Revenue impact of Arizona's tax expenditures 2005 Final |
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THE REVENUE IMPACT OF ARIZONA’S TAX EXPENDITURES FY 2004/05 PREPARED FOR: THE GOVERNOR AND THE LEGISLATURE BY: THE OFFICE OF ECONOMIC RESEARCH & ANALYSIS Janice K. Brewer Gale Garriott Governor Director A R I Z O N A D E PA RT M E N T O F R E V E N U E November 15, 2005, Preliminary June 2009, Final The following report on Arizona's Tax Expenditures was prepared for the Governor and the Legislature in compliance with A.R.S. §42-1005. The fiscal year 2004/2005 report provides a broad range of information. The report contains sections for all taxes imposed by the state. The preliminary report, released November 15, 2005 did not include information on tax expenditures from Individual Income Tax. The individual income tax information included in this final report was made available through the 2003 Individual Income Tax Simulation Model. If you have any questions or comments regarding this report, please contact the Arizona Department of Revenue at (602) 716-6090. TABLE OF CONTENTS INTRODUCTION........................................................................................................Page 1 AIRCRAFT LICENSE TAX EXPENDITURES.....................................................Page 3 AVIATION FUEL TAX EXPENDITURES ...........................................................Page 9 BINGO TAX EXPENDITURES .............................................................................Page 13 BOXING TAX EXPENDITURES..........................................................................Page 19 CORPORATE INCOME TAX EXPENDITURES..............................................Page 23 ESTATE TAX EXPENDITURES............................................................................Page 33 FIDUCIARY INCOME TAX EXPENDITURES ................................................Page 37 FLIGHT PROPERTY TAX EXPENDITURES ...................................................Page 47 IN LIEU PROPERTY TAX EXPENDITURES ...................................................Page 51 INDIVIDUAL INCOME TAX EXPENDITURES .............................................Page 55 INSURANCE PREMIUM TAX EXPENDITURES ............................................Page 73 JET FUEL EXCISE AND USE TAX EXPENDITURES...................................Page 81 LUXURY TAX EXPENDITURES ..........................................................................Page 85 MOTOR CARRIER FEE EXPENDITURES........................................................Page 91 MOTOR VEHICLE FUEL TAX EXPENDITURES ..........................................Page 97 PARI-MUTUEL TAX EXPENDITURES............................................................Page 101 PRIVATE CAR PROPERTY TAX EXPENDITURES.....................................Page 105 PROPERTY TAX EXPENDITURES ...................................................................Page 109 SEVERANCE TAX EXPENDITURES................................................................Page 115 TRANSACTION PRIVILEGE AND USE TAX EXPENDITURES.............Page 119 UNDERGROUND STORAGE TANK TAX EXPENDITURES..................Page 141 UNEMPLOYMENT INSURANCE TAX EXPENDITURES.........................Page 145 USE FUEL TAX EXPENDITURES .....................................................................Page 151 VEHICLE LICENSE TAX EXPENDITURES...................................................Page 155 WATERCRAFT LICENSE TAX EXPENDITURES ........................................Page 161 WORKERS’ COMPENSATION PREMIUM LIEU TAX EXPENDITURES......................................................................................Page 167 1 THE 2005 ARIZONA TAX EXPENDITURE REPORT INTRODUCTION The Arizona Tax Expenditure Report is a study prepared for the Governor and the Legislature by the Arizona Department of Revenue's Office of Economic Research and Analysis. The report is prepared in compliance with A.R.S. §42-1005. Tax expenditures are provisions within the law (exemptions, exclusions, deductions and credits) that are designed to encourage certain kinds of activity or to aid taxpayers in certain categories. Such provisions, when enacted into law, result in a loss of tax revenues, thereby reducing the amount of revenues available for state (as well as local) programs. In effect, the fiscal impact of implementing a tax expenditure would be similar to a direct expenditure of state funds. This report provides a list of tax expenditures, plus, whenever possible, details the approximate costs of exempting certain types of income, goods, services or property from their respective tax statutes. The purpose of this report is to provide a better understanding of the costs associated with the existing set of tax exemptions, exclusions, deductions and credits. There are sections on every tax imposed in Arizona. In each section, provisions dealing with that specific tax type are analyzed. The analysis includes a detailed explanation of the provision as well as the approximate cost of that provision, if possible. Sections pertaining to tax types not administered by the Arizona Department of Revenue were reviewed by the agency administering the tax. Any figures presented in these sections were provided by that agency. ASSUMPTIONS This report is not intended in any way to determine the desirability of the tax expenditures currently established in law. The Legislature and the Governor determine the taxation environment that they wish to create in Arizona and formulate law to create this taxation policy. All tax expenditures were conscious public policy decisions at the time of enactment. For example, since 1990, public policy decisions were made to relieve the individual income tax burden on persons age 65 and over in Arizona. To that end, the amount of the age 65 and over exemption was increased in 1992 to $1,750 from $1,500 and increased again for tax year 1993 to $2,100. From tax years 1993 through 2003, the age 65 and over exemption has remained at $2,100. The costs associated with the specific provisions shown in this report are the estimated impact of that provision based upon the information available for the stated fiscal or calendar year. There is no consideration of decreased demand as a result of higher taxes. For example, if taxes on a certain type of liquor were increased to $3 per gallon, the calculations presented assume that the same demand exists under the $3 per gallon tax as exists when the tax is 84¢ per gallon. This constant demand would not exist in the "real" world, but the tools are not available to the Department of Revenue to estimate the elasticity of demand. Therefore, the estimated costs should be used only as a guide and not as an exact representation of what would occur in later years. Finally, the summary page(s) at the end of each section provides a total value of the tax expenditure. This total value is only a general guide and should not be used in isolation from the rest of the expenditure amounts. In fact, the expenditures for any particular tax cannot generally be added to reach a total. The presence or absence of one expenditure for a tax type can directly affect the value of another expenditure for that same tax type. 2 3 AIRCRAFT LICENSE TAX EXPENDITURES 4 5 AIRCRAFT LICENSE TAX EXPENDITURES1 1Any figures presented for Aircraft License Tax Expenditures were provided by the Arizona Department of Transportation. A license tax is imposed on aircraft operating in this state at the rate of 0.5% of the average fair market value of the particular make, model and year of the aircraft, but not less than $20. The proceeds from this tax are deposited into the state aviation fund. AIRCRAFT LICENSE TAX EXEMPTIONS Certain aircraft are exempt from this license tax, as set out in A.R.S. §28-8322. Aircraft operated by an airline company and regularly scheduled for the primary purpose of carrying persons or property for hire in interstate, intrastate, or international transportation are exempt from this tax. Calculating the tax value of this tax expenditure would require knowing the average fair market value of every aircraft carrying persons or property for hire that stops at an airport in this state. Therefore, the tax value of this tax expenditure is not quantifiable. Aircraft owned and operated exclusively in the public service by the federal government, by the state or by any political subdivision thereof, or by the civil air patrol is exempt from the vehicle license tax (A.R.S. §28- 8323). The average fair market value of aircraft owned by the federal government and operated in Arizona is unknown. It is known that there were 109 aircraft owned by the Arizona Department of Transportation, the Arizona Department of Public Safety, various Arizona counties and cities, and the civil air patrol in fiscal year 2004/05. The average fair market value of each aircraft is approximately $131,100, which equates to a tax value of $71,450 for this tax expenditure. A.R.S. §28-8383B also exempts aircraft owned and held by a bona fide aircraft dealer solely for the purposes of sale, as long as these aircraft are registered within ten days of the dealer's purchase date. There were 72 aircraft of this type registered by bona fide aircraft dealers in Arizona in fiscal year 2004/05. The tax value of these aircraft was approximately $402,607. PREFERENTIAL TAX RATES There are preferential aircraft license tax rates granted to certain types of aircraft in A.R.S. §28-8336. The license tax rate for a nonresident who bases his aircraft in Arizona for more than 90 days but less than 210 days in a given calendar year, provided that the aircraft is not engaged in any intrastate commercial activity, is equal to 0.1% of the average fair market value of the particular make, model, and year of aircraft (A.R.S. §28-8336). This tax rate is 20% of the tax rate imposed on resident-owned aircraft. In fiscal year 2004/05, there were 37 nonresident aircraft based in Arizona. The total aircraft license tax paid by nonresidents falling into this category in fiscal year 2004/05 was $15,635. The value of this expenditure can be calculated by multiplying this figure by four, which yields the foregone tax collections allowed by this preferential rate, or $62,542. Aircraft in storage or being repaired is charged a license tax of $20 (A.R.S. §28-8337). There are 279 aircraft, which have been granted this license tax rate with a fair market value of approximately $ 494.8 million. The tax value of this preferential license tax is $2.5 million which is the total fair market value multiplied by 0.5% less $20 per aircraft. The annual license tax for a salvage aircraft that is in storage or that is being restored is $5 (A.R.S. §28- 8338). There are 84 aircraft registered under this provision. Assuming no market value for salvage aircraft, the tax value of this tax 6 expenditure is the difference between the $20 minimum license tax imposed on all other aircraft and the $5 minimum license tax imposed on these tax, or $1,260. A.R.S. §28-8339 allows a $20 license tax for an antique, classic, warbird, glider, experimental, homebuilt, or balloon aircraft. There are 3,109 aircraft registered in Arizona under this provision, with a total market value of $ 12.4 million. The tax value of this tax expenditure is the total market value multiplied by 0.5% less the $20 license tax paid per aircraft, or $0. Maintenance aircraft owned by a nonresident (A.R.S. §28-8341) and manufacturer's aircraft (A.R.S. §28- 8340) are required to pay an aircraft license tax of $20. There are 11 nonresident-owned maintenance aircraft and 18 manufacturer's aircraft registered in Arizona, for a total market value of $142.9 million. The tax value of this tax expenditure can be calculated by multiplying the total market value by 0.5% and subtracting the $20 per aircraft tax paid, or $713,875. 7 SUMMARY OF AIRCRAFT LICENSE TAX EXPENDITURES Revenue Gain AIRCRAFT LICENSE TAX EXEMPTIONS: Aircraft operated for the primary purpose of carrying persons or property for hire ..................................................................................................................NIA* Nonresident-owned aircraft in the state for less than 90 days..........................................NIA Aircraft owned by a government or by the civil air patrol .......................................... $71,450 Aircraft owned by an aircraft dealer for sale ................................................................. 402,607 PREFERENTIAL TAX RATES Preferential rate for nonresidents with aircraft in the state from 90 to 210 days........................................................................................................................ $62,542 Preferential rate for aircraft in storage or being repaired..........................................2,468,634 Preferential rate for salvage aircraft in storage or being repaired................................... 1,260 Preferential rate for antique, classic, warbird, etc., aircraft......................................................0 Preferential rate for maintenance aircraft...................................................................................0 Preferential rate for manufacturer's aircraft................................................................... 713,875 TOTAL QUANTIFIABLE AIRCRAFT LICENSE TAX EXPENDITURES2 ................................................................................................ $3,720,367 *No Information Available. 2These tax expenditures represent foregone revenues to the state aviation fund. 8 9 AVIATION FUEL TAX EXPENDITURES 10 11 AVIATION FUEL TAX EXPENDITURES3 3Any figures presented for Aviation Fuel Tax Expenditures were provided by the Arizona Department of Transportation. An aviation fuel tax is imposed on every distributor for each gallon of aviation fuel possessed, refined, manufactured, produced, blended or compounded in this state by the distributor or imported by the distributor, whether in the original package or container in which it was imported or otherwise. All suppliers are required to pay tax on all aviation fuel. In order to qualify for exemptions on certain types of aviation fuel, the taxpayer must file for a refund. The fuel tax rate is 5¢ per gallon. Exemptions from the aviation fuel tax are set out in A.R.S. §28-5610. Aviation fuel moving in interstate or foreign commerce, not destined or diverted to a point within this state is exempt from aviation fuel tax. There is no requirement for reporting this information, therefore, the tax value of this expenditure is unknown. Also exempt from aviation fuel tax is aviation fuel sold to the United States armed forces for use in ships or aircraft, or for use without this state (A.R.S. §28-5610). The amount of aviation fuel purchased by the United States armed forces is not reported and the tax value is unknown. Although not listed as an exemption, a taxpayer may request a refund for aviation fuel for use in applying seeds, fertilizer or pesticides (A.R.S. §28- 5611A). If such fuel were subject to taxation in fiscal year 2004/05, an additional $842 would have been received. Aviation fuel, which is exported from the state, is exempt from aviation fuel tax (A.R.S. §28- 5611A). The taxpayer must apply for a refund. If such fuel were subject to taxation in fiscal year 2004/05, an additional $5,933 in aviation fuel tax would have been received. Also not listed as an exemption, a taxpayer may request a refund for losses of fuel due to fire, theft or other accident (A.R.S. §28-5611A). No requests for refunds were made in fiscal year 2004/05. 12 SUMMARY OF AVIATION FUEL TAX EXPENDITURES Revenue Gain Aviation fuel moving in interstate or foreign commerce.................................................................... NIA* Aviation fuel sold to the United States armed forces............................................................................. NIA Aviation fuel for use in applying seeds, fertilizer or pesticides.............................................................$842 Exported aviation fuel ...............................................................................................................................5,933 Aviation fuel lost due to fire, theft or other accident................................................................................... 0 TOTAL QUANTIFIABLE AVIATION FUEL TAX EXPENDITURES4 ..................................................................................................................... $6,775 * No Information Available. 4The tax expenditures represent foregone revenues to the state aviation fund. 13 BINGO TAX EXPENDITURES 14 15 BINGO TAX EXPENDITURES The tax on state licensed bingo operations is based on a multi-tiered licensing structure. There are three classes of bingo licenses, each of which has a different tax rate. Each class' tax rate is based on bingo receipts. All bingo tax collections are deposited into the general fund. Class A licensees, whose gross receipts do not exceed $15,600 per year, are taxed at 2.5% of their adjusted gross receipts (A.R.S. §5-414). Adjusted gross receipts equals gross receipts less the amount paid for prizes. Therefore, prize money is exempt from taxation for this class of bingo licensees. In fiscal year 2004/05, this group of taxpayers subtracted $3.1 million from gross receipts. Determination of the tax value of this subtraction, however, is not a simple matter. If prize money were not allowed as a subtraction from gross receipts, it is unlikely that this group would have a 2.5% tax rate. However, if a 2.5% tax rate is not used, a more appropriate tax rate must be selected. The tax value of the prize money subtraction for Class A taxpayers is calculated in two ways. Option 1 is to multiply the subtraction amount by 2.5%, the Class A tax rate. This results in potential collections of $77,121. Option 2 is to multiply the subtraction amount by the average effective tax rate of the Class A licensees, calculated by dividing Class A tax collections by Class A total gross receipts. This rate for the Class A licensees is 0.31%. (This method is based on the premise that the Class A tax rate would not be 2.5% if the subtraction were not allowed.) Multiplying the prize money subtraction amount by 0.32% results in potential collections of $9,914. Class B and Class C licensees are taxed on their gross receipts. Class B licensees, whose gross receipts do not exceed $300,000, are taxed at 1.5% of their gross receipts. Class C licensees, whose gross receipts exceed $300,000 annually, are taxed at 2.0% of their gross receipts. This is a preferential rate structure because different tax rates are imposed on similar taxpayers (all involved in the business of bingo) based on criteria set in Arizona statutes. This preferential rate structure allows taxpayers with lower gross receipts to be taxed at a lower tax rate. Measuring the tax value of allowing a preferred tax rate for bingo is difficult because the lowest-income taxpayers (recipients of less than $15,600 annually) have a tax rate higher than the highest-income taxpayers. Normally, this type of calculation would simply involve applying the highest tax rate to all taxpayers to find the revenues that might have been received. Therefore, the tax value of allowing preferential tax rates is also calculated in two ways. Option 1 determines the additional tax that would be received if all classes of licensee were taxed at the highest rate. However, the tax rate of 0.32% mentioned previously, is considered to be the effective tax rate for Class A. This would make the highest tax rate among the three classes 2.0%. If Class A and Class B were taxed at 2.0%, additional general fund revenues would total $145,756. (The calculation for Class A involves substituting 2.0% as the effective tax rate.) The problem with this method of determining the tax value of preferential tax rates is that it assumes (1) there is a possibility of a legislative change which would raise the bingo tax to a uniform rate that is the highest tax rate currently being imposed and (2) small bingo operations would not be affected by an increase in the tax rate (the same level of bingo activities would occur irrespective of the tax rate). Option 2 looks at preferential rates slightly differently. This option assumes that if a uniform tax rate were to be imposed to tax all licensees identically, the new rate would be revenue neutral, resulting instead in a burden shift. The effective tax rate on all bingo activities, determined by dividing total tax collections into gross receipts, is 1.60%. If this rate is applied to all classes of bingo licensees, total tax collections remain the same, but, as can be seen below, the amount of tax paid by class of licensee shifts. 