State and local governments have different agendas than the Federal government. The former seeks to protect their constituents’ interests, win funding for them, and gain advantages unique to their economic and regional characteristics. The latter often struggles to gain consensus which sometimes creates provisions within the laws that are less ideal for those impacted.
In February 2023, Arizona updated their guidelines and FAQs (frequently asked questions) to further define their 2022 law that implemented a PTE tax and corresponding deductible credit for certain business owners. They also provided examples for taxpayers that are shareholders in an S corporation or have partnerships with pass-through entities. (Department of Revenue Publication 713). While regulations are similar for shareholders and partners, some require different treatment. Careful reading of the regulation is necessary.
Recovering Control over PTE Taxation
The TCJA Act of 2017 (Tax Cuts and Jobs Act) includes a provision that limits pass-through entities’ (PTE)—including S corporations and partnerships—allowable deductions of only $10,000. Successful businesses bring substantial revenue to states and these business owners have been hampered by this limitation. 30 states—including Arizona—have taken it upon themselves to create workarounds that circumvent the Federal guideline.
Image source: us.aicpa.org, AICPA, https://us.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/56175896-pte-map.pdf.
Arizona PTE Election and Notifications
PTE elections must be made annually for businesses registered and/or doing business in Arizona and submitted to the state before or in conjunction with their Arizona tax return by its due date or extended due date. Before partnerships and S corporations can make the PTE election, they must notify all partners or shareholders of their intent to make the election and provide each individual, estate, trust, partner, or shareholder the right to opt out of the election. The recipients must be allowed 60 days from receipt of the notice to exercise their right to opt out. Those who don’t respond are included as agreeing with the PTE election.
Arizona PTE Tax Rates, Payments, and Credits
Arizona implemented a PTE tax of 2.98% for the 2022 tax year which they updated to 2.5% for 2023 to align with the flat rate income tax that became effective on January 1, 2023. Four estimated PTE tax payments are required annually for all partnerships and S corporations who exceeded $150,000 in taxable income during the prior year. Payments made by EFT (electronic funds transfer) are required for each PTE with an anticipated tax liability of $500 or more. In 2022, the EFT requirement went into effect during the third quarter and no penalty will be assessed due to the first two quarter payments not being made by EFT in 2022. EFT registration is no longer required.
The PTE tax credits are not refundable. Valid, unused credits may be carried forward for no more than five years.
2023 Updates for Partnerships and S Corps
The key differences between partnership and S corporation calculations and treatments are included in the updated 2023 FAQs along with responses to commonly asked questions. Partnerships and S Corporations may not file composite returns on behalf of its nonresident partners or shareholders who opt out of the PTE election. Those who opt out or are not permitted to be included in the PTE election must file their own Arizona income tax returns to claim the PTE tax credit. Importantly, taxpayers should ensure that they follow the guidelines specified in Publication 713, taking special note of the differences between partnerships and S corporation shareholders.
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Nuances of the tax filing and remittance process can be challenging to follow, even for the most educated individuals. REDW’s trusted State and Local Tax experts are staying on top of current and pending legislation to ease your decision-making process. Contact us today for any questions.
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