Notable Arizona Tax Legislation Enacted in 2011
Tax Law Alert 05/03/11
Arizona's Fiftieth Legislature adjourned on April 20, 2011 without setting a date to reassemble. Particularly notable tax provisions enacted into law this year include (i) the expansion and extension of a number of income tax and property tax incentives for business, (ii) a temporary special assessment on employers, (iii) the expansion of the agricultural property classification for real property taxes, (iv) use tax reporting required for nonbusiness purchases, and (v) limits on municipalities' ability to contract out for tax audit services. These provisions are summarized below.
1. TAX INCENTIVES FOR BUSINESS EXPANDED AND EXTENDED.
The most interesting enactment may be House Bill 2001 (50th Legislature, 2nd Special Session). House Bill 2001 establishes the Arizona Commerce Authority and expands and/or extends a number of tax incentives for business with the intent to make Arizona more economically competitive with other states. Key provisions in House Bill 2001 include the following:
- Corporate income tax rate reduction, from 6.968 percent to 6.5 percent for taxable years beginning during 2014, 6.0 percent for taxable years beginning during 2015, 5.5 percent for taxable years beginning during 2016 and 4.9 percent for taxable years beginning after 2016.
- A more favorable optional apportionment formula for Arizona businesses which make sales in other states. The weight of the sales factor in the optional enhanced sales factor apportionment formula for corporate income tax will increase from 80 percent to 85 percent for taxable years beginning during 2014, 90 percent for taxable years beginning during 2015, 95 percent for taxable years beginning during 2016 and 100 percent for taxable years beginning after 2016.
- Quality Jobs Program credits replace enterprise zone employment credits. Income tax credits for new hires in enterprise zones expire effective July 1, 2011. After June 30, 2011 the Quality Jobs Program credit applies. The new program allows income tax credits and insurance premium tax credits of $9,000 over three years for each new full time employee. To qualify, the taxpayer/employer must satisfy the applicable threshold for capital investment and job creation: (i) in a city or town with a population of 50,000 or more which is located in a county with a population of 800,000 or more, a minimum capital investment of $5 million and at least 25 new positions, or (ii) in any other location, a minimum capital investment of $1 million and at least 5 new positions. New hires must receive compensation at or above the county median, and the employer must provide health insurance and pay at least 65 percent of the premiums. An annual cap of 400 new employees applies per taxpayer for new credits, and a statewide cap of 10,000 employees also applies annually for new credits.
- Additional R&D credit for research conducted by an Arizona state university. For taxable years beginning after 2011, additional research and development credit is allowed for payments for basic research to a university under the jurisdiction of the Arizona Board of Regents. The allowable additional credit is 10 percent of such expenses which exceed the taxpayer's base amount for the R&D credit. An aggregate $10 million limitation applies each calendar year to all taxpayers, and amounts exceeding the limitation may be carried forward to the next five tax years. Priority with respect to the $10 million limitation will be based on the date taxpayers file applications with the Arizona Department of Revenue for pre-approval of additional R&D credits.
- Expansion and extension of the "angel investment program" credit. The Small Business Capital Investment Tax Incentive Program provides for individual income tax credits of 30 to 35 percent of investments in a bioscience enterprise or a qualified small business. The sunset date for authorization of new (so-called "angel investment") tax credits has been extended from June 30, 2011 to June 30, 2016. Beginning in 2012, the limit on the assets of a qualified small business increases from $2 million to $10 million. After June 30, 2011, the definition for "qualified small business" is expanded to include companies with a principal business involving retail sales of goods, restaurant operations, real estate activities, professional services, personal services, health care services, financial services, agricultural activities, mining and other exploitation of natural resources, or operation on an investment company or fund. In addition, the population limit for the 35 percent credit applicable for investments in a qualified small business located in a rural county has also been expanded, from 400,000 to 750,000.
- Exclusion of capital gain on small business investment. For taxable years beginning after 2013, individuals may exclude capital gains on an investment in a business which satisfies the requirements for qualified small business eligible for the "angel investment" program.
- Additional depreciation increased for property tax valuations of business personal property. Business and agricultural personal property, which currently qualifies for additional depreciation for the first five tax years, will qualify for increased additional depreciation, for property initially classified after tax year 2011. The additional depreciation adjustment for the first tax year will increase from 30 to 25 percent of the property's value under depreciation tables adopted by the Department of Revenue, from 46 to 41 percent for the second tax year, from 62 to 57 percent for the third year, from 78 to 73 percent for the fourth year, and from 94 to 89 percent for the fifth year.
