Income Tax Fight At Legislature Puts Arizona Tax Returns In Legal Limbo

By Howard Fischer, Capitol Media Services
Published: Tuesday, February 5, 2019 - 10:33am
Updated: Tuesday, February 5, 2019 - 8:34pm

Arizona taxpayers who are ready to start filing their state returns are in a sort of legal and financial limbo because of a fight over income taxes between Gov. Doug Ducey and Republican lawmakers.

The tax forms printed up and being sent out by the Department of Revenue presume that lawmakers eventually will cave in to Ducey and adopt changes he wants in state tax law. That would mean the deductions allowed on those forms would be the same as those now permitted following the decision in late 2017 by President Trump to sign the Tax Cut and Jobs Act.

Only thing is, Ducey has been unable to get the Republicans who control the House and Senate to agree. In fact, he vetoed an alternate plan last week offered by GOP lawmakers.

The bottom line is that what's in the tax forms Arizonans are getting — the Ducey plan — does not match the way state law actually reads today.

And that means taxpayers have to decide whether to follow the law the way it actually is or the way Ducey wants it to be.

The differences can be significant.

For example, the new federal law limits to $10,000 the amount of taxes paid to state and local governments that can be deducted from an individual's federal taxable income.

What lawmakers approved last week would have conformed state law to those federal changes. That's what Ducey wants.

But it also would have cut income tax rates by 0.11 percentage points to offset any additional taxes owed due to new limits on deductions. Ducey found that part unacceptable and vetoed the whole bill, leaving Arizona tax law — and allowable deductions — unaltered.

Put simply, the state Tax Code still reads that Arizonans can deduct all the taxes they pay to other state and local governments.

Tax attorney Bob Kamman said that creates problems for those ready to file.

Take the case of someone whose state and local taxes paid last year total $30,000. Under current law, all of that is deductible.

"If someone files a return today, what's to prevent claiming the $30,000?'' he asked. "It's exactly what the law provides.''

Even assuming lawmakers do conform — with or without the offset with lower income tax rates that Ducey finds unacceptable — that law might not take effect until sometime this summer.

"Is there an obligation to file another return and pay the additional tax?'' Kamman asked. "The return was correct when it was filed.''

Ed Greenberg, spokesman for the Department of Revenue, said it doesn't matter what the law is on the day the return was filed.

The agency is presuming that any changes eventually made would be retroactive. And that means the taxpayer would have to go back and file an amended return — and pay any additional taxes due.

But Greenberg said taxpayers who choose to follow the law as it is on the books, versus the Ducey-wished version, will be on their own.

That's because the state form won't tell them what is deductible. What that means, he said, is taxpayers will have to research all the changes in federal law, figure out which changes apply, and make adjustments for those changes on the state return.

All of that goes back to the question of whether there will be conformity -- and whether what GOP lawmakers call a "windfall'' to the state will be offset with the lower tax rates they want

On Monday, Ducey made it clear that he is waiting for Republican lawmakers to blink in his bid to collect more taxes from Arizona residents.

The governor said he does not plan to present any sort of counter offer after he vetoed legislation Friday which would have offset higher tax revenues from conformity with the Internal Revenue Code with an across-the-board cut in state income tax rates.

"We're going to move on to the budget process,'' the governor told Capitol Media Services. But ultimately Ducey said he intends to prevail.

"We're going to have conformity,'' he said.

The governor also said one reason he vetoed the cut in tax rates is he believes it is "uncertain'' what will be the effect of changes in federal tax laws on what Arizonans owe the state.

But Ducey has known about the changes in federal law for more than a year. And he sidestepped questions Monday about whether it has been his plan all along to have state coffers enriched by the additional tax burden that conforming to federal law will place on some Arizona residents.

"The plan is to be financially responsible,'' he responded.

Legislative budget analysts figure that the new federal limit on deductions will add $195 million to what Arizonans owe in state income taxes when they file their returns in April. But businesses will do better, with conformity to changes in federal law decreasing their state tax liability by $40 million.

In seeking a 0.11 percentage point drop in the rates, the excess would have gone back to individual taxpayers overall.

Ducey's veto keeps tax rates as they are, with the assumption that lawmakers will come around and the state will set that net $155 million increase in revenues. And the governor said he sees no reason to change his mind.

"In terms of what we want to do, we've been clear,'' he said, calling his plan to conform to the federal tax code and keep the extra cash "good policy.''

Ducey wants to put whatever Arizona gets into the state's "rainy-day'' fund, a special account designed to keep programs operating when the economy falters and state tax collections drop. He said that is being "financially responsible.''

"I don't know how many times I have to talk about where we were four years ago and where we are today,'' Ducey said, referring to his oft-mentioned comments about the state having a $1 billion deficit when he took office in 2015 and now with close to $1 billion in revenues above what's needed to operate existing programs and services.

"We're in a position where we can have good decisions and good policy,'' the governor said. "And that's what I'm going to commit to.''

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