Proposition 208 and Arizona Income Taxes
The hotly debated Proposition 208, which assessed a 3.5% surtax on income over $250,000 was approved in the 2020 state elections. The statute, which was set to bolster education spending in the State of Arizona has since been challenged by a lawsuit (Fann v. Arizona), contending that this would exceed a constitutional cap for education spending with this sum of tax revenue. So what does this mean for Arizona taxpayers? We will walk through what this means for you and how to use it for financial planning moving forward.
What is Proposition 208?
Referred to as the “Invest in Education Act” or Prop 208, would generate funds for schools by placing a 3.5% income tax surcharge on taxable individual income that is more than $250,000 for a single person (or married person filing separately) or $500,000 for a married couple (or a single person who is a head of household). In simple terms, high-income individuals or couples would be paying more taxes to fund education. This proposition was approved by voters on November 3rd, 2020. This would result in a top marginal individual income tax rate of 8%.
Challenging the Prop. 208 ruling
Fann v. Arizona was filed to challenge the constitutionality of Prop. 208 and reached the Maricopa County Supreme Court on August 19th, 2021. The proposition was overturned as unconstitutional and will not remain in effect in Arizona. Because the “grants” in Prop. 208 come from a tax increase on more wealthy Arizonans as opposed to gifts or donations, they are subject to local spending limits, according to the Supreme Court. I will spare you the granular details of the court case and get to what this means for you.
Arizona as a tax-friendly state
On March 11th, 2022, Governor Doug Ducey commented on the Maricopa County Supreme Court ruling, saying:
“This ruling is a win for Arizona taxpayers. It’s another step in undoing the damage of Prop 208 and making sure we continue to benefit from having the lowest flat income tax rate in the nation. While we expect the ruling may be appealed, we are confident the Arizona Supreme Court will find 208 unconstitutional, as they did last year. Arizona is – and will remain – a state that knows how to prioritize education while keeping taxes low and attracting jobs.”
While the immediate effect of this ruling is lightening the tax burden on high-income earners in Arizona, there are also some other tax-friendly developments on the horizon. Through S.B. 1828, the state would convert from a graduated income tax for individuals to a flat tax. Arizona would join the 11 other states that currently have a single income tax rate.
The merits of a flat individual income tax rate are debated frequently. Graduated tax structures essentially impose higher rates on higher levels of marginal income, which makes it less attractive to earn as income rises near the margins of rate increases. A flat income tax would lower the already highly competitive tax rates, which are lower than 36 states as well as Washington D.C.. The bottom line here is that Arizona will continue to be an attractive state for high-income earners, as well as retirees.
How to plan for taxes in Arizona
Low tax rates stretch every dollar of retirement income further. In today’s world of higher inflation, that fact matters more than ever. If you’re a retiree considering taking large retirement account distributions, making Roth Conversions, or selling taxable assets, consider the merits of waiting until 2024 to lock in a lower tax rate.
If you are uncertain about how any of this will impact your current financial planning, feel free to contact us and we will be happy to provide a no-fee, no-obligation wealth planning evaluation.
