Each year the Tax Foundation publishes the State Business Tax Climate Index, which compares the tax systems of all 50 states by examining their corporate, individual income, sales, property, and unemployment tax.
For the last 10 years, Arizona has ranked between the 20th and the 24th best business tax climate in the United States. Among its regional competitors – California, Colorado, Nevada, New Mexico, and Utah – it has consistently ranked below Nevada, Utah, and Colorado but ahead of New Mexico and California.
However, in the past three years, Arizona has made significant progress toward lowering the tax burden on its citizens and businesses with significant changes in three areas of taxation:
- individual income tax,
- commercial property tax, and
- residential rental tax.
The changes helped Arizona crack the top 20 business tax climates for 2023, ranking 19th nationwide and moving Arizona into third place regionally behind Nevada and Utah.
Flat-Rate Income Tax
Under the current law, Arizona taxpayers pay a single flat rate of 2.5%, the lowest top rate of any state with an individual income tax.
In establishing that rate, the Arizona Legislature settled a contentious policy and legal debate that began in 2020, when Arizona voters approved Proposition 208, which would have imposed an income surtax of 3.5% on taxpayers earning incomes over $250,000 ($500,000 for joint filers), resulting in a top marginal tax rate of 8%.
The Arizona Supreme Court ultimately ruled that the proposed tax was unconstitutional. While Prop. 208 was being litigated, the Legislature passed a series of countermeasures, eventually settling on a flat tax plan that eliminated the state’s graduated tax scale, which ranged from 2.59% to 4%.
Commercial Property Tax Reduction
Lowering commercial property taxes received less media attention in recent years but was certainly important for Arizona businesses.
The first change involved a phased-in reduction of the assessment ratio for commercial property. Beginning in 2022, the assessment ratio was reduced from 18% to 17.5%, with further reductions of 0.5% per year until 2025, when it will be set at 16%. This reduction should translate to an approximate 10% savings in commercial property taxes.
The Legislature also accelerated and simplified the depreciation schedule for business personal property. Under the prior law, most business personal property was valued at about 25% of its scheduled depreciated value in the first year it was placed in service. Depending on the asset being depreciated, this value increased to as high as 89% of the scheduled depreciated value in the fifth tax year of assessment.
Under the new law, business personal property placed in service during or after 2022 will be valued at 2.5% of its scheduled deprecation value. Because of the change in the law, a business can expect to see its business personal property tax liability reduced by between 93% and 99%, depending on the equipment.
Abolishing the Residential Rental Tax
In 2023, the Legislature abolished Arizona’s municipal rental residential tax. The new law prohibits municipalities and counties from levying a municipal tax on the business of renting or leasing real property for residential purposes. The law applies to the rental of houses, apartments, condominiums, townhomes, and manufactured and mobile homes for more than 31 days.
The tax rate varies by municipality but is generally between 2% and 2.5% of the total amount paid by a tenant to the lessor, which includes not just rent but also any fees passed on to a tenant (e.g., late fees, pet fees, non-refundable deposits, HOA fees, common area fees). The law also requires landlords to stop charging tenants for the tax. The existing law will remain in effect until January 1, 2025.
While Arizona abolished its rental residential tax, its tax on leasing property (land or structure) for commercial purposes (i.e., the commercial lease tax) remains in effect, as does the taxing of many other business activities, such as transportation, publishing, job printing, amusements, and the renting of personal property.
Conclusion
These and other recent changes to Arizona’s tax policy should help Arizona remain strongly competitive with its neighbors for years to come.
Douglas S. John represents individuals and companies in state and local tax and property tax matters. For more information on these tax changes and other state and local tax issues, please contact Mr. John by email.