16 Class Original Tax Collections* New Tax Collections Difference A $ 9,915 $ 49,614 $39,699 B $241,023 $269,390 $28,367 C $351,391 $283,326 ($68,066) Total $602,329 $602,329 $ 0 *This amount reflects collections for tax only, and does not include penalty and interest. 17 SUMMARY OF BINGO TAX EXPENDITURES Revenue Gain Subtraction from Gross Receipts for Class A Licensees Option 1..................................................................................................................................................$77,000 Option 2......................................................................................................................................................9,900 Preferential Tax Rates for Class A and Class B Licensees Option 1............................................................................................................................................... $145,700 Option 2............................................................................................................................................................. 0 TOTAL QUANTIFIABLE BINGO TAX EXPENDITURES5 RANGES FROM .........................................................................$9,900 -$145,700 5These tax expenditures represent foregone revenues to the state general fund. 18 19 BOXING TAX EXPENDITURES 20 21 BOXING TAX EXPENDITURES6 6Any figures presented for Boxing Tax Expenditures were provided by the Arizona Boxing Commission. Any person who promotes a boxing contest in Arizona must pay to the Department of Racing (collecting for the state Boxing Commission) a 4% tax on the gross receipts of such match or exhibition, after deduction of city, state and federal taxes (A.R.S. §5-104.02A). Gross receipts are defined as receipts from the face value of tickets sold. Tickets issued as complimentary by the promoter of a boxing match are exempt from taxation, as long as the number of complimentary tickets does not exceed 2% of total number of tickets issued or 75 tickets, whichever is greater. During fiscal year 2004/05, 40 boxing contests were held. At each event, 75 complimentary tickets were issued with an average price of $25 each. Had the value of these tickets been taxable, an additional $3,000 in boxing taxes would have been received. 22 SUMMARY OF BOXING TAX EXPENDITURES Revenue Gain Complimentary tickets issued .................................................................................................................$3,000 TOTAL QUANTIFIABLE BOXING TAX EXPENDITURES7 ............. $3,000 7These tax expenditures represent foregone revenues to the state general fund. 23 CORPORATE INCOME TAX EXPENDITURES 24 25 CORPORATE INCOME TAX EXPENDITURES The Department of Revenue collected over $700 million in net corporate income taxes during fiscal year 2004/05. Net corporate income tax is deposited into the general fund. However, 15% of the tax is distributed to cities and towns two years after the year in which it was collected. For example, 15% of tax collected in fiscal year 2004/05 will be distributed to incorporated cities and towns in fiscal year 2006/07. Therefore, only 85% of the tax collected is actually available for the state’s use. This fact should be kept in mind when reviewing the reported tax value of subtractions and credits. The assumption can be made that 85% of the tax value is general fund revenue, with the remaining 15% distributed to cities and towns two years after collection. Arizona corporate taxable income is calculated beginning with federal taxable income. Therefore, by conforming Arizona law to the Internal Revenue Code, any subtractions allowed under federal law in the calculation of federal taxable income are allowed under Arizona law. From federal taxable income, certain additions and subtractions are allowed to reach Arizona taxable income. After calculating tax liability, corporate taxpayers may take advantage of a number of credits to reduce tax liability. Most of the corporate tax expenditures are not quantifiable. The tax value of the federal subtractions in the calculation of federal taxable income cannot be determined because these are for corporate income from all states, not just Arizona income. The tax value of Arizona's subtractions from federal taxable income cannot be calculated because subtractions are deducted from federal taxable income prior to apportionment of income to Arizona. Therefore, it cannot be determined what percent of the subtractions is used in the calculation of Arizona tax. The remaining subtractions and tax credits are only quantifiable to the extent that data exists. SUBTRACTIONS ALLOWED IN THE CALCULATION OF FEDERAL TAXABLE INCOME The starting point for the calculation of Arizona corporate tax liability is federal taxable income, as calculated on the federal corporate income tax return. The Arizona legislature must approve legislation to conform to the definition of federal taxable income as of January of each year. In conforming to the definition of federal taxable income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Compensation of officers. • Salaries and wages. • Incidental repairs that do not add to the value of the property or appreciably prolong its life. • Debts that became worthless in whole or in part during the tax year. • Expenses of renting or leasing a vehicle. • Contributions or gifts actually paid within the tax year to charitable and governmental organizations and any unused contributions carried over from prior years, except the total amount claimed may not be more than 10% of taxable income. • Depreciation, plus the part of the cost that the corporation elected to expense for certain tangible property placed in service during the tax year. • Certain percentage depletion rates applicable to natural deposits. • Contributions to pensions, profit sharing or other funded deferred compensation plans. • Contributions to employee benefit programs not elsewhere claimed. • Certain taxes paid or accrued during the tax year. • Interest paid on certain debts. 26 • Other deductions including amortization of organizational expenses, losses from partnership trade or business activities, travel and meal expenses, membership dues, etc. It is not possible to estimate the tax value of these subtractions. While the Department of Revenue receives information from the Internal Revenue Service from federal tax returns for corporations with an Arizona address, data on corporations headquartered outside of Arizona but operating within the state is not available. Even if it were available, multi-state corporations would include income and deductions from all states in which they operate in the calculation of federal taxable income, making it useless for Arizona tax expenditure calculation purposes. EXEMPT ORGANIZATIONS Certain organizations are exempt from corporate income tax according to Arizona law. The organizations specifically set out in statute as exempt are: • The United States, the state, counties, municipalities, school districts or other political subdivisions or units of this state or the federal government [A.R.S. §43-104(23)]. • Labor, agricultural or horticultural organizations, other than cooperative organizations [A.R.S. §43-1201(1)]. • Qualifying fraternal beneficiary societies, orders or organizations [A.R.S. §43-1201(2)]. • Cemetery companies owned and operated exclusively for the benefit of their members or which are not operated for profit [A.R.S. §43- 1201(3)]. • Qualifying corporations organized and operated exclusively for religious, charitable, scientific, literary or educational purposes or for the prevention of cruelty to children or animals [A.R.S. §43-1201(4)]. • Nonprofit business leagues, chambers of commerce, real estate boards or boards of trade [A.R.S. §43-1201(5)]. • Nonprofit qualifying civic leagues or organizations operated exclusively for the promotion of social welfare, or local organizations of employees [A.R.S. §43- 1201(6)]. • Clubs organized and operated exclusively for pleasure, recreation and other non-profit making purposes [A.R.S. §43-1201(7)]. • Corporations organized for the exclusive purpose of holding title to property, collecting income therefrom and turning over the entire amount of such income, less expenses, to an organization which itself is exempt from the tax imposed by this title [A.R.S. §43-1201(8)]. • Voluntary employee's beneficiary organizations providing for the payment of life, sick, accident or other benefits to the members of such organizations or their dependents, providing certain requirements are met [A.R.S. §43- 1201(9)]. • Teachers' or public employees' retirement fund organizations of a purely local character, provided certain requirements are met [A.R.S. §43-1201(10)]. • Religious or apostolic organizations or corporations, if such organizations or corporations have a common treasury or community treasury, even if such corporations or organizations engage in business for the common benefit of the members, but only if the members thereof include, at the time of filing their returns, in their Arizona gross income their pro rata shares, whether distributed or not, of the net income of the organizations or corporations for such year [A.R.S. §43-1201(11)]. • Voluntary employees' beneficiary organizations providing for the payment of life, sick, accident or other benefits to the members of such organization, their dependents or their designated beneficiaries, provided membership is limited to officers or employees of the U.S. government [A.R.S. §43-1201(12)]. • Corporations classified as diversified management companies under §5 of the Federal Investment Company Act of 1940 and registered as provided in that act [A.R.S. §43- 1201(13)]. 27 • Insurance companies paying to the state tax upon premium income derived from sources within this state [A.R.S. §43-1201(14)]. • Mutual ditch, irrigation or water companies or similar nonprofit organizations if 85% or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses [A.R.S. §43-1201(15)]. • Workers’ compensation pools established pursuant to §23-961.01 [A.R.S. §43- 1201(16)]. • A small business corporation which makes an election for a taxable year pursuant to subtitle A, chapter 1, subchapter S of the Internal Revenue Code is not subject to corporate taxes for such year but only to the extent such corporation is not subject to federal income taxes [A.R.S. §43-1126). Three of these organizations - religious or apostolic organizations, insurance companies and Subchapter S corporations - are exempt from corporate tax but their income does not escape taxation. In the case of the religious or apostolic corporations and the Subchapter S corporations, the income is taxed at the individual income tax level. Insurance companies are required to pay insurance premium tax rather than corporate income tax. It is not possible to calculate the corporate tax that would be collected if all exempt organizations were subject to corporate taxation. That calculation would require completion of federal and state tax forms by the exempt organizations. ARIZONA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME Arizona statutes set out certain items that can be subtracted from federal taxable income to reach adjusted income attributable to Arizona. The tax value of these subtractions cannot be determined because these are subtracted from federal taxable income prior to apportionment of income to Arizona. It is impossible to isolate those subtractions attributable to Arizona only. • Annuity income included pursuant to §72 of the Internal Revenue Code if the first payment with respect to such annuity was received prior to 12/31/78 [A.R.S. §43-1022(8)]. • The excess of a partner's share of income required to be included under §702(a)(8) of the Internal Revenue Code over the income required to be included under chapter 14, article 2 of Title 43 [A.R.S. §43-1022(9)]. • The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of Title 43 over the losses allowable under §702(a)(8) of the Internal Revenue Code [§43- 1022(10)]. • The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to Title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the Internal Revenue Code [A.R.S. §43-1022(11)]. • The amount allowed by A.R.S. §43-1024 for amortization by a qualified defense contractor certified by the Department of Commerce under §41-1508, of a capital investment for private commercial activities [A.R.S. §43-1022(12)]. • Gain included on the sale or other disposition of a capital investment that a qualified defense contractor has elected to amortize pursuant to A.R.S. §43-1024 [A.R.S. §43-1022(13)]. • The amount allowed by §43-1025 for contributions during the taxable year of agricultural crops to charitable organizations [A.R.S. §43-1022(14)]. • The portion of any wages or salaries paid or incurred by the taxpayer for the taxable year that is equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips, and the Indian employment credit that the taxpayer received under §§45A, 45B, 51(a) and 1396 of the IRC [A.R.S. §43-1022(15)]. • An adjustment for federal bonus depreciation [A.R.S. §43-1022(28, 29)]. 28 • Arizona capital loss carryover in an amount not to exceed $1,000 for tax years beginning prior to 1/1/88 [A.R.S. §43-1122(2)]. • Expenses and interest relating to tax-exempt income disallowed pursuant to §265 of the Internal Revenue Code [A.R.S. §43-1122(3)]. • Dividends received from another corporation owned or controlled directly or indirectly by a recipient corporation [A.R.S. §43-1122(4)]. • Interest income received on obligations of the U.S. [A.R.S. §43-1122(5)]. • Dividend income from foreign corporations [A.R.S. §43-1122(6)]. • The amount of net operating loss allowed by A.R.S. §43-1123 [A.R.S. §43-1122(7)]. • State income tax refunds received which were included as income in computing federal taxable income [A.R.S. §43-1122(8)]. • Expense recapture included in income pursuant to §617 of the Internal Revenue Code for mine exploration expenses [A.R.S. §43-1122(9)]. • Deferred exploration expenses allowed by A.R.S. §43-1127 [A.R.S. §43-1122(10)]. • Exploration expenses related to the exploration of oil, gas or geothermal resources [A.R.S. §43- 1122(11)]. • Amortization of pollution control devices [A.R.S. §43-1122(12)]. • Amortization of the cost of child care facilities [A.R.S. §43-1122(13)]. • Income from a domestic international sales corporation required to be included in the income of its shareholders pursuant to §995 of the Internal Revenue Code [A.R.S. §43-1122(14)]. • The income of an insurance company that is exempt under A.R.S. §43-1201 to the extent that it is included in computing Arizona gross income on a consolidated return [A.R.S. §43- 1122(15)]. • The amount of contributions by the taxpayer during the taxable year to individual medical savings accounts pursuant to A.R.S. §43-1028 [A.R.S. §43-1122(16)]. • The amount by which capital loss carryover allowable per A.R.S. §43-1130.01 F exceeds the capital loss carryover allowable per section 13410(b)(5) of the internal revenue code [A.R.S. §43-1122(17)]. ARIZONA NET OPERATING LOSSES All corporate taxpayers are allowed to subtract from their Arizona adjusted gross income the amount of unused net operating losses attributable to Arizona for the last five years (A.R.S. §43- 1122.08). Corporations claimed Arizona-based net operating losses totaling $6.3 billion in tax year 2003. In many cases a corporation’s reported net operating loss exceeded its Arizona adjusted gross income. Subtracting the net operating loss in these cases resulted in negative taxable income. To calculate the tax value of the net operating losses, the loss was multiplied by 6.968% for those businesses with positive taxable income. For those businesses with negative taxable income, that portion of net operating loss that was used to reduce taxable income to zero was multiplied by 6.968%8. These calculations result in a maximum tax value of $64 million. About 24.8% of the 48,317 corporations that filed Arizona corporate income tax returns for tax year 2003 reported net operating losses. The table below shows the number of corporations by size of net operating loss and by whether or not there was enough taxable income to generate a tax liability other than the minimum $50 tax. 8For example, if the net operating loss was $10,000 and the negative taxable income was $9,000, adding back the loss results in $1,000 of net operating loss being used to reduce taxable income to zero. The tax rate was applied against the $1,000 to arrive at the tax value of the operating loss. 29 2003 - Size of NOL # with Tax Liability greater than $50 # with Tax Liability less than or equal to $50 Total $1 to $99 59 608 667 $100 to $999 273 1,130 1,403 $1,000 to $9,999 974 2,911 3,885 $10,000 to $49,999 775 2,466 3,241 $50,000 to $99,999 191 754 945 $100,000 to $499,999 233 927 1,160 $500,000 to $999,999 33 197 230 $1,000,000 to $9,999,999 37 314 351 Over $9,999,999 4 88 92 Total 2,579 9,395 11,974 NOL $ Value $292,096,345 $6,042,699,718 $6,334,796,063 COMMERCIAL TAX CREDITS A tax credit reduces corporate tax liability, as opposed to a subtraction, which reduces taxable income. Most tax credits that currently exist in Arizona corporate tax law are nonrefundable; any credit amount greater than a firm's tax liability will not be refunded. The unused credit is then carried forward for use in future tax years. A corporation receives a credit for expenditures in the following areas: • for increased employment in enterprise zones (A.R.S. §43-1161). • for the purchase of recycling equipment (A.R.S. §43-1164). • for employment and for property taxes paid by a qualified defense contractor (A.R.S. §43-1165, A.R.S. §43-1166). • for increased employment in military reuse zones (A.R.S. §43-1167). • for research and development expenses (A.R.S. §43-1168). • for costs in constructing a qualified environmental technology manufacturing, producing or processing facility (A.R.S. §43-1169). • 1for expenses to purchase property used to control or prevent pollution (A.R.S. §43-1170). • for expenses