A veteran lawmaker is proposing what amounts to an end-run to allow some business owners to avoid paying the just-approved income tax surcharge for education.
The proposal by Sen. J.D. Mesnard, R-Chandler, would create an entirely new alternate tax category for small businesses, generally those organized in a way so their income passes through to the owners. That means the owners compute what they owe the state on their personal income tax forms after deducting all business expenses.
What makes that significant is that Proposition 208 imposes a 3.5% surcharge on adjusted personal income of more than $250,000 for individuals and $500,000 for married couples filing jointly. That is on top of the current 4.5% rate that applies for income above those figures.
SB1783 would give business owners the option of instead paying a 4.5% tax on their adjusted business income.
More to the point, the surcharge in Proposition 208 would not apply because this proposed new tax category did not exist at the time voters approved the measure. So business owners could compute their tax liability using both the existing formula or the new one – and then choose the one that costs them less.
Mesnard told Capitol Media Services that creating this new category makes sense because it will allow lawmakers to craft special tax provisions targeted at helping small businesses.
He acknowledged, though, that a prime reason was to help business owners escape paying that new voter-approved surcharge. Mesnard said that’s justified.
“We heard time and time again this will not or is not meant to impact small businesses,” he said. “And so what this is doing is ensuring that’s the case.”
But David Lujan, who helped organize the Prop. 208 fight, said Mesnard isn’t telling the whole story. The way he sees it, the initiative does not target small business.
Lujan points out that what’s subject to the tax is not the gross proceeds of any business. It’s what’s left after an owner pays all expenses, from employee salaries to equipment purchases. It’s also what remains after any other deductions, like money a business owner puts into a 401(k) retirement account.
What that leaves, he said, is the net income the owner pockets. And Prop. 208 kicks in only on any net earnings above $500,000 for a married couple.
Lujan also pointed out that SB1783, which awaits a vote of the full Senate, doesn’t just set a new optional tax category for small business. It also creates this same 4.5% tax rate for income from estates and trusts.
All this leaves the issue of whether it’s legal to effectively alter what was the intent of the voters to subject certain income to the higher levy.
Attorney Roopali Desai, who represents the Invest in Ed committee that put Prop. 208 on the ballot, acknowledged that lawmakers do have the power to alter the state tax code and create new categories.
“The question is whether the Legislature is able to pass legislation that directly or indirectly changes the voter-protected law that was put in place through Prop. 208,” she said.
That goes to the Voter Protection Act, which bars lawmakers from repealing or making changes in anything approved at the ballot. The only exception is for amendments that “further the purpose” of the original law, and then only with a three-fourths vote.
Desai said courts have concluded that legislation runs afoul of the Voter Protection Act even if it doesn’t directly repeal the measure approved at the ballot.
“You can do something more surreptitious and more malicious by going to make other changes elsewhere (in the statutes) that would have the same effect, which is to undermine the ultimate will of the voters,” she said.
What isn’t known is how much would be lost from the anticipated income for education if lawmakers approve the measure.
Estimates of what the initiative, as originally crafted, would raise have ranged from $827 million to $940 million a year. So far, legislative budget analysts have not produced a fiscal impact statement of SB1783, which was approved earlier this month by the Senate Finance Committee on a party-line vote.
Lujan noted that there was some IRS tax data brought into court last year by business interests who tried, unsuccessfully, to keep the measure off the ballot. The expert suggested that close to half of tax filers in that income category claim at least some of their income from businesses that pass their earnings on to owners.
Still, Lujan, who heads the Arizona Center for Economic Progress, said that doesn’t necessarily translate into a dollar-for-dollar loss for the education programs that Proposition 208 is designed to fund.
“That doesn’t tell you if it is 100% of their income or do they just have a side business,” he said. “So it’s hard to gauge.”
But Lujan said SB1783 is likely to affect a “significant portion” of the anticipated revenues.
Half of whatever is raised is earmarked for schools to hire teachers and classroom support personnel, a category that also includes librarians, nurses, counselors and coaches. Those dollars also could be used for raises.
Another 25% would be for support services personnel. That covers classroom aides, service personnel, food service and transportation.
There’s 12% for grants for career and technical education programs and 10% for mentoring and retaining new teachers in the classroom. The last 3% is for the Arizona Teachers Academy, which provides tuition grants for people pursuing careers in education.
No date has been set for Senate debate on the measure.