A routine piece of tax code legislation that is usually one of the first measures to be passed by the Legislature was held up in the Senate much longer than normal, and the delay led to confusion statewide as Arizona residents file tax returns that might have to be amended later.
But after nearly three months of waiting, the Senate and the House voted in rapid succession April 2 to make changes to the state tax code.
The bill, S1185, lines up state tax statutes to conform to the federal Internal Revenue Code. Changes were made to the federal tax code in 2008, and Arizona lawmakers needed to pass the measure for the same changes to take effect at the state level.
But the bill became bogged down by a separate debate over whether to change Arizona’s income tax withholding system so that it isn’t tied to the income taxes withheld by the federal government.
Here’s the issue: The federal stimulus package provided a tax credit by lowering the federal withholding rate. And because Arizona’s withholding tax rate is a percentage of the federal withholding, the reduction of federal withholding would mean a reduction in the amount of money the state withholds, for example, from payroll checks.
Absent legislative action, Arizona’s total tax collections would have remained unchanged at the end of each tax cycle, but reducing the withholding amount would have crimped the state’s ability to cover operational expenses as they are incurred. Because of the difference in fiscal and calendar years, the state would have been short about $73 million in income taxes in fiscal 2009, and an additional $37 million in fiscal 2010.
The state wouldn’t have sustained a net loss, but a portion of the money normally withheld during one fiscal year would not have been collected until the next fiscal year. The federal tax credit is set to expire in 2011.
In an effort to avoid that scenario, however, lawmakers successfully tacked on an amendment to break the state from its tradition of setting its income tax withholding rate as a percentage of the federal withholding.
The decision essentially decoupled the two withholding rates to void a reduction in the state withholding while still allowing residents to benefit from the federal reduction.
“If we had not decoupled, it is my understanding that the withholding would take place, which would mean that there would be less money in the state’s pocket,” Senate President Bob Burns said.
As for business that already made the changes to reflect the reduction in the federal withholding rate, Burns said it’s just one of those “unfortunate things” created by the legislative process. If they could have passed the bill sooner, it would have been a lot better, Burns said.
Essentially, the goal of the legislation is to prevent the hit to the general fund from the reduction in the amount of money that the federal government now withholds, thereby helping keep the state afloat. The other reason is to “clean up” the system, Burns said, adding that Arizona apparently is the only state that still “coupled” its withholding rate to the federal withholding rate.
The Making Work Pay provision of the American Recovery and Reinvestment Act will provide a refundable tax credit of up to $400 for individuals and up to $800 for couples filing joint returns. The credit will phase out for individual taxpayers with modified adjusted gross income in excess of $75,000, or $150,000 for couples filing jointly.
How much a worker gets depends on his or her salary, marital status and how many exemptions he or she takes. As a rough estimate, single workers will likely see between $10 and $15 more each week.
The Internal Revenue Service had asked employers to implement the tax credit through the federal withholding rate no later than April 1, although some workers might have already seen a little extra in their take-home pay much earlier.
Taxpayers who do not have taxes withheld by an employer during the year can claim the credit on their 2009 tax return.
Until the bill is signed by the governor and becomes law, the base withholding rate for employees earning less than $15,000 is 10 percent. A worker can elect to have more taken out at the beginning of employment.
The base rate for those earning more than $15,000 is 19 percent, although the worker can elect to have as much as 37 percent taken out of the paycheck.
The legislation, though, will do a couple of things. From May 1 through the end of the year, it would increase the base withholding rates to 11.5 percent from 10 percent for those earning less than $15,000 and to 21.9 percent from 19 percent for those earning more than $15,000 annually.
That, presumably, would take care of the cash-flow problem during that period.
Beginning July 1, 2010, however, the Arizona Department of Revenue will prescribe the state’s own withholding tables.
The presumed net effect of the legislation is this: Taxpayers will still get their two-year tax credit from the federal government, which will be reflected in their paycheck, but the state would also get to collect the amount of income taxes it would otherwise have kept had it not been for the stimulus package.
When taxpayers file their 2009 return next April, it all evens out because people will know exactly what they owe the government or what their refund from the government will be.
Typically, the tax conformity legislation is passed early because it gives people, particularly accountants and their clients, assurance that the state would indeed conform to the Internal Revenue Service Code.
Most accountants prepare tax returns — and this year is no different — as if Arizona would conform to the federal revenue code. By assuming conformity, accountants and individuals do not have to file amended tax returns when the state does conform.
Every year since 1978, the Legislature has adopted an updated statutory definition of the state revenue code to include any federal provisions that became effective in the previous year. There were years in which the Legislature did not conform to all the changes made by Congress.
“Taxpayers don’t know how to file their tax returns right now,” said Cindie Hubiak, president & CEO of the Arizona Society of Certified Public Accountants. “Taxpayers have to guess on what the tax law is going to be. If they guessed right, that is great. If they guessed wrong, they have to file amended returns and that is more expense for the taxpayers, and it is more expense for the state.”
When Congress makes changes to the federal code, the changes don’t automatically apply to Arizona and other states that use federal adjusted gross income as the starting point for state income tax assessment.
So the Legislature periodically updates statute to conform to the revenue code and include any federal provisions that kicked in during the previous year. The strike-everything amendment to S1185 includes changes adopted by Congress, specifically the Economic Stimulus Act of 2008; the Heartland, Habitat, Harvest and Horticulture Act of 2008; the Heroes Earnings Assistance and Relief Tax Act of 2008; the Housing Assistance Tax Act of 2008; the Emergency Economic Stabilization Act of 2008; and the Worker, Retiree and Employer Recovery Act of 2008. For Kevin DeMenna, who lobbies for the Arizona Society of Certified Public Accountants at the Legislature, the conformity legislation was an important issue. “April 15 is right around the corner and what you have is everyone is getting ready to file their tax returns and everything they did, pretty much all of the tax preparers, have done it as though Arizona will conform,” DeMenna said.
“That is one of the first bills we try to get done because it sends the signal that you don’t need to adjust, deduct or alter this, and it’s a huge clerical piece of le
gislation,” he said.
What was supposed to be a quick Senate Appropriations Committee hearing on S1185 ran a bit longer when Sen. Jack Harper, who eventually voted against the measure, offered an amendment to eliminate two tax credits — the “working poor” tax credit and the public school tax credit for extra-curricular activities. Harper argued that every dollar diverted away from the general fund is money that goes out of the classroom.
Sen. Ron Gould, who also voted against the conformity bill, supported the Harper amendment, but the rest of the committee voted against it.
Pearce said he believes fundamentally with what Harper was trying to accomplish, but he said the conformity legislation needed to move as quickly as possible.