incurred for tangible personal property used to control or prevent pollution, relating to agriculture (A.R.S. §43-1170.01). • for construction materials incorporated into a qualifying facility (A.R.S. §43-1171). • for an agricultural water conservation system (A.R.S. §43-1172). • for corrective action costs for underground storage tanks (A.R.S. §43-1173). • for employment of TANF recipients (A.R.S. §43-1175). • for solar hot water heater plumbing stub outs and electric vehicle recharge outlets installed (A.R.S. §43-1176). • for the fair market value of a vehicle, up to $1500, donated to the wheels to work program (A.R.S. §43-1177). • for coal consumed in generating electric power (A.R.S. §43-1178). • a refundable credit for providing technological skills training to not more than 20 employees (A.R.S. §43-1179). • a refundable credit for conveying ownership or development rights of agricultural property to an agricultural preservation district (A.R.S. §43- 1180) • for donating real property or improvements to a school district (A.R.S. §43-1181) • for donations made directly to the Clean Elections Fund ( A.R.S. §16-954B) • for corporations that elected to file consolidated returns in Arizona and amended their 1986 through 1993 tax returns, thus creating a credit that could be taken over ten years. When reviewing the credit data, it is important to mention two points. First, corporate tax information for a given tax year changes over time. Late returns are filed, corporations are 30 audited, amended returns are filed, retroactive legislation is enacted, etc. Therefore, figures stated here will change next year and figures cited in previous years will not match what is presented here. Second, information cannot be revealed about certain credits claimed without breaching confidentiality. If less than three firms claim a credit or if one firm claims more than 90% of the total credit amount claimed or if providing statistics on one credit would result in confidential information being divulged about other credits, then that information cannot legally be released. Data for tax year 2003 is shown below, but it is preliminary. For tax year 2002, corporations claimed 477 commercial tax credits and used a total of $25.3 million in credits to offset taxes and get refunds where allowed. Asterisks indicate instances in which release of information would breach confidentiality laws. TYPE OF 2001 2002 2003 CREDIT # $ USED # $ USED # $ USED Enterprise zone 128 $6,456,049 127 $5,944,633 67 $3,047,546 Recycling equipment 4 21,442 4 5,145 4 3,426 Defense contracting 0 0 ** ** ** ** Military reuse zone 3 109,373 ** ** ** ** Research & development 123 9,301,385 124 10,901,624 79 21,592,007 Environmental technology facility 3 1.084,588 ** ** 0 0 Pollution control device 29 2,173,882 28 1,386,455 18 1,739,959 Agricultural pollution control equip’t ** ** ** ** 0 0 Construction materials 3 100 3 100 ** ** Agricultural water conservation system ** ** ** ** ** ** Underground storage tanks 0 0 ** ** 0 0 Alternative fuel vehicles (Nonref) ** ** 8 32,969 5 1,726 Alternative fuel vehicles (Refundable) 12 218,560 Neighborhood electric vehicles 20 69,701 16 31,172 8 19,026 Vehicle refueling apparatus & infrastructure (Nonref) ** ** ** ** ** ** Vehicle refueling apparatus & infrastructure (Refundable) 0 0 Alternative fuel delivery systems (Nonref) 3 184,431 3 1,039 ** ** Alternative fuel delivery systems (Refundable) 0 0 Employment of TANF recipients 6 57,851 7 173,550 5 461,980 Solar hot water plumbing stub outs & electric vehicle recharge outlets 0 0 0 0 0 0 Donation of motor vehicle to wheels to work program 0 0 0 0 School site donation ** ** ** ** ** ** Agricultural preservation district 0 0 0 0 0 0 Taxes paid for coal consumed in generating electrical power ** ** ** ** 0 0 Technology training 10 40,595 4 41,083 ** ** Clean election 97 2,913 102 646 111 1,563 Consolidated filer 35 3,492,320 30 2,196,494 32 2,335,704 Total 498 $24,207,863 477 $25,310,248 345 $29,902,588 31 SUMMARY OF CORPORATE INCOME TAX EXPENDITURES Revenue Gain Subtractions Allowed in Calculation of Federal Taxable Income: Compensation of Officers.......................................................................................................................NIA* Salaries and wages.......................................................................................................................................NIA Incidental repairs adding no value to property........................................................................................NIA Debts becoming worthless during the tax year .......................................................................................NIA Expenses of renting or leasing a vehicle .................................................................................................. NIA Charitable or governmental organization contributions........................................................................NIA Depreciation ................................................................................................................................................NIA Certain percentage depletion rates applicable to natural deposits........................................................NIA Pension, profit-sharing, etc. contributions...............................................................................................NIA Contributions to employee benefit programs .........................................................................................NIA Certain taxes paid or accrued during the tax year ...................................................................................NIA Interest paid on certain debts.....................................................................................................................NIA Other miscellaneous deductions................................................................................................................NIA Exempt Organizations: Political subdivisions or units of the state or federal government .......................................................NIA Labor, agricultural or horticultural organizations ...................................................................................NIA Qualifying fraternal beneficiary societies.................................................................................................. NIA Cemetery companies not for profit...........................................................................................................NIA Qualifying religious, charitable, scientific, etc., corporations................................................................NIA Nonprofit business leagues ........................................................................................................................NIA Nonprofit qualifying civic leagues.............................................................................................................NIA Clubs organized for pleasure, recreation or other nonprofit purposes ...............................................NIA Corporations organized to hold title to property for exempt organization ........................................NIA Voluntary employee's beneficiary organizations .....................................................................................NIA Teachers' or public employees' retirement fund organization ..............................................................NIA Religious or apostolic organizations which pass through income........................................................NIA Voluntary employee's beneficiary organizations with a twist................................................................NIA Diversified management companies.........................................................................................................NIA Insurance companies subject to the insurance premium tax.................................................................NIA Mutual ditch, irrigation or water companies............................................................................................NIA Subchapter S corporations .........................................................................................................................NIA Arizona Subtractions from Federal Taxable Income: Annuity income included pursuant to §72 of the IRC...........................................................................NIA Excess of a partner's share of income under §702(a)(8) of IRC...........................................................NIA Excess of a partner's share of partnership losses ...................................................................................NIA Excess of adjusted basis of property held for income production.......................................................NIA Amortization by a qualified defense contractor......................................................................................NIA Gain on amortized capital investment by a qualified defense contractor ...........................................NIA Dividend income received from Arizona corporations ....................................................................... NIA* * No Information Available. 32 Arizona capital loss carryover not to exceed $1,000 prior to 1/1/88..................................................NIA Expenses/interest relating to tax-exempt income disallowed per IRC ...............................................NIA Dividends received from controlled corporation ................................................................................... NIA Interest income received on obligations of the U.S. .............................................................................. NIA Dividend income from foreign corporations ..........................................................................................NIA State income tax refunds ............................................................................................................................NIA Expense recapture for mine exploration expenses.................................................................................NIA Deferred exploration expenses allowed by §43-1127.............................................................................NIA Exploration expenses related to oil, gas or geothermal exploration ....................................................NIA Amortization of pollution control devices...............................................................................................NIA Amortization of the cost of child care facilities ......................................................................................NIA Income from domestic international sales corporation .........................................................................NIA Contributions to individual medical savings accounts ...........................................................................NIA Excess capital loss carryover......................................................................................................................NIA Net Operating Losses.................................................................................................................$64,022,000 Commercial Tax Credits: Enterprise zone employment.......................................................................................................... $3,048,000 Recycling equipment .................................................................................................................................3,000 Defense contracting ...................................................................................................................................NR9 Military reuse zone........................................................................................................................................NR Research & Development ............................................................................................................... 21,592,000 Environmental technology facility .................................................................................................................. 0 Pollution control devices................................................................................................................... 1,740,000 Agricultural pollution control equipment ...................................................................................................... 0 Construction materials .................................................................................................................................NR Agriculture water conservation system.......................................................................................................NR Underground storage tanks............................................................................................................................. 0 Alternative fuel vehicles............................................................................................................................2,000 Neighborhood electric vehicles ..............................................................................................................19,000 Vehicle refueling apparatus and infrastructure..........................................................................................NR Alternative fuel delivery systems .................................................................................................................NR Employment of TANF recipients........................................................................................................462,000 Solar hot water plumbing stub outs and electric vehicle recharge outlets ................................................ 0 Donation of motor vehicles to wheels to work program ............................................................................ 0 Taxes paid for coal consumed in generating electrical power..................................................................... 0 Agricultural preservation district ..................................................................................................................... 0 Technology training......................................................................................................................................NR School site donation.....................................................................................................................................NR Clean election .............................................................................................................................................2,000 Consolidated filer............................................................................................................................... 2,336,000 Total Commercial Tax Credits ................................................................................................$29,903,000 TOTAL QUANTIFIABLE CORPORATE INCOME TAX EXPENDITURES10 ............................................................................................................. $93,925,000 * No Information Available. 9 NR indicates that the information is not releasable due to Arizona confidentiality laws. Fewer than ten license holders took advantage of this refund. 10These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 33 ESTATE TAX EXPENDITURES 34 35 ESTATE TAX EXPENDITURES The Arizona estate tax is a tax on the transfer of property or interest in property that takes effect upon the owner's death. The estate tax is an amount equal to the federal credit for state death taxes. Estate taxes are deposited into the general fund. Estate tax collections totaled $31.2 million in fiscal year 2004/05. If the decedent owned realty or tangible personal property located in another state, the Arizona tax is reduced by the smaller of the amount of death tax paid to the other state or the federal credit times the percentage of total real or tangible personal property located in another state. The total deductions allowed from the federal credit in fiscal year 2003/04 was $1.5 million. This deduction is a dollar-for-dollar reduction in the estate tax liability. SUMMARY OF ESTATE TAX EXPENDITURES Revenue Gain Deduction from federal credit for state death taxes.................................................................... $1,458,721 TOTAL QUANTIFIABLE ESTATE TAX EXPENDITURES11 ............................................................................................................... $1,458,721 11These expenditures represent foregone revenues to the state general fund. 36 37 FIDUCIARY INCOME TAX EXPENDITURES 38 39 FIDUCIARY INCOME TAX EXPENDITURES Arizona imposes fiduciary income tax on trusts and estates. The taxability of the income is determined by the residence of the fiduciary, beneficiary or deceased taxpayer. For estates, the tax applies to the entire taxable income if the deceased taxpayer was an Arizona resident. The fiduciary or beneficiary residence is immaterial. In contrast, for trusts, the tax applies to the entire taxable income when the fiduciary or beneficiary is an Arizona resident. Arizona taxable income is calculated beginning with federal taxable income. By conforming Arizona law to the Internal Revenue Code, subtractions allowed under federal law in calculating federal taxable income are allowed under Arizona law. From federal taxable income, certain additions, subtractions and exemptions are allowed to reach Arizona taxable income. After calculating tax liability, fiduciary taxpayers may reduce their tax liability by using a credit for taxes paid to other states or countries or a credit for clean elections. Fiduciary income tax is deposited into the general fund. However, 15% of the tax is distributed to cities and towns two years after the year in which it was collected. For example, 15% of tax collected in fiscal year 2004/05 will be distributed to incorporated cities and towns in fiscal year 2006/07. Therefore, only 85% of the tax collected, or of the tax value of any expenditure, is actually available for the state’s use. This fact should be kept in mind when reviewing the reported tax value of the various subtractions, exemptions and credits. SUBTRACTIONS ALLOWED IN THE CALCULATION OF FEDERAL TAXABLE INCOME The starting point for calculating Arizona fiduciary income tax liability is federal taxable income, as calculated on the federal form 1041 (U.S. Fiduciary Income Tax Return). The Arizona legislature must approve legislation to conform to the definition of federal taxable income by January of each year. In conforming to the definition of federal taxable income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Deduction for interest paid by the estate or trust on amounts borrowed by the estate or trust or on debt acquired by the estate or trust. This includes any investment interest (subject to limitations), qualified residence interest and any interest payable on any unpaid portion of the estate tax attributable to the value of a reversionary or remainder interest in property. • Deductible taxes, including state income or real property tax and generation-skipping transfer tax imposed on income distributions. • Deductible fees paid to the fiduciary for administering the estate or trust during the tax year. • Other deductions, such as amortizable bond premiums, casualty and theft losses, net operating loss deduction and fiduciary's share of amortization, depreciation and depletion not claimed elsewhere. • Miscellaneous itemized deductions in excess of 2% AGI. • Income Distribution Deduction. • Estate tax paid. • $600 exemption for estates. $300 exemption for trusts in which all income must be distributed currently. $100 exemption for all other trusts unless the trust is filing for the final year (in which case no exemption is allowed). It is not possible to calculate the tax value of these subtractions. Information from the Internal Revenue Service would be required to determine the value and this information is not readily available. 