There are plenty of reasons why we love calling Arizona home—the weather, the beautiful sunsets, and Spring Training baseball (just to name a few). I can add another reason to that list—a new “flat” state income tax.
That’s right! Starting in 2023, all Arizona residents will pay a flat 2.5% state income tax. While this change was a few years in the making, former Governor Doug Ducey announced prior to leaving office that the flat tax will take effect for the 2023 tax year—one year ahead of schedule.
Flat tax explained
What is a flat tax? Just like the name suggests, a flat tax includes one single tax rate for all taxpayers regardless of income.
Previously, Arizona used a progressive income tax, the same system Congress uses for Federal income tax. In a progressive tax system, the tax rate increases as income increases. Lower income earners pay a lower rate, while higher income earners pay a higher rate.
Not anymore. Starting in 2023, all Arizona taxpayers will pay a 2.5% income tax rate.
How much will this change the amount I pay in tax?
At first glance, it doesn’t seem like Arizona’s new flat tax will drastically change your take-home income. For tax year 2022 (the tax returns filed in Spring of 2023), Arizona used a progressive tax system with two rates: 2.55% and 2.98%.
Under Arizona’s new flat tax, all taxpayers will be taxed at 2.5%, regardless of income. There are no more “tax brackets” since the tax rate doesn’t increase with income.
Why Arizona’s new flat tax is a big deal
If the new flat tax doesn’t seem like a big transformation, that’s because you’re comparing it to the current low tax rates. The two bracket system was merely paving the way for the new flat tax. In fact, Arizona’s income tax rate was much higher only a couple years ago!
Arizona’s income tax was the target of ballot initiatives, legislative responses, and court challenges starting in 2020 when voters approved Proposition 208. This levied an additional 3.5% “surcharge” on high income earners.
At the time, Arizona had four income tax brackets: 2.59%, 3.34%, 4.17%, and 4.5%. The additional 3.5% tax would have pushed the highest income tax bracket to 8%!
For reference, this would have put Arizona in the top 10 of states with the highest income tax rate.
Opponents of Proposition 208 saw this measure as damaging Arizona’s competitiveness—especially with business owners and entrepreneurs. The Arizona legislature responded by enacting several changes to our tax system:
- S.B. 1827: for taxpayers subject to the 3.5% surcharge, this capped their tax rate at 4.5% (effectively nullifying the new surcharge).
- S.B. 1828: reduced Arizona’s four income tax brackets to two—the 2.55% and 2.98% brackets. This also established the 2.5% flat tax to be introduced in 2024, or earlier.
- S.B. 1783: established a separate “Small Business Income” tax return to allow owners of pass-through businesses to have their business income taxed at a lower rate.
As you can see, Arizona’s new flat tax is a big deal when you look at it in the context of our former income tax brackets. Every taxpayer is in a lower bracket under the new 2.5% flat tax.
Why does the flat tax start in 2023?
Arizona’s new flat tax was slated to go into effect for the 2024 tax year. However, the law allowed for an earlier start date if the state met certain revenue targets.
Because Arizona’s economy has performed so well, the new flat tax went into effect a year early. This means the income you earn in 2023 will fall under the new 2.5% flat tax rate.
What do I need to do?
If you work in Arizona, you should have already had the opportunity to fill out a new Arizona Form A-4. This is the form where you elect what percentage you want withheld from your paycheck for state income tax.
If you have additional questions, feel free to reach out to your financial or tax advisor.