income tax return.”

For taxable years beginning from and after December 31, 2020, a small business taxpayer may elect to file a return for the taxable year with ADOR to report that small business taxpayer’s share of Arizona small business gross income.

A “small business taxpayer” means any individual taxpayer who reports on their federal income tax return any income that constitutes Arizona small business gross incomes as defined below:

“Arizona small business gross income” of a resident taxpayer means the sum of the amounts, whether positive or negative, that are included in a taxpayer’s federal adjusted gross income for the taxable year, computed according to the internal revenue code, and that are reported on the following schedules and forms or on equivalent successor schedules and forms designated by the Internal Revenue Service:

• Schedule B, interest and ordinary dividends.
• Schedule C, profit or loss from business.
• Schedule E, supplemental income or loss.
• Schedule F, profit or loss from farming.
• Form 4797, sale of business property.
• Form 4835, farm rental income and expenses.

Includes any amount reported on Schedule D, capital gains and losses, that is recognized concerning either the taxable disposition of an ownership interest in any entity other than a publicly-traded entity, or the taxable disposition of capital assets used in connection with a trade or business activity, including goodwill and going concern value.

The Arizona small business return is subject to most of the additions and subtractions provided in the individual income tax chapter to the extent the adjustments directly relate to the small business income.

Deductions claimed on the federal return are only included in the Arizona small business return if they are already included in the net amounts reported on the federal schedules listed in the definition of “Arizona small business gross income.”

Business credits that would normally be allowed on the individual income tax return will instead be allowed on the Arizona small business return.  Any excess business credits remaining after offsetting the Arizona small business return will be allowed to offset tax on the individual income tax return.  Credits not derived from business activities remain with the regular individual income tax return.

If an Arizona small business taxpayer makes the election under section Arizona Revised Statutes (A.R.S.) § 43-302, there shall be levied, collected, and paid for each taxable year on the Arizona small business taxable income an amount equal to 3.5% of the Arizona small business taxable income.

Small Business Income Frequently Asked Questions

For small businesses needing additional clarity on SBI, see the frequently asked questions.

¹During the 2021 legislative session, the Arizona Legislature lowered the 2022 individual income tax rates to two rates, a starting rate of 2.55% and a maximum rate of 2.98% as taxable income increases.  These lowered tax rates are subject to being challenged by voter referendum in the November 2022 election.  If the voters vote against the tax cuts, the highest ordinary rate in 2022 would return to the 2021 tax rates, meaning the highest rate would reset to 4.5%.  However, if the voters vote to keep the reduced rates, the new rates would be 2.55% and 2.98%, both of which are lower than the 2022 SBI tax rate of 3.0%.