40 ARIZONA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME The Arizona fiduciary income tax return lists the following specific items that can be subtracted from federal taxable income to reach adjusted gross income attributable to Arizona: • Negative Arizona fiduciary adjustment from another trust or estate. This adjustment is used if the Schedule K-1 indicates a difference between the federal and state distributable income. [A.R.S. §43- 1332(1)]. • Interest income on U.S. obligations. Interest income received on U.S. obligations, less any interest on indebtedness, or other related expenses, and deducted in arriving at Arizona gross income, which were incurred or continued to purchase or carry such obligations. [A.R.S. §43- 1022(6)] • Energy efficient residence. The amount authorized by A.R.S. §43-1031 for constructing an energy efficient residence. [A.R.S. §43-1022(27)] The remaining subtractions on the Arizona fiduciary tax form are entered in aggregate on the line "Other Subtractions from federal taxable income." The following is a list of "Other Subtractions": • Benefits, annuities and pensions. Benefits, annuities and pensions totaling not more than $2,500 received from any of the following: U.S. government service retirement and disability fund; retired or retainer pay of the U.S. uniformed services; the U.S. foreign service retirement and disability system; any other retirement system or plan established by federal law; the state retirement system or plan; the corrections officer retirement plan; the public safety personnel retirement system; the elected officials' retirement plan; an optional retirement program established by the AZ board of regents; an optional retirement program established by a community college district board; or a retirement plan established for employees of a county, city or town in Arizona. [A.R.S. §43- 1022(2)] • Refunds from other states. The amount of any income tax refunds received from states other than Arizona and included as income. [A.R.S. §43-1022(7)] • Annuity income. Annuity income included pursuant to §72 of the IRC if the first payment with respect to such annuity was received prior to 12/31/78. [A.R.S. §43-1022(8)] • Wood stoves and fireplaces. The amount authorized by A.R.S. §43-1027 for the purchases of qualified wood stoves, wood fireplaces or gas fired fireplaces. [A.R.S. §43-1022(21)] • Operating loss carryover. The amount by which an operating loss carryover or capital loss carryover, allowable pursuant to A.R.S. §43-1029 F, exceeds the net operating loss carryover or capital loss carryover allowable pursuant to section 1341(b)(5) of the internal revenue code. [A.R.S. §43-1022(23)] • Federal credits. The portion of any wages or salaries paid or incurred by the taxpayer equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips and the Indian employment credit that the taxpayer received under §§45A, 45B, 51(a) and 1396 of the IRC. [A.R.S. §43- 1022(15)] • Individual medical savings accounts. With respect to individual medical savings accounts established pursuant to A.R.S. §43-1028, the account holder may subtract the amount of contributions made by the employer, to the extent that these contributions are included in the taxpayer's federal adjusted gross income, 41 and the amount deposited by the taxpayer in the account during the year. [A.R.S. §43-1022(22)] • Contribution of agricultural crops. The amount allowed by A.R.S. §43-1025 for contributions of agricultural crops to charitable organizations [A.R.S. §43- 1022(14)]. • Installment income. The amount of income on an installment receivable which is recognized pursuant to the IRC and which has already been recognized on the death of the taxpayer for purposes of this title for tax years ending before 1/1/90. [A.R.S. §43-1022(5)] • Holocaust survivors. The amount authorized by A.R.S. §43-1030 relating to holocaust survivors. [A.R.S. §43-1022(26)] • Adjustment for bonus depreciation allowed under IRC §168(k) added to Arizona gross income. This adjustment relates to the 30% and/or 50% bonus depreciation allowed at the federal level. [A.R.S. §43-1022(28)] • Federal income from other fiduciaries. When the estate or trust is the beneficiary of another estate or trust, the beneficiary's share of the trust or estate income recognized under the Internal Revenue Code may be subtracted [A.R.S. §43- 1022(3)]. • Exemptions for blind persons, persons over 65, dependents and qualifying ancestors. Exemptions are allowed for blind persons ($1,500), persons over 65 years ($2,100), dependents ($2,300) and qualifying ancestors that live with the taxpayer and requires assistance with activities of daily living ($10,000) [A.R.S. §43-1022(1)]. • Distributions from individual retirement accounts. The amount of any distributions from an individual retirement account as provided for in §408 of the IRC or from a qualified retirement plan of a self-employed individual as provided for in §401 of the IRC to the extent that total adjustments made pursuant to this paragraph in all tax years do not exceed the total of all contributions made by the taxpayer to such plans prior to 12/31/75, which were included in computing Arizona taxable income. [A.R.S. §43-1022(4)] • Partner’s share of income. The excess of a partner's share of income required to be included under §702(a)(8) of the IRC over the income required to be included under chapter 14, article 2 of title 43. [A.R.S. §43-1022(9)] • Partner’s share of losses. The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of title 43 over the losses allowable under §702(a)(8) of the IRC. [A.R.S. §43-1022(10)] • Sale of income producing property. The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the IRC. [A.R.S. §43-1022(11)] • Amortization of capital investment. The amount allowed by §43-1024 for amortization, by a qualified defense contractor certified by the department of commerce under §41-1508, of a capital investment for private commercial activities. [A.R.S. §43-1022(12)] • Gain on capital investment. The amount of gain included on the sale or other disposition of a capital investment that a qualified defense contractor has elected to amortize pursuant to §43-1024. [§43- 1022(13)] • State lottery winnings. The amount of winnings less than $5000 in a taxable 42 year from any of the state lotteries, except that all such winnings before 3/22/83, including periodic distributions from such winnings made after 3/2/83, may be subtracted. [A.R.S. §43- 1022(16)] • Mining exploration expenses. The amount of mining exploration expenses determined pursuant to §617 of the IRC which have been deferred in a taxable year ending before 1/1/90 and for which a subtraction has not been previously made. [A.R.S. §43-1022(17)] • Social security benefits. The amount included pursuant to §86 of the IRC, relating to taxation of social security and railroad retirement benefits. [A.R.S. §43- 1022(18)] • Compensation for armed forces active service. To the extent not already excluded, compensation received for active service as a member of the armed forces of the U.S. for any month during any part of which the member served in a combat zone. [A.R.S. §43-1022(19) • Adoption costs. The amount of unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption not to exceed three thousand dollars. [A.R.S. §43-1022(20)] • Qualified educational expenses. Any amount of qualified educational expenses distributed from a qualified state tuition program determined pursuant to §529 of the Internal Revenue Code and that is included in income. [A.R.S. §43-1022(24)] • Installment sale subject to tax in another state. Any item of income resulting from an installment sale that has been properly subject to tax in another state in a previous year and is included in Arizona gross income in the current taxable year. [A.R.S. §43-1022(25)]. • Income from a trust established as a medical savings accounts In the cast of a trust that is established as a medical savings account pursuant to A.R.S. §43-1028, income earned by the trust is included in the trsut’s Arizona gross income. [A.R.S. §43-1332(2)]. • Arizona distribution to beneficiaries. The income of the estate or trust which is to be distributed or credited during the year to any legatee, heir or beneficiary is allowed as a subtraction from federal taxable income [A.R.S. §§43-1333]. In tax year 2003, all subtractions on fiduciary tax returns were reported in aggregate with the exception of “Income from a trust established as a medical savings account.” Income of $73,199 was reported. Using an effective tax rate of 4.38%, the tax value of this subtraction was $3,203. All other subtractions that reduced tax liability totaled $95.6 million. (This does not include subtractions that were greater than income. Those subtractions would have no tax value because they didn’t actually offset any income.) Using the effective tax rate of 4.38%, the tax value of these subtractions was $4,134 million. PREFERENTIAL TAX RATES Fiduciary income tax is calculated according to a graduated tax rate schedule as shown below: at least but less than $0 $10,000 2.87% of taxable income 10,000 25,000 3.20% of taxable income, minus $33 25,000 50,000 3.74% of taxable income, minus $168 50,000 150,000 4.72% of taxable income, minus $658 150,000 and over 5.04% of taxable income, minus $1,138 43 As can be seen from the table, lower taxable incomes are taxed at a lower rate. If all taxpayers were treated identically, the same tax rate would be applied regardless of the amount of taxable income. A question arises, however, as to what tax rate should be applied to determine the revenue impact of treating all taxpayers identically. One argument may be that since the highest tax rate is 5.04%, determining the impact of taxing all income at 5.04% would seem appropriate. However, no taxpayer currently pays 5.04% tax on all taxable income. If a flat tax rate of 5.04% was applied regardless of income level, all taxpayers would experience a tax increase. A more reasonable approach to a flat tax rate would be to apply the effective tax rate on taxable income for all fiduciary taxpayers. Applying this effective tax rate to all fiduciary taxpayers will result in the same tax collections as with the graduated tax rate structure; however, the burden of the tax will shift. Taxpayers with lower Federal Adjusted Gross Income would pay more tax and taxpayers with higher Federal Adjusted Gross Income would pay less tax. CREDITS After fiduciary income tax liability is calculated, two credits can be subtracted from the tax liability. If the estate or trust is considered to be a resident of Arizona and also a resident of another state or country, the estate or trust will be allowed a tax credit against the Arizona income tax liability for taxes paid to the other state or country. In 2003, $2.5 million was claimed as credit for taxes paid to other states or countries. Additionally, if the trust or estate makes a contribution to the Clean Elections Fund, a credit may be claimed for those contributions. The total clean elections credit claimed in 2002 by estates and trusts was $56. Both credits are a direct reduction to tax liability. 44 SUMMARY OF FIDUCIARY INCOME TAX EXPENDITURES Revenue Gain SUBTRACTIONS IN CALCULATION OF FEDERAL TAXABLE INCOME: Deduction for interest paid ......................................................................................................................NIA* Deductible taxes..........................................................................................................................................NIA Deductible fiduciary fees ............................................................................................................................NIA Other miscellaneous deductions................................................................................................................NIA Miscellaneous itemized deductions in excess of 2% AGI ..................................................................... NIA Income distribution deduction ..................................................................................................................NIA Estate tax paid.............................................................................................................................................NIA $600/$300/$100 estate/trust exemption.................................................................................................NIA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME: Negative Arizona fiduciary adjustment from another trust or estate Interest income on U.S. obligations Energy efficient residence U.S./state pensions not over $2,500 Income tax refunds from other states Annuity income included pursuant to §72 of the IRC Certain IRA distributions or 401Ks Qualified wood stoves and fireplaces Installment income recognized pursuant to IRC Excess operating loss carryover Certain federal credits Medical savings accounts Contribution of agricultural crops Installment income Holocaust survivors Adjustment for bonus depreciation Federal income from other fiduciaries Exemptions for blind persons, persons over 65 years of age, dependents and qualifying ancestors Distributions from individual retirement accounts Partner’s share of income Partner’s share of losses Sale of income producing property Amortization of capital investment Gain on capital investment State lottery winnings Mining explorations expenses Social security benefits * No Information Available. 45 Compensation for armed forces active service Adoption costs Qualified educational expenses Installment sale subject to tax in another state Income from a trust established as a medical savings account..........................................................$3,000 Arizona distribution to beneficiaries Value of subtractions other than medical savings account trusts ................................... $4,184,000 TOTAL TAX VALUE OF SUBTRACTIONS FROM FEDERAL TAXABLE INCOME................................................................................................................... $4,187,000 CREDIT FOR TAXES PAID TO OTHER STATES/COUNTRIES.......................... $2,461,000 CREDIT FOR CONTRIBUTIONS TO THE CLEAN ELECTION FUND....................$56 TOTAL QUANTIFIABLE FIDUCIARY INCOME TAX EXPENDITURES12 ...............................................................................................................$6,648,000 12These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 46 47 FLIGHT PROPERTY TAX EXPENDITURES 48 49 FLIGHT PROPERTY TAX EXPENDITURES The airline companies in Arizona pay a tax on the flight property within the state. The taxable value, or net assessed value, of the flight property is determined by multiplying the full cash value of the property by an assessment ratio. The tax rate that is applied to the net assessed value is equal to the statewide average tax rate, which was $11.81 in tax year 2004. EXEMPTIONS If an airline is operating in Arizona with a maximum passenger capacity of less than 56 seats and a maximum pay load capacity of less than 18,000 pounds (A.R.S. §42-14251.10), this small flight property shall be valued at 30% of its original cost less depreciation multiplied by the assessment ratio (A.R.S. §42- 14254C). Had the taxable value been 100%, the state would have raised $2.6 million more in fiscal year 2004/05. PREFERENTIAL ASSESSMENT RATIO Arizona statutes set out the assessment ratios to be used in determining the net assessed values of the various classes of property. These assessment ratios range from 25% to 5%. For flight property, the assessment ratio is equal to the ratio which the total net assessed valuation of all taxable property in class 1, class 6 paragraph 3 and personal property in class 2 bears to the total full cash value of such property (A.R.S. §42-14255). For tax year 2004, the assessment ratio used for flight property was 21%. This is considered to be a preferential assessment ratio because it is an average of the assessment ratios in several other classes of property. If flight property had an assessment ratio equal to the highest assessment ratio imposed, 25%, tax collections would have increased by $5.6 million. SUMMARY OF FLIGHT PROPERTY TAX EXPENDITURES Revenue Gain EXEMPTION Tax value at 30% for small airplanes ...................................................................................... $2,567,719 PREFERENTIAL ASSESSMENT RATIOS: Preferential assessment ratio at 25%....................................................................................... $5,633,995 TOTAL QUANTIFIABLE FLIGHT PROPERTY TAX EXPENDITURES13 ............................................................................................................... $8,201,715 13These expenditures represent foregone revenues to the state aviation fund. 50 51 IN LIEU PROPERTY TAX EXPENDITURES 52 53 IN LIEU PROPERTY TAX EXPENDITURES Irrigation districts, power districts, electrical districts or agricultural improvement districts directly engaged in the sale of electric power or energy other than for irrigation purposes may elect to make voluntary contributions to Arizona and the political subdivisions thereof for property taxes. These districts are not legally liable for property taxes imposed by the state and the political subdivisions, so these voluntary contributions are known as in lieu property taxes. (However, according to A.R.S. §9-432B, water may not be transported from remote municipal property by a city, town or political subdivision, unless voluntary contributions have been paid.) The Department of Revenue determines the full cash value of the district electing to make in lieu property tax payments. The county assessor of each county where district electric facilities are located computes the gross contribution to be made. The district may subtract certain amounts from this gross contribution figure. A subtraction is allowed for the contribution related to that portion of the electric system related to pumping water (A.R.S. §48-242C1). A deduction of $10,000 is allowed from the gross contribution (A.R.S. §48-242C2). Certain taxes or assessments paid to any political subdivision during the preceding calendar year may be deducted from the gross contribution (A.R.S. §48-242C3). The annual average of the total water costs devoted to municipal use during the last three calendar years is also deductible from the gross contribution (A.R.S. §48-242C4). The effect of these deductions from the gross contribution amount is that the district in question pays a certain percentage of the gross contribution. The primary contributor, Salt River Project, paid approximately 81.9% of the tax that would have been levied in fiscal year 2004/05 had they been legally bound to pay property tax. Given the repeal of the state rate, the dollar expenditure that previously appeared in this report is no longer applicable. However, because the exemptions filter through to the tax base at the local level, descriptions of the exemptions remain. 