- Reduced assessment ratios for property tax. The assessment ratio (the percentage of the property's value subject to tax) will decrease for "Class One" commercial property, from 20 percent for tax year 2012, by 0.5 percent each year after through 2016. The assessment ratio will thus be 19.5 percent for tax year 2013, 19 percent for 2014 and so on down to 18 percent for 2016 and thereafter. The assessment ratio for "Class Two" agricultural property, golf courses and vacant land will decrease from 16 to 15 percent for tax years after 2015.
2. SPECIAL ASSESSMENTS OF UNEMPLOYMENT TAX IMPOSED FOR 2011 AND 2012.
House Bill 2619 (50th Legislature, 1st Regular Session) imposes special assessments of Arizona unemployment tax for 2011 and 2012 by increasing the tax rate each employer is required to pay. The special assessments will increase Arizona unemployment tax by $28 per employee during 2011 and at least $42 per employee during 2012. The funds collected will be used to repay $358 million which Arizona borrowed from the United States Department of Labor to continue paying employment benefits. (If the loans are not fully repaid by November 10, 2012, Arizona unemployment tax may increase annually by up to $21 per employee. The special assessments are intended to prevent that outcome.)
If the Department of Labor waives the interest due on the loans, the special assessments will be reduced by $7 per employee for each year interest is waived. If it is determined that the special assessments will not be sufficient to repay the loans in full by November 10, 2012, the additional assessments for 2012 may be increased by up to $14 per employee.
The special assessment on wages paid during the first three quarters of 2011 is payable with unemployment tax due for the third quarter of 2011. The assessment on wages paid during the remaining quarters of 2011 and during 2012 is payable with unemployment tax due each quarter.
3. REAL PROPERTY USED FOR EQUINE ACTIVITIES QUALIFIES AS AGRICULTURAL PROPERTY.
House Bill 2552 (50th Legislature, 1st Regular Session) expands the definition of "agricultural real property" to include property used for (i) commercial breeding, raising, boarding or training of horses, mules, burros and/or asses and (ii) equine rescue facilities registered with the Arizona Department of Agriculture. Agricultural property is valued for property tax based on income derived from similar agricultural operations, rather than the property's market value for other use. Before House Bill 2552, the only real property involving animals which qualified as agricultural real property was grazing land and real property used for "high density" production of commodities such as milk or eggs.
4. USE TAX REPORTING FOR NONBUSINESS PURCHASES AND LIMITATION ON PENALTIES AND INTEREST ON NONCONFORMITY DEFICIENCIES.
House Bill 2332 (50th Legislature, 1st Regular Session) requires use tax reporting for nonbusiness purchases and limits penalties and interest on income tax deficiencies based on a nonconformity issue. With respect to use tax, individuals must report Arizona use tax annually, by making a declaration on the individual's income tax return, for taxable tangible personal property acquired during the taxable year for use, storage or consumption for a nonbusiness purpose where use tax or sales tax has not been collected by a licensed retailer. With respect to income tax deficiencies, the Department of Revenue may not assess penalties or interest on a deficiency resulting from Arizona tax provisions which do not conform to the IRC, provided the following conditions are satisfied:
- The taxpayer reported and paid tax based on the Department's forms and instructions;
- The applicable provision resulting in additional tax does not conform to the IRC;
- The Department supplements its published forms and instructions and requires the taxpayer to amend his or her return; and
- By the extended due date for the next year's return, the taxpayer files an amended return reporting the additional tax and pays the tax.
Both provisions are effective July 20, 2011.
5. LIMITS ON CONTRACTING OUT MUNICIPAL TAX AUDITS.
Senate Bill 1165 (50th Legislature, 1st Regular Session) prohibits cities and towns from compensating employees or engaging third parties to conduct audits of transaction privilege and/or affiliated city taxes on a contingent fee basis. Cities and towns which engage the Department of Revenue to collect, administer or process their taxes may not contract for such services with a party other than the state or a political subdivision of the state. While these new limitations do not affect contracts entered into before January 1, 2011, they will apply after 2010 to the renewal of such contracts.
For more information on Arizona's recent tax legislation, please contact Mark Vilaboy at (602) 229-5508 / [email protected] or your Quarles & Brady attorney.