54 55 INDIVIDUAL INCOME TAX EXPENDITURES 56 57 INDIVIDUAL INCOME TAX EXPENDITURES For tax year 2003 tax returns filed in calendar year 2004, the Arizona Department of Revenue collected over $2.16 billion in resident individual income taxes before credits. In the same tax year, the state allowed exemptions, deductions, exclusions, and credits worth as much as $1.73 billion in tax liability. This report details the value of each of these exemptions, deductions, exclusions, credits and preferential rates. The figures presented in this report were determined using the Individual Income Tax Simulation Model, containing a 2003 database. This model contains 48,525 resident returns, selected using stratified sampling techniques. The information on the back of Arizona Individual Income Tax Form 140 and on Schedule A was entered for the sample returns, making the detailed information presented below available. Please remember these figures are for tax year 2003. All tax expenditures in this report refer to tax law in existence in 2003, filed in 2004. Examination of the detail presented in this section reveals that summing the tax value of certain tax expenditures individually does not produce the total value of removing all of those same tax expenditures at one time. (The sum of the parts is less than the whole.) Disallowing exemptions, subtractions or deductions can have the effect of changing the tax rate applied to a portion of a taxpayer's taxable income. For example, the taxpayer may have had taxable income of $40,000 prior to the removal of the tax exemption device, resulting in a tax rate of 3.74% on part of this income. Removal of deductions may result in pushing the taxpayer's taxable income to $55,000, resulting in a tax rate of 4.72% on part of this income. Removal of all exemptions, subtractions and deductions may make taxable income high enough to hit the 5.04% tax rate. Therefore, adding back income that was previously untaxed can push the taxpayer into two or three higher tax brackets. In other areas of this report, it can be seen that adding the impacts of individual deductions together results in a larger impact than what the figure for removal of the entire section indicates. (The sum of the parts is greater than the whole.) For example, if the components of the Taxes Paid Deduction on the Schedule A were added together, the total would be $148 million. However, removal of the entire Taxes Paid Deduction section results in a value of $145 million. In this case, removal of individual pieces may lower the Schedule A total and may or may not push the taxpayer into a higher tax bracket. Removal of the entire section, however, may push the Schedule A total below the standard deduction level. If this happens, the standard deduction amount is substituted for the Schedule A amount. Therefore, there is a constant deduction level (equal to the standard deduction) below which the taxpayer will not fall, regardless of how much of the Schedule A is removed. This constant deduction level serves to buffer the impact of losing the Schedule A deductions and could potentially keep the taxpayer from moving into a higher tax bracket. Net income tax (corporate, individual and fiduciary) collections are deposited in the general fund after 15% of net income tax collections received two years prior is disbursed to cities and towns. In other 58 words, 15% of net individual plus corporate plus fiduciary income tax received in Fiscal Year 2004/05 will be distributed to incorporated cities/towns in Fiscal Year 2006/07. When reviewing the tax value of individual income tax expenditures, therefore, the assumption can be made that 85% of the tax value is general fund revenue, although the remaining 15% is not actually disbursed for two years in the future. SUBTRACTIONS ALLOWED IN CALCULATING FEDERAL ADJUSTED GROSS INCOME The starting point for the calculation of Arizona individual income tax liability is federal adjusted gross income, as calculated on the federal form 1040, 1040A and 1040EZ U.S. Individual Income Tax returns. The Arizona legislature must approve legislation annually to conform to the definition of federal adjusted gross income as of January of the current year. In conforming to the definition of federal adjusted gross income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Qualified expenses for eligible educators of up to $250. • Qualified tuition and fees of up to $3,000 under certain conditions. • Individual Retirement Account contributions for individuals with qualifying incomes. • Interest paid on student loans for qualified higher education expenses for individuals with qualifying incomes. • Moving expenses in connection with a job or business, with certain requirements. • One-half of self-employment tax paid. • Self-employed health insurance payments. • Self-employed SEP, SIMPLE, and Qualified Plans. • Penalty on early withdrawal of savings. • Alimony paid. • Archer MSA deduction. • Performing arts-related expenses that meet certain conditions. • Jury duty pay given to your employer. • Deductible expenses related to income from the rental of personal property. • Reforestation amortization. • Repayment of supplemental unemployment benefits under the Trade Act of 1974. • Contributions to section 501(c)(18) pension plans. • Deduction for clean-fuel vehicles. • Contributions by certain chaplains to section 403(b) plans. • Employee business expenses of fee-basis for state or local government officials. It is only possible to estimate the tax value of those subtractions that appear on the front of the federal 1040 tax return as subtractions to gross income. 59 SUBTRACTION 2003 (Millions) Educator expense/tuition fees subtraction $2.71 Individual Retirement Account for qualifying individuals 5.11 Student loan interest deduction 2.07 Moving expenses 0.48 One-half of self-employment tax 8.25 Self-employed health insurance deduction 8.36 KEOGH retirement plan and self-employed SEP deduction 10.31 Penalty on early withdrawal of savings 0.03 Alimony paid 6.17 TOTAL VALUE OF SUBTRACTIONS $43.86 EXEMPTIONS Like the federal government, Arizona grants exemptions for taxpayers meeting certain conditions. In Arizona, the amount of exemption varies according to type. Personal Exemption The personal exemption is the most broad-based of all exemptions: every taxpayer (and spouse) is eligible for one (A.R.S. §43- 1043). Single taxpayers and those who are married but filing separately were allowed exemptions of $2,100 for tax year 2003. Married couples filing jointly with no children and unmarried head of household taxpayers were allowed $4,200 exemptions. The higher personal exemption allowed unmarried head of household filers is a preferential personal exemption amount, double the amount normally allowed for one person. Married couples filing jointly with at least one dependent are allowed a personal exemption of $6,300; married filing separate taxpayers with at least one dependent are allowed an exemption of half this amount, $3,150. This higher personal exemption for married couples with children is also a preferential personal exemption. Age 65 or Older Exemption Taxpayers age 65 or older were eligible for an additional exemption equal to $2,100 for primary filer and for eligible spouse in 2003 (A.R.S. §43-1023E).. Dependent Exemption Arizona taxpayers may claim a dependent exemption for children and certain other relatives for whom they provide more than 50% support (A.R.S. §43-1023B). The dependent exemption was $2,300 in 2003. Blind Exemption Taxpayers who have corrected vision of no better than 20/200 or have a field of vision no wider than 20 degrees are eligible for a blind exemption (A.R.S. §43-1023A1). The exemption amount was $1,500 in 2003. 60 Qualifying Parents and Ancestors Exemption Arizona residents may claim a $10,000 exemption for each qualifying parent and ancestor. (A.R.S. §43-1023C) A qualifying parent or ancestor may be a parent, a parent's ancestor or a spouse's parent or spouse's parent ancestor. The qualifying parent or ancestor must have lived in the taxpayer's residence for the entire taxable year, was 65 years old or older and the taxpayer paid more than one-half of the support and maintenance costs of the parent or ancestor during the taxable year. Additionally, the parent or ancestor must have required assistance with activities of daily living. TYPE OF EXEMPTION 2003 (Millions) Personal exemption $200.24 Preferential personal exemption for Unmarried Head of Household filers 11.21 Preferential personal exemption for married filers claiming at least one dependent 26.75 Age 65 or older exemption 19.10 Dependent exemption 81.83 Blind exemption 0.20 Qualifying parent or ancestor exemption 1.59 TOTAL VALUE OF EXEMPTIONS $350.70 ARIZONA SUBTRACTIONS FROM INCOME Arizona taxpayers can subtract certain amounts from their gross income. The largest subtraction in 2003 was for Social Security or Railroad Retirement benefits included on the federal Form 1040 (A.R.S. §43-1022.18). Arizona also allowed these amounts to be subtracted: the first $2,500 of a federal, State or local retirement annuity (A.R.S. §43-1022.2), the first $5,000 in Arizona lottery winnings (A.R.S. §43-1022.16), interest on U.S. obligations (A.R.S. §43-1022.6), agricultural crops contributed to Arizona charitable organizations (A.R.S. §43-1022.14), deposits or employee contributions into medical savings accounts (A.R.S. §43- 1022.22), the amount of income tax refunds received from states other than Arizona and which were included as income in computing federal adjusted gross income (A.R.S. §43-1022.7) and an amount equal to the “bonus” depreciation allowable pursuant to the internal revenue code (A.R.S. §43-1022.28, 29, 30).. In addition, there were a myriad of "other subtractions" including, but not limited to: • A beneficiary's share of the fiduciary adjustment to the extent that the amount decreases the beneficiary’s Arizona gross income (A.R.S. §43-1022.3). • Distributions from an individual retirement account as provided for in §408 of the internal revenue code or from a qualified retirement plan of a self-employed individual (A.R.S. §43-1022.4). • Income on an installment receivable which is recognizable pursuant to the internal revenue code and which has already been recognized on the death of the taxpayer for purposes of this title for tax years ending before 1/90 (A.R.S. §43-1022.5). • Annuity income included in income pursuant to §72 of the internal revenue code if the first payment with respect to such annuity was received prior to 12/31/78 (A.R.S. §43-1022.8). 61 • The excess of a partner's share of income required to be included under §702(a)(8) of the internal revenue code over the income required to be included under Chapter 14, article 2 of title 43 (A.R.S. §43-1022.9). • The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of title 43 over the losses allowable under §702(a)(8) of the internal revenue code (A.R.S. §43- 1022.10). • The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the internal revenue code (A.R.S. §43-1022.11). • The amount allowed for amortization, by a qualified defense contractor, of a capital investment for private commercial activities or the amount of gain included in income on the sale or disposition of a capital investment that a qualified contractor has elected to amortize (A.R.S. §43-1022.12, 13) • Any wages paid for the taxable year that is equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips and the Indian employment credit (A.R.S. §43-1022.15). • Exploration expenses determined pursuant to §617 of the internal revenue code, which have been deferred in a taxable year ending before 1/90 and for which a subtraction has not been previously made (A.R.S. §43-1022.17). • To the extent not already excluded from gross income under §112 of the internal revenue code, compensation received for active service as a member of the armed forces of the U.S. for any month during any part of which the member served in a combat zone (A.R.S. §43-1022.19). • Unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption, not to exceed $3,000 (A.R.S. §43- 1022.20). • Authorized amounts for purchase of, and nonoptional equipment directly related to the operation of, qualified wood stoves, wood fireplaces or gas fired fireplaces (A.R.S. §43-1022.21). • Excess net operating loss carryover or capital loss carryover (A.R.S. §43- 1022.23). • Qualified educational expenses distributed from a qualified state tuition program that is included in income (A.R.S. §43- 1022.24). • Income resulting from an installment sale properly subjected to income tax in another state (A.R.S. §43-1022.25). • An amount authorized relating to holocaust survivors (A.R.S. §43- 1022.26). • An amount authorized relating to constructing an energy efficient residence (A.R.S. §43-1022.27). 62 TYPE OF ARIZONA SUBTRACTION 2003 (Millions) Interest on U.S. obligations $7.35 Exclusion for federal, Arizona or local pensions 7.19 Exempt Arizona lottery winnings 0.09 Social Security or Railroad Retirement benefits included in income 59.97 Adjustment for bonus depreciation 2.67 Certain wages of Native Americans 14.43 Income tax refunds from other states 0.75 Construction of an energy efficient residence 0.04 Other subtractions (from back of 140) 6.41 Deposits and employee contributions into medical savings accounts 0.15 Elective subtraction of 2003 federal retirement contributions 0.40 TOTAL VALUE OF ARIZONA SUBTRACTIONS $100.19 DEDUCTIONS Arizona taxpayers can deduct the part of their income used to pay for certain expenses, such as taxes or medical bills, by either listing (itemizing) deductions or taking a standard deduction. Arizona allows the same itemized deductions as the federal government, with three exceptions. Medical deductions are fully deductible in Arizona; gambling losses are adjusted to consider the lottery subtraction; and a property tax adjustment is made to offset a property tax credit claimed. Standard Deduction In 2003, the standard deduction was $4,050 for single and married filing separate filers and $8,100 for married filing joint and unmarried head of household filers (A.R.S. §43-1041). Removing the standard deduction would result in additional tax revenue of $161.82 million. The higher standard deduction amount allowed for unmarried head of household filers is a preferential deduction amount, double the amount normally allowed one person (A.R.S. §43-1041A2). The value of this preferential standard deduction was $15.12 million in 2003. Itemized Deductions (Schedule A): The provisions allowed on the Schedule A are in A.R.S. §43-1042 as described below. When calculating the impact of disallowing portions of the Schedule A and the entire Schedule A, the standard deduction replaces the Schedule A total if the Schedule A total drops below the standard deduction amount. In other words, if the Schedule A total dropped below $4,050 or $8,100 (the standard deduction amounts based on filing status) the standard deduction amount was used. Medical Deduction The medical deduction on the federal Schedule A equals medical expenses greater than 7.5% of the taxpayer's federal adjusted gross income. This deduction is adjusted on the Arizona return to allow all medical expenses incurred. The value of the 2003 medical deductions was $85.77 million. Taxes Paid Deduction Deductions allowed for taxes included state and local income taxes, real estate taxes and other taxes, including personal property taxes. 63 TYPE OF TAX DEDUCTION 2003 (Millions) State and local income taxes $91.77 Real estate taxes 43.92 Personal property taxes and Other taxes 11.99 VALUE OF TAXES PAID DEDUCTIONS $145.03 Interest Expense Deduction The interest expense deduction is the largest of all the itemized deductions. Deductible interest includes home mortgage interest, points paid on the purchase of a home and some investment interest. TYPE OF INTEREST EXPENSE DEDUCTION 2003 (Millions) Home mortgage interest $206.57 Deductible points 2.13 Deductible investment interest 9.82 VALUE OF INTEREST EXPENSE DEDUCTION $217.93 Charitable Contribution Deduction Deductions were allowed for contributions made to religious, charitable, educational, scientific or literary organizations. The contributions could be cash, property or out-or-pocket expenses incurred while doing volunteer work. TYPE OF CHARITABLE CONTRIBUTION DEDUCTION 2003 (Millions) Cash contributions $59.68 Contributions other than cash 17.56 Carryover from prior year 4.83 VALUE OF CHARITABLE CONTRIBUTION DEDUCTION $82.02 Casualty and Theft Losses Losses on non-business property arising from theft, vandalism, fire, storm, and car, boat and other accidents or similar causes are deductible. Money kept in a financial institution that was lost because of insolvency or bankruptcy of the institution was also deductible in some cases. However, only those losses that exceeded 10% of Federal Adjusted Gross Income were deductible. The value of this type of deduction was $0.78 million in 2003. Job Expenses and Most Other Miscellaneous Deductions This deduction includes unreimbursed job expenses, tax return preparation fees, safe deposit box rental, certain legal and accounting fees, etc., which exceed 2% of Federal Adjusted Gross Income. The value of this deduction in 2003 was $34.37 million. Other Miscellaneous Deductions These fully deductible miscellaneous deductions include gambling losses to the extent of gambling winnings, federal estate tax on income in respect of a decedent, amortizable bond premiums on bonds acquired before 10/23/86, etc. Any gambling losses taken on the 64 federal Schedule A were adjusted for Arizona to offset the subtraction for Arizona lottery winnings. Without this adjustment, a double deduction could have been allowed for gambling losses associated with the Arizona lottery. An adjustment is also made to the Arizona itemized deductions for the amount of property taxes included on the federal Schedule A for those qualified defense contractors who claim a credit. This deduction was worth $15.28 million in 2003. TYPE OF DEDUCTION 2003 (Millions) Standard Deduction $161.82 Preferential standard deduction for unmarried head of household filers 15.12 Itemized Deductions: Medical and dental expenses 85.77 Taxes paid 145.03 Interest expense 217.93 Charitable contributions 82.02 Casualty or theft losses 0.78 Job expenses and most other miscellaneous deductions 34.37 Other miscellaneous deductions (nonlimited) 15.28 Value of All Itemized Deductions $421.85 VALUE OF STANDARD AND ITEMIZED DEDUCTIONS $788.03 PREFERENTIAL TAX RATES Individual income tax for single and married filing separate filers is calculated according to a graduated tax rate schedule as presented below (double this for married filing joint and unmarried head of household filers): at least but less than $0 $10,000 2.87% of the amount 10,000 25,000 3.2% of the amount, less $33 25,000 50,000 3.74% of the amount, less $168 50,000 150,000 4.72% of the amount, less $658 150,000 and over 5.04% of the amount, less $1,138 Lower taxable incomes are taxed at a lower level, or, in other words, are treated preferentially. If all taxpayers were treated identically, the same tax rate would be applied regardless of the level of taxable income. A question arises, however, as to what tax rate should be applied to determine the revenue impact of treating all taxpayers identically. One argument may be that since the highest tax rate is 5.04%, determining the impact of taxing all income at 5.04% would be appropriate. Using this reasoning, an additional $871.6 million would have been collected from individual income tax if a flat 5.04% tax rate had been used. 65 However, no taxpayer is currently taxed solely at 5.04%; only that income greater than $150,000 is taxed at this rate. If a flat tax rate were applied to individual income, the logical tax rate applied would be the effective tax rate of all individual income taxpayers. Dividing total tax liability on individual income tax returns by the total Arizona taxable income results in an effective tax rate 3.57%. Applying this tax rate to all taxpayers results in the same individual income tax collections as with the graduated tax rate structure, but the burden of the tax will change. Taxpayers with lower Federal Adjusted Gross Income will pay more tax and taxpayers with higher Federal Adjusted Gross Income would pay less tax. CREDITS A tax credit differs from an exemption, subtraction or deduction in that it directly reduces tax liability, not taxable income. A $100 deduction, for example, would reduce tax liability by, at most, $5.04 ($100 times the maximum tax rate of 5.04%). On the other hand a $100 credit reduces tax liability by the full $100. Family Tax Credit Single and married filing separately filers with a federal adjusted gross income of $10,000 or less, and married filing jointly filers with a federal adjusted gross income of $31,000 or less with dependents, may claim the family tax credit (A.R.S. §43- 1073). The amount of the credit is set at $40 per person in the household, and is capped at $240 for married filing jointly and unmarried head of household filers, and $120 for single and married filing separately filers. Property Tax Credit The property tax credit program provides tax relief to the state's low-income elderly. Under this program, full-year residents age 65 or older with a household income of less than $5,500 are eligible for credits ranging from $56 to $502 (A.R.S. §43- 1072). The property tax credit is refundable, meaning that those eligible for the credit receive money even if they had no income tax liability. Clean Elections Credit A credit is allowed for donations made directly to the Clean Elections Fund or a clean election donation made on the individual income tax return. The credit is not to exceed 20% of the tax liability or $550 for single filers ($1,100 for married filing jointly) whichever is greater. The maximum credit is adjusted biennially (A.R.S. §16-954B). Credit for Increased Excise Taxes Paid A refundable credit is allowed against income tax to mitigate the increase in transaction privilege tax rates for education (A.R.S. §43- 1072.01). To qualify, claimants must have federal adjusted gross income of $25,000 or less for married filing jointly or $12,500 or less for single filers. The credit shall not exceed $25 for each person who is a resident and for whom a personal or dependent exemption is allowed with a maximum credit of $100 per household. Other Credits Other credits are filed on a separate Schedule CR. In many instances, the credit claimed exceeds the tax liability on the return. With those credits that are non-refundable, the unused portion of the credit is superfluous. For this reason, in order to generate the true expenditure associated with credits, each credit claim must be reviewed. Credit for Taxes Paid to Other States or Countries In the past, the majority of the credits claimed on the Schedule CR, in terms of dollars and volume, were for taxes paid to other states or countries (A.R.S. §43-1071). Enterprise Zone Credits Enterprise zone credits are income tax credits provided for non-retail businesses located in an enterprise zone established under Arizona law who have a net increase in employment of qualified 66 employees (A.R.S. §43-1074). A maximum of $500 per each net new employee can be claimed in the first or partial year of employment. In the second year of continuous employment, a maximum of $1,000 per net new employee can be claimed. The limit in the third year of continuous employment is $1,500 per net new employee. Research and Development Credit A.R.S. §43-1074.01 provides a tax credit for research and development expenses. The amount of credit is computed based on the excess of the qualified research expenses for the taxable year over the base amount. Recycling Equipment Credit The recycling equipment credit is an income tax credit for businesses or individuals that acquire and place in service recycling equipment in the state (A.R.S. §43-1076). This credit is equal to 10% of the installed cost of the recycling equipment but not to exceed 25% of the tax liability for that tax year or $5,000. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Defense Contracting Credit Defense contracting credits are provided to qualified defense contractors for net increases in full-time employment positions under the United States Department of Defense contracts and for net increases in private commercial full-time employment within Arizona by a qualified defense contractor (A.R.S. §43-1077). An income tax credit is also allowed equal to a portion of the amount paid as property taxes during the taxable year by a qualified defense contractor on property that is classified as Class 3 (A.R.S. §43-1078). Military Reuse Zone Credit The military reuse zone credit is a tax credit for net increases in employment by the taxpayer of full-time employees working in a military reuse zone who are primarily engaged in manufacturing, assembling or fabricating aviation or aerospace products (A.R.S. §43-1079). The amount of the credit is determined by a dollar amount allowed for net new employee positions other than dislocated military base employees and by a dollar amount allowed for net new dislocated military base employee positions. Environmental Technology Credit An income tax credit is provided for expenses incurred in constructing a qualified environmental technology manufacturing, producing or processing facility (A.R.S. §43-1080). The amount of the credit is equal to 10% of the amount spent during the taxable year to construct the facility. Pollution Control Device Credit The pollution control device credit is a tax credit for expenses incurred to purchase real or personal property that is used in Arizona in the taxpayer's trade or business to control or prevent pollution (A.R.S. §43-1081). The amount of the credit is equal to the lesser of 10% of the purchase price or $500,000. Agricultural Pollution Control Equipment Credit A credit is allowed for expenses that a taxpayer (involved in the commercial production of livestock, livestock products or agricultural, horticultural, viticultural or floricultural corps or products) incurs to purchase tangible personal property that is primarily used in the taxpayer’s trade or business in the state to control or prevent pollution (A.R.S. §43-1081.01). Construction Materials Credit A.R.S. §43-1082 provides a tax credit of 5% of the purchase price of new construction materials incorporated into a qualifying facility located in Arizona if the facility has a total cost of $5 million. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Solar Energy Device Credit A solar energy credit is provided for an individual who installs a solar energy device in his or her residence in Arizona. The credit for buying or installing such a device is 25% of the cost, including installation, or $1,000, whichever is less (A.R.S. §43-1083). 67 Agricultural Water Conservation System Credit A credit is allowed for expenses incurred by a taxpayer to purchase and install an agricultural water conservation system (A.R.S. §43-1084). The agricultural water conservation system must be primarily designed to substantially conserve water on land that is used to produce agricultural products, raise, harvest or grow trees, or sustain livestock. The amount of the credit is 75% of the qualifying expenses. Underground Storage Tanks Credit Taxpayers that incur expenses for corrective actions taken with respect to the release of a regulated substance from an underground storage tank are allowed an income tax credit. The credit is 10% of the amount spent for corrective actions during the taxable year, if certified by the Department of Environmental Quality. (A.R.S. §43-1085) Alternative Fuel Vehicles Credit An income tax credit was provided for the purchase of one or more new alternative fuel vehicles for use in this state or for expense incurred for converting one or more conventional vehicles to operate on alternative fuel (A.R.S. §43-1086). This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Vehicle Refueling Apparatus Credit A.R.S. §43-1086.01 provided a credit for the purchase of a vehicle refueling apparatus including storage tanks, for installation on one or more properties in Arizona. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Alternative Fuel Delivery System Credit A credit was allowed for construction costs or operating costs for constructing or operating an alternative fuel delivery system in Arizona (A.R.S. §43-1086.02). This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Employment of TANF Recipients Credit A.R.S. §43-1087 provides for an income tax credit for net increases in qualified employment of recipients of temporary assistance for needy families who are Arizona residents. A maximum of $500 per each net new employee can be claimed in the first year of employment, $1,000 in second year of employment and $1,500 in the third year. Contributions to Charities that Provide Assistance to the Working Poor Credit Up to $200 in voluntary cash contributions to a charitable organization that spends at least 50% of its budget on services to Arizona residents who receive TANF benefits or low income Arizona residents (income of less than 150% of the federal poverty level) can be taken as an income tax credit (A.R.S. §43-1088). Private School Tuition Organization Credit The private school tuition organization credit is allowed for cash contributions to a school tuition organization, up to $500 for single/married filing separate and $625 for married filing joint/unmarried head of household filers. (A.R.S. §43-1089). Public School Extra Curricular Activity Fee Credit A.R.S. §43-1089.01 allows an income tax credit for the amount of fees paid to a public school located in Arizona for the support of extra curricular activities, up to $200 for single/married filing separate and $250 for married filing joint/unmarried head of household filers. School Site Donation Credit A.R.S. §43-1089.02 provides a credit for donation of real property and improvements to a school district or charter school for use as a school or a site for the construction of a school. The amount of the credit is 30% of the value of real property and improvements donated. 68 Solar Hot Water Heater Plumbing Stub Outs and Electric Vehicle Recharge Outlets Credit A credit is allowed for costs incurred of installing an electric vehicle recharge outlet and for including solar hot water heater plumbing stub outs in one or more houses in Arizona constructed by the taxpayer. (A.R.S. §43-1090) Agricultural Preservation District Credit A refundable credit is allowed for a taxpayer who conveys ownership or development rights of Class Two property to an agricultural preservation district (A.R.S. §43-1081.02). The amount of the credit is either the appraised value of the property or the difference between the appraised value of the undeveloped land and the appraised value of the land for development purposes. The credit cannot exceed $33,000 in a calendar year. Technology Training Credit A refundable credit is allowed for providing technological skills training to employees (A.R.S. §43-1088.01). The credit is equal to 50% of the cost of training in taxable year, not to exceed $1,500 per employee, for a maximum of 20 employees. TYPE OF CREDIT # of claimants 2003 (Millions) Family tax credit 417,451 $7.45 Property tax credit 15,028 5.30 Clean elections credit 32,042 0.73 Credit for increased excise taxes paid 548,831 29.58 Credit for taxes paid to other states or countries 25,722 62.48 Enterprise zone credit 202 1.71 Research and development credit 121 1.10 Recycling equipment credit 4 0.00 Defense contracting credit 0 0.00 Military reuse zone credit 0 0.00 Environmental technology credit 0 0.00 Pollution control device credit 9 0.03 Agricultural pollution control equipment credit NR14 NR Construction materials credit NR NR Solar energy device credit 1,171 0.48 Agricultural water conservation system credit 154 1.61 Underground storage tanks credit 0 0.00 Alternative fuel vehicles credit 50 0.06 Alternative fuel vehicle credit – neighborhood electric vehicle portion 1,203 1.58 Vehicle refueling apparatus credit 5 0.01 Alternative fuel delivery system credit 0 $0.00 Employment of TANF recipients credit NR15 NR Contributions to charities that provide assistance to the working poor credit 17,467 3.26 14 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 15 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 69 TYPE OF CREDIT # of claimants 2003 (Millions) Private school tuition organization credit 58,122 29.45 Public school extra curricular activity credit 201,407 27.75 School site donation credit 45 2.05 Solar hot water heater plumbing stub outs and electric vehicle recharge outlets credit NR NR Agricultural preservation district credit (refundable) 0 0.00 Technology training credit (refundable) 0 0.00 TOTAL VALUE OF ALL CREDITS (credit used and refunded) 16 1,319,043 $174.66 16 Figures for all credits shown here are subject to change due to the verification process. 70 SUMMARY OF INDIVIDUAL INCOME TAX EXPENDITURES Tax Year 2003 FEDERAL SUBTRACTIONS FROM INCOME: Educator expenses/tuition fees deduction ............................................................. $2,713,000 Individual Retirement Account for qualifying individuals...................................... 5,108,000 Student Loan Interest deduction................................................................................ 2,068,000 Moving expenses ............................................................................................................. 480,000 One-half of self-employment tax ............................................................................... 8,249,000 Self-employed health insurance deduction ............................................................... 8,359,000 Keogh retirement plan and self-employed SEP deduction .................................. 10,307,000 Penalty on early withdrawal of savings........................................................................... 30,000 Alimony paid ............................................................................................................ 6,166,000 TOTAL VALUE OF FEDERAL SUBTRACTIONS FROM INCOME....................................................................................$43,861,000 EXEMPTIONS: Personal exemptions ..............................................................................................$200,236,000 Preferential personal exemption for unmarried head of household ................... 11,206,000 Preferential personal exemption for married filers with one or more dependents.................................................................................................................. 26,753,000 Age 65 or over exemptions ....................................................................................... 19,104,000 Dependent exemptions.............................................................................................. 81,828,000 Blind exemptions ............................................................................................................. 197,000 Qualifying parent or ancestor exemption........................................................... 1,587,000 TOTAL VALUE OF EXEMPTIONS.......................................................... $350,697,000 SUBTRACTIONS FROM INCOME: Interest on US obligations......................................................................................... $7,349,000 Exclusion for federal, Arizona state or local pensions............................................ 7,186,000 Exempt Arizona state lottery winnings .......................................................................... 87,000 Social Security or Railroad Retirement benefits included on federal form 1040 ............................................................................................................... 59,974,000 Bonus depreciation adjustment .................................................................................. 2,667,000 Certain wages of Native Americans......................................................................... 14,434,000 Income tax refunds from other states .......................................................................... 753,000 Constructing energy efficient residences........................................................................ 39,000 Other Subtractions ....................................................................................................... 6,413,000 Deposits and employee contributions into medical savings accounts..................... 149,000 Elective subtraction of 2003 federal retirement contributions ....................... 397,000 TOTAL VALUE OF SUBTRACTIONS...................................................... $100,188,000 71 DEDUCTIONS: Standard deduction.................................................................................................$161,815,000 Preferential standard deduction for unmarried head of household .................... 15,116,000 Itemized deductions: Medical & dental expenses ........................................................................................ 85,768,000 Taxes paid: State and local income taxes ................................................... 91,772,000 Real estate taxes ........................................................................ 43,924,000 Personal property and Other Taxes....................................... 11,996,000 Total value of taxes paid deduction ................................................................$145,027,000 Interest Expense: Home Mortgage Interest .......................................................206,570,000 Deductible Points ....................................................................... 2,130,000 Deductible Investment Interest............................................ 9,821,000 Total Value of Interest Expense .....................................................................$217,933,000 Charitable Contributions: Cash Contribution .................................................................... 59,684,000 Contributions Other Than Cash ............................................ 17,563,000 Carryover From Prior Year..................................................... 4,831,000 Total Value of Charitable Contributions ...........................................................$82,016,000 Casualty & Theft Losses................................................................................................... 784,000 Job Expenses and Most Other Miscellaneous Deductions ....................................34,368,000 Nonlimited Miscellaneous Deductions ................................................................ 15,276,000 Total Value of Itemized Deductions .....................................................................$421,849,000 TOTAL VALUE OF STANDARD AND ITEMIZED DEDUCTIONS................................................................ $788,025,000 CREDITS: Family tax credit............................................................................................................$7,446,000 Property tax credit ..........................................................................................................5,302,000 Clean elections fund credit............................................................................................... 727,000 Credit for increased excise taxes paid........................................................................29,582,000 Credit for taxes paid to other states or countries.....................................................62,485,000 Enterprise zone credit....................................................................................................1,714,000 Research and development credit ................................................................................1,109,000 Recycling equipment credit .................................................................................................. 2,000 Defense contracting credit ...........................................................................................................0 Military reuse zone credit .............................................................................................................0 Environmental technology credit................................................................................................0 Pollution control device credit........................................................................................... 31,000 Agricultural pollution control equipment credit ................................................................NR17 Construction materials credit...................................................................................................NR Solar energy device credit ................................................................................................. 480,000 Agricultural water conservation system credit............................................................1,611,000 Underground storage tanks credit...............................................................................................0 Alternative fuel vehicles credit........................................................................................... 61,000 17 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 72 Neighborhood electric vehicle credit.........................................................................$1,583,000 Vehicle refueling apparatus credit ....................................................................................... 9,000 Alternative fuel delivery system credit........................................................................................0 Employment of TANF recipients credit.............................................................................NR18 Contributions to charities providing assistance to working poor credit.................3,259,000 Private school tuition organization credit .................................................................29,445,000 Public school extra curricular activity fee credit ......................................................27,754,000 School site donation credit............................................................................................2,049,000 Solar water heater plumbing stub outs and electric vehicle recharge outlets credit............................................................................................................................NR Agricultural preservation district credit (refundable) ...............................................................0 Technology training credit (refundable)............................................................... 0 TOTAL VALUE OF CREDITS....................................................................... $174,664,000 VALUE OF INDIVIDUAL INCOME TAX EXPENDITURES19 ............................................................................................................$1,727,012,000 18 Too few taxpayers have claimed this credit to allow for a release of the cost without violating confidentiality laws. 19These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 73 INSURANCE PREMIUM TAX EXPENDITURES 74 75 INSURANCE PREMIUM TAX EXPENDITURES20 20Any figures presented for Insurance Premium Tax Expenditures were provided by the Department of Insurance. Each admitted insurer doing business in the state is required to annually report its total direct premium income to the Arizona Department of Insurance (A.R.S. § 20-224). Total direct premium income excludes “...applicable cancellations, returned premiums, the amount of reduction in or refund of premiums allowed to industrial life policyholders for payment of premiums direct to an office of the insurer, all policy dividends, refunds, savings coupons and other similar returns paid or credited to policyholders within this state and not reapplied as premiums for new, additional or extended insurance.” Direct premium income also excludes “considerations received on annuity contracts,” as well as the “unabsorbed portion of any premium deposit.” No information is available on the value of these exclusions from
Object Description
TITLE | Revenue impact of Arizona's tax expenditures |
CREATOR | Arizona. Department of Revenue. Office of Economic Research & Analysis. |
SUBJECT | Tax exemption--Arizona; Tax expenditures--Arizona; |
Browse Topic |
Business and industry |
DESCRIPTION | This title contains one or more publications. |
Language | English |
Contributor | Arizona. Office of the Governor; Arizona. Legislature. |
Publisher | Arizona. Dept. of Revenue. |
TYPE | Text |
Material Collection |
State Documents Annual Reports |
Source Identifier | REV 1.3:R 38/ |
Location | 19885180 |
REPOSITORY | Arizona State Library, Archives and Public Records--Law and Research Library. |
Description
TITLE | Revenue impact of Arizona's tax expenditures 2005 Final |
DESCRIPTION | 174 pages (PDF version). File size: 483 KB |
TYPE |
Text |
RIGHTS MANAGEMENT | Copyright to this resource is held by the creating agency and is provided here for educational purposes only. It may not be downloaded, reproduced or distributed in any format without written permission of the creating agency. Any attempt to circumvent the access controls placed on this file is a violation of United States and international copyright laws, and is subject to criminal prosecution. |
DATE ORIGINAL | 2009-06 |
Time Period |
2000s (2000-2009) |
ORIGINAL FORMAT | Born Digital |
Source Identifier | REV 1.3:R 38 |
Location | 19885180 |
DIGITAL IDENTIFIER | exp2005.pdf |
DIGITAL FORMAT | PDF (Portable Document Format) |
REPOSITORY | Arizona State Library, Archives and Public Records--Law and Research Library. |
File Size | 494136 Bytes |
Full Text | THE REVENUE IMPACT OF ARIZONA’S TAX EXPENDITURES FY 2004/05 PREPARED FOR: THE GOVERNOR AND THE LEGISLATURE BY: THE OFFICE OF ECONOMIC RESEARCH & ANALYSIS Janice K. Brewer Gale Garriott Governor Director A R I Z O N A D E PA RT M E N T O F R E V E N U E November 15, 2005, Preliminary June 2009, Final The following report on Arizona's Tax Expenditures was prepared for the Governor and the Legislature in compliance with A.R.S. §42-1005. The fiscal year 2004/2005 report provides a broad range of information. The report contains sections for all taxes imposed by the state. The preliminary report, released November 15, 2005 did not include information on tax expenditures from Individual Income Tax. The individual income tax information included in this final report was made available through the 2003 Individual Income Tax Simulation Model. If you have any questions or comments regarding this report, please contact the Arizona Department of Revenue at (602) 716-6090. TABLE OF CONTENTS INTRODUCTION........................................................................................................Page 1 AIRCRAFT LICENSE TAX EXPENDITURES.....................................................Page 3 AVIATION FUEL TAX EXPENDITURES ...........................................................Page 9 BINGO TAX EXPENDITURES .............................................................................Page 13 BOXING TAX EXPENDITURES..........................................................................Page 19 CORPORATE INCOME TAX EXPENDITURES..............................................Page 23 ESTATE TAX EXPENDITURES............................................................................Page 33 FIDUCIARY INCOME TAX EXPENDITURES ................................................Page 37 FLIGHT PROPERTY TAX EXPENDITURES ...................................................Page 47 IN LIEU PROPERTY TAX EXPENDITURES ...................................................Page 51 INDIVIDUAL INCOME TAX EXPENDITURES .............................................Page 55 INSURANCE PREMIUM TAX EXPENDITURES ............................................Page 73 JET FUEL EXCISE AND USE TAX EXPENDITURES...................................Page 81 LUXURY TAX EXPENDITURES ..........................................................................Page 85 MOTOR CARRIER FEE EXPENDITURES........................................................Page 91 MOTOR VEHICLE FUEL TAX EXPENDITURES ..........................................Page 97 PARI-MUTUEL TAX EXPENDITURES............................................................Page 101 PRIVATE CAR PROPERTY TAX EXPENDITURES.....................................Page 105 PROPERTY TAX EXPENDITURES ...................................................................Page 109 SEVERANCE TAX EXPENDITURES................................................................Page 115 TRANSACTION PRIVILEGE AND USE TAX EXPENDITURES.............Page 119 UNDERGROUND STORAGE TANK TAX EXPENDITURES..................Page 141 UNEMPLOYMENT INSURANCE TAX EXPENDITURES.........................Page 145 USE FUEL TAX EXPENDITURES .....................................................................Page 151 VEHICLE LICENSE TAX EXPENDITURES...................................................Page 155 WATERCRAFT LICENSE TAX EXPENDITURES ........................................Page 161 WORKERS’ COMPENSATION PREMIUM LIEU TAX EXPENDITURES......................................................................................Page 167 1 THE 2005 ARIZONA TAX EXPENDITURE REPORT INTRODUCTION The Arizona Tax Expenditure Report is a study prepared for the Governor and the Legislature by the Arizona Department of Revenue's Office of Economic Research and Analysis. The report is prepared in compliance with A.R.S. §42-1005. Tax expenditures are provisions within the law (exemptions, exclusions, deductions and credits) that are designed to encourage certain kinds of activity or to aid taxpayers in certain categories. Such provisions, when enacted into law, result in a loss of tax revenues, thereby reducing the amount of revenues available for state (as well as local) programs. In effect, the fiscal impact of implementing a tax expenditure would be similar to a direct expenditure of state funds. This report provides a list of tax expenditures, plus, whenever possible, details the approximate costs of exempting certain types of income, goods, services or property from their respective tax statutes. The purpose of this report is to provide a better understanding of the costs associated with the existing set of tax exemptions, exclusions, deductions and credits. There are sections on every tax imposed in Arizona. In each section, provisions dealing with that specific tax type are analyzed. The analysis includes a detailed explanation of the provision as well as the approximate cost of that provision, if possible. Sections pertaining to tax types not administered by the Arizona Department of Revenue were reviewed by the agency administering the tax. Any figures presented in these sections were provided by that agency. ASSUMPTIONS This report is not intended in any way to determine the desirability of the tax expenditures currently established in law. The Legislature and the Governor determine the taxation environment that they wish to create in Arizona and formulate law to create this taxation policy. All tax expenditures were conscious public policy decisions at the time of enactment. For example, since 1990, public policy decisions were made to relieve the individual income tax burden on persons age 65 and over in Arizona. To that end, the amount of the age 65 and over exemption was increased in 1992 to $1,750 from $1,500 and increased again for tax year 1993 to $2,100. From tax years 1993 through 2003, the age 65 and over exemption has remained at $2,100. The costs associated with the specific provisions shown in this report are the estimated impact of that provision based upon the information available for the stated fiscal or calendar year. There is no consideration of decreased demand as a result of higher taxes. For example, if taxes on a certain type of liquor were increased to $3 per gallon, the calculations presented assume that the same demand exists under the $3 per gallon tax as exists when the tax is 84¢ per gallon. This constant demand would not exist in the "real" world, but the tools are not available to the Department of Revenue to estimate the elasticity of demand. Therefore, the estimated costs should be used only as a guide and not as an exact representation of what would occur in later years. Finally, the summary page(s) at the end of each section provides a total value of the tax expenditure. This total value is only a general guide and should not be used in isolation from the rest of the expenditure amounts. In fact, the expenditures for any particular tax cannot generally be added to reach a total. The presence or absence of one expenditure for a tax type can directly affect the value of another expenditure for that same tax type. 2 3 AIRCRAFT LICENSE TAX EXPENDITURES 4 5 AIRCRAFT LICENSE TAX EXPENDITURES1 1Any figures presented for Aircraft License Tax Expenditures were provided by the Arizona Department of Transportation. A license tax is imposed on aircraft operating in this state at the rate of 0.5% of the average fair market value of the particular make, model and year of the aircraft, but not less than $20. The proceeds from this tax are deposited into the state aviation fund. AIRCRAFT LICENSE TAX EXEMPTIONS Certain aircraft are exempt from this license tax, as set out in A.R.S. §28-8322. Aircraft operated by an airline company and regularly scheduled for the primary purpose of carrying persons or property for hire in interstate, intrastate, or international transportation are exempt from this tax. Calculating the tax value of this tax expenditure would require knowing the average fair market value of every aircraft carrying persons or property for hire that stops at an airport in this state. Therefore, the tax value of this tax expenditure is not quantifiable. Aircraft owned and operated exclusively in the public service by the federal government, by the state or by any political subdivision thereof, or by the civil air patrol is exempt from the vehicle license tax (A.R.S. §28- 8323). The average fair market value of aircraft owned by the federal government and operated in Arizona is unknown. It is known that there were 109 aircraft owned by the Arizona Department of Transportation, the Arizona Department of Public Safety, various Arizona counties and cities, and the civil air patrol in fiscal year 2004/05. The average fair market value of each aircraft is approximately $131,100, which equates to a tax value of $71,450 for this tax expenditure. A.R.S. §28-8383B also exempts aircraft owned and held by a bona fide aircraft dealer solely for the purposes of sale, as long as these aircraft are registered within ten days of the dealer's purchase date. There were 72 aircraft of this type registered by bona fide aircraft dealers in Arizona in fiscal year 2004/05. The tax value of these aircraft was approximately $402,607. PREFERENTIAL TAX RATES There are preferential aircraft license tax rates granted to certain types of aircraft in A.R.S. §28-8336. The license tax rate for a nonresident who bases his aircraft in Arizona for more than 90 days but less than 210 days in a given calendar year, provided that the aircraft is not engaged in any intrastate commercial activity, is equal to 0.1% of the average fair market value of the particular make, model, and year of aircraft (A.R.S. §28-8336). This tax rate is 20% of the tax rate imposed on resident-owned aircraft. In fiscal year 2004/05, there were 37 nonresident aircraft based in Arizona. The total aircraft license tax paid by nonresidents falling into this category in fiscal year 2004/05 was $15,635. The value of this expenditure can be calculated by multiplying this figure by four, which yields the foregone tax collections allowed by this preferential rate, or $62,542. Aircraft in storage or being repaired is charged a license tax of $20 (A.R.S. §28-8337). There are 279 aircraft, which have been granted this license tax rate with a fair market value of approximately $ 494.8 million. The tax value of this preferential license tax is $2.5 million which is the total fair market value multiplied by 0.5% less $20 per aircraft. The annual license tax for a salvage aircraft that is in storage or that is being restored is $5 (A.R.S. §28- 8338). There are 84 aircraft registered under this provision. Assuming no market value for salvage aircraft, the tax value of this tax 6 expenditure is the difference between the $20 minimum license tax imposed on all other aircraft and the $5 minimum license tax imposed on these tax, or $1,260. A.R.S. §28-8339 allows a $20 license tax for an antique, classic, warbird, glider, experimental, homebuilt, or balloon aircraft. There are 3,109 aircraft registered in Arizona under this provision, with a total market value of $ 12.4 million. The tax value of this tax expenditure is the total market value multiplied by 0.5% less the $20 license tax paid per aircraft, or $0. Maintenance aircraft owned by a nonresident (A.R.S. §28-8341) and manufacturer's aircraft (A.R.S. §28- 8340) are required to pay an aircraft license tax of $20. There are 11 nonresident-owned maintenance aircraft and 18 manufacturer's aircraft registered in Arizona, for a total market value of $142.9 million. The tax value of this tax expenditure can be calculated by multiplying the total market value by 0.5% and subtracting the $20 per aircraft tax paid, or $713,875. 7 SUMMARY OF AIRCRAFT LICENSE TAX EXPENDITURES Revenue Gain AIRCRAFT LICENSE TAX EXEMPTIONS: Aircraft operated for the primary purpose of carrying persons or property for hire ..................................................................................................................NIA* Nonresident-owned aircraft in the state for less than 90 days..........................................NIA Aircraft owned by a government or by the civil air patrol .......................................... $71,450 Aircraft owned by an aircraft dealer for sale ................................................................. 402,607 PREFERENTIAL TAX RATES Preferential rate for nonresidents with aircraft in the state from 90 to 210 days........................................................................................................................ $62,542 Preferential rate for aircraft in storage or being repaired..........................................2,468,634 Preferential rate for salvage aircraft in storage or being repaired................................... 1,260 Preferential rate for antique, classic, warbird, etc., aircraft......................................................0 Preferential rate for maintenance aircraft...................................................................................0 Preferential rate for manufacturer's aircraft................................................................... 713,875 TOTAL QUANTIFIABLE AIRCRAFT LICENSE TAX EXPENDITURES2 ................................................................................................ $3,720,367 *No Information Available. 2These tax expenditures represent foregone revenues to the state aviation fund. 8 9 AVIATION FUEL TAX EXPENDITURES 10 11 AVIATION FUEL TAX EXPENDITURES3 3Any figures presented for Aviation Fuel Tax Expenditures were provided by the Arizona Department of Transportation. An aviation fuel tax is imposed on every distributor for each gallon of aviation fuel possessed, refined, manufactured, produced, blended or compounded in this state by the distributor or imported by the distributor, whether in the original package or container in which it was imported or otherwise. All suppliers are required to pay tax on all aviation fuel. In order to qualify for exemptions on certain types of aviation fuel, the taxpayer must file for a refund. The fuel tax rate is 5¢ per gallon. Exemptions from the aviation fuel tax are set out in A.R.S. §28-5610. Aviation fuel moving in interstate or foreign commerce, not destined or diverted to a point within this state is exempt from aviation fuel tax. There is no requirement for reporting this information, therefore, the tax value of this expenditure is unknown. Also exempt from aviation fuel tax is aviation fuel sold to the United States armed forces for use in ships or aircraft, or for use without this state (A.R.S. §28-5610). The amount of aviation fuel purchased by the United States armed forces is not reported and the tax value is unknown. Although not listed as an exemption, a taxpayer may request a refund for aviation fuel for use in applying seeds, fertilizer or pesticides (A.R.S. §28- 5611A). If such fuel were subject to taxation in fiscal year 2004/05, an additional $842 would have been received. Aviation fuel, which is exported from the state, is exempt from aviation fuel tax (A.R.S. §28- 5611A). The taxpayer must apply for a refund. If such fuel were subject to taxation in fiscal year 2004/05, an additional $5,933 in aviation fuel tax would have been received. Also not listed as an exemption, a taxpayer may request a refund for losses of fuel due to fire, theft or other accident (A.R.S. §28-5611A). No requests for refunds were made in fiscal year 2004/05. 12 SUMMARY OF AVIATION FUEL TAX EXPENDITURES Revenue Gain Aviation fuel moving in interstate or foreign commerce.................................................................... NIA* Aviation fuel sold to the United States armed forces............................................................................. NIA Aviation fuel for use in applying seeds, fertilizer or pesticides.............................................................$842 Exported aviation fuel ...............................................................................................................................5,933 Aviation fuel lost due to fire, theft or other accident................................................................................... 0 TOTAL QUANTIFIABLE AVIATION FUEL TAX EXPENDITURES4 ..................................................................................................................... $6,775 * No Information Available. 4The tax expenditures represent foregone revenues to the state aviation fund. 13 BINGO TAX EXPENDITURES 14 15 BINGO TAX EXPENDITURES The tax on state licensed bingo operations is based on a multi-tiered licensing structure. There are three classes of bingo licenses, each of which has a different tax rate. Each class' tax rate is based on bingo receipts. All bingo tax collections are deposited into the general fund. Class A licensees, whose gross receipts do not exceed $15,600 per year, are taxed at 2.5% of their adjusted gross receipts (A.R.S. §5-414). Adjusted gross receipts equals gross receipts less the amount paid for prizes. Therefore, prize money is exempt from taxation for this class of bingo licensees. In fiscal year 2004/05, this group of taxpayers subtracted $3.1 million from gross receipts. Determination of the tax value of this subtraction, however, is not a simple matter. If prize money were not allowed as a subtraction from gross receipts, it is unlikely that this group would have a 2.5% tax rate. However, if a 2.5% tax rate is not used, a more appropriate tax rate must be selected. The tax value of the prize money subtraction for Class A taxpayers is calculated in two ways. Option 1 is to multiply the subtraction amount by 2.5%, the Class A tax rate. This results in potential collections of $77,121. Option 2 is to multiply the subtraction amount by the average effective tax rate of the Class A licensees, calculated by dividing Class A tax collections by Class A total gross receipts. This rate for the Class A licensees is 0.31%. (This method is based on the premise that the Class A tax rate would not be 2.5% if the subtraction were not allowed.) Multiplying the prize money subtraction amount by 0.32% results in potential collections of $9,914. Class B and Class C licensees are taxed on their gross receipts. Class B licensees, whose gross receipts do not exceed $300,000, are taxed at 1.5% of their gross receipts. Class C licensees, whose gross receipts exceed $300,000 annually, are taxed at 2.0% of their gross receipts. This is a preferential rate structure because different tax rates are imposed on similar taxpayers (all involved in the business of bingo) based on criteria set in Arizona statutes. This preferential rate structure allows taxpayers with lower gross receipts to be taxed at a lower tax rate. Measuring the tax value of allowing a preferred tax rate for bingo is difficult because the lowest-income taxpayers (recipients of less than $15,600 annually) have a tax rate higher than the highest-income taxpayers. Normally, this type of calculation would simply involve applying the highest tax rate to all taxpayers to find the revenues that might have been received. Therefore, the tax value of allowing preferential tax rates is also calculated in two ways. Option 1 determines the additional tax that would be received if all classes of licensee were taxed at the highest rate. However, the tax rate of 0.32% mentioned previously, is considered to be the effective tax rate for Class A. This would make the highest tax rate among the three classes 2.0%. If Class A and Class B were taxed at 2.0%, additional general fund revenues would total $145,756. (The calculation for Class A involves substituting 2.0% as the effective tax rate.) The problem with this method of determining the tax value of preferential tax rates is that it assumes (1) there is a possibility of a legislative change which would raise the bingo tax to a uniform rate that is the highest tax rate currently being imposed and (2) small bingo operations would not be affected by an increase in the tax rate (the same level of bingo activities would occur irrespective of the tax rate). Option 2 looks at preferential rates slightly differently. This option assumes that if a uniform tax rate were to be imposed to tax all licensees identically, the new rate would be revenue neutral, resulting instead in a burden shift. The effective tax rate on all bingo activities, determined by dividing total tax collections into gross receipts, is 1.60%. If this rate is applied to all classes of bingo licensees, total tax collections remain the same, but, as can be seen below, the amount of tax paid by class of licensee shifts. 16 Class Original Tax Collections* New Tax Collections Difference A $ 9,915 $ 49,614 $39,699 B $241,023 $269,390 $28,367 C $351,391 $283,326 ($68,066) Total $602,329 $602,329 $ 0 *This amount reflects collections for tax only, and does not include penalty and interest. 17 SUMMARY OF BINGO TAX EXPENDITURES Revenue Gain Subtraction from Gross Receipts for Class A Licensees Option 1..................................................................................................................................................$77,000 Option 2......................................................................................................................................................9,900 Preferential Tax Rates for Class A and Class B Licensees Option 1............................................................................................................................................... $145,700 Option 2............................................................................................................................................................. 0 TOTAL QUANTIFIABLE BINGO TAX EXPENDITURES5 RANGES FROM .........................................................................$9,900 -$145,700 5These tax expenditures represent foregone revenues to the state general fund. 18 19 BOXING TAX EXPENDITURES 20 21 BOXING TAX EXPENDITURES6 6Any figures presented for Boxing Tax Expenditures were provided by the Arizona Boxing Commission. Any person who promotes a boxing contest in Arizona must pay to the Department of Racing (collecting for the state Boxing Commission) a 4% tax on the gross receipts of such match or exhibition, after deduction of city, state and federal taxes (A.R.S. §5-104.02A). Gross receipts are defined as receipts from the face value of tickets sold. Tickets issued as complimentary by the promoter of a boxing match are exempt from taxation, as long as the number of complimentary tickets does not exceed 2% of total number of tickets issued or 75 tickets, whichever is greater. During fiscal year 2004/05, 40 boxing contests were held. At each event, 75 complimentary tickets were issued with an average price of $25 each. Had the value of these tickets been taxable, an additional $3,000 in boxing taxes would have been received. 22 SUMMARY OF BOXING TAX EXPENDITURES Revenue Gain Complimentary tickets issued .................................................................................................................$3,000 TOTAL QUANTIFIABLE BOXING TAX EXPENDITURES7 ............. $3,000 7These tax expenditures represent foregone revenues to the state general fund. 23 CORPORATE INCOME TAX EXPENDITURES 24 25 CORPORATE INCOME TAX EXPENDITURES The Department of Revenue collected over $700 million in net corporate income taxes during fiscal year 2004/05. Net corporate income tax is deposited into the general fund. However, 15% of the tax is distributed to cities and towns two years after the year in which it was collected. For example, 15% of tax collected in fiscal year 2004/05 will be distributed to incorporated cities and towns in fiscal year 2006/07. Therefore, only 85% of the tax collected is actually available for the state’s use. This fact should be kept in mind when reviewing the reported tax value of subtractions and credits. The assumption can be made that 85% of the tax value is general fund revenue, with the remaining 15% distributed to cities and towns two years after collection. Arizona corporate taxable income is calculated beginning with federal taxable income. Therefore, by conforming Arizona law to the Internal Revenue Code, any subtractions allowed under federal law in the calculation of federal taxable income are allowed under Arizona law. From federal taxable income, certain additions and subtractions are allowed to reach Arizona taxable income. After calculating tax liability, corporate taxpayers may take advantage of a number of credits to reduce tax liability. Most of the corporate tax expenditures are not quantifiable. The tax value of the federal subtractions in the calculation of federal taxable income cannot be determined because these are for corporate income from all states, not just Arizona income. The tax value of Arizona's subtractions from federal taxable income cannot be calculated because subtractions are deducted from federal taxable income prior to apportionment of income to Arizona. Therefore, it cannot be determined what percent of the subtractions is used in the calculation of Arizona tax. The remaining subtractions and tax credits are only quantifiable to the extent that data exists. SUBTRACTIONS ALLOWED IN THE CALCULATION OF FEDERAL TAXABLE INCOME The starting point for the calculation of Arizona corporate tax liability is federal taxable income, as calculated on the federal corporate income tax return. The Arizona legislature must approve legislation to conform to the definition of federal taxable income as of January of each year. In conforming to the definition of federal taxable income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Compensation of officers. • Salaries and wages. • Incidental repairs that do not add to the value of the property or appreciably prolong its life. • Debts that became worthless in whole or in part during the tax year. • Expenses of renting or leasing a vehicle. • Contributions or gifts actually paid within the tax year to charitable and governmental organizations and any unused contributions carried over from prior years, except the total amount claimed may not be more than 10% of taxable income. • Depreciation, plus the part of the cost that the corporation elected to expense for certain tangible property placed in service during the tax year. • Certain percentage depletion rates applicable to natural deposits. • Contributions to pensions, profit sharing or other funded deferred compensation plans. • Contributions to employee benefit programs not elsewhere claimed. • Certain taxes paid or accrued during the tax year. • Interest paid on certain debts. 26 • Other deductions including amortization of organizational expenses, losses from partnership trade or business activities, travel and meal expenses, membership dues, etc. It is not possible to estimate the tax value of these subtractions. While the Department of Revenue receives information from the Internal Revenue Service from federal tax returns for corporations with an Arizona address, data on corporations headquartered outside of Arizona but operating within the state is not available. Even if it were available, multi-state corporations would include income and deductions from all states in which they operate in the calculation of federal taxable income, making it useless for Arizona tax expenditure calculation purposes. EXEMPT ORGANIZATIONS Certain organizations are exempt from corporate income tax according to Arizona law. The organizations specifically set out in statute as exempt are: • The United States, the state, counties, municipalities, school districts or other political subdivisions or units of this state or the federal government [A.R.S. §43-104(23)]. • Labor, agricultural or horticultural organizations, other than cooperative organizations [A.R.S. §43-1201(1)]. • Qualifying fraternal beneficiary societies, orders or organizations [A.R.S. §43-1201(2)]. • Cemetery companies owned and operated exclusively for the benefit of their members or which are not operated for profit [A.R.S. §43- 1201(3)]. • Qualifying corporations organized and operated exclusively for religious, charitable, scientific, literary or educational purposes or for the prevention of cruelty to children or animals [A.R.S. §43-1201(4)]. • Nonprofit business leagues, chambers of commerce, real estate boards or boards of trade [A.R.S. §43-1201(5)]. • Nonprofit qualifying civic leagues or organizations operated exclusively for the promotion of social welfare, or local organizations of employees [A.R.S. §43- 1201(6)]. • Clubs organized and operated exclusively for pleasure, recreation and other non-profit making purposes [A.R.S. §43-1201(7)]. • Corporations organized for the exclusive purpose of holding title to property, collecting income therefrom and turning over the entire amount of such income, less expenses, to an organization which itself is exempt from the tax imposed by this title [A.R.S. §43-1201(8)]. • Voluntary employee's beneficiary organizations providing for the payment of life, sick, accident or other benefits to the members of such organizations or their dependents, providing certain requirements are met [A.R.S. §43- 1201(9)]. • Teachers' or public employees' retirement fund organizations of a purely local character, provided certain requirements are met [A.R.S. §43-1201(10)]. • Religious or apostolic organizations or corporations, if such organizations or corporations have a common treasury or community treasury, even if such corporations or organizations engage in business for the common benefit of the members, but only if the members thereof include, at the time of filing their returns, in their Arizona gross income their pro rata shares, whether distributed or not, of the net income of the organizations or corporations for such year [A.R.S. §43-1201(11)]. • Voluntary employees' beneficiary organizations providing for the payment of life, sick, accident or other benefits to the members of such organization, their dependents or their designated beneficiaries, provided membership is limited to officers or employees of the U.S. government [A.R.S. §43-1201(12)]. • Corporations classified as diversified management companies under §5 of the Federal Investment Company Act of 1940 and registered as provided in that act [A.R.S. §43- 1201(13)]. 27 • Insurance companies paying to the state tax upon premium income derived from sources within this state [A.R.S. §43-1201(14)]. • Mutual ditch, irrigation or water companies or similar nonprofit organizations if 85% or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses [A.R.S. §43-1201(15)]. • Workers’ compensation pools established pursuant to §23-961.01 [A.R.S. §43- 1201(16)]. • A small business corporation which makes an election for a taxable year pursuant to subtitle A, chapter 1, subchapter S of the Internal Revenue Code is not subject to corporate taxes for such year but only to the extent such corporation is not subject to federal income taxes [A.R.S. §43-1126). Three of these organizations - religious or apostolic organizations, insurance companies and Subchapter S corporations - are exempt from corporate tax but their income does not escape taxation. In the case of the religious or apostolic corporations and the Subchapter S corporations, the income is taxed at the individual income tax level. Insurance companies are required to pay insurance premium tax rather than corporate income tax. It is not possible to calculate the corporate tax that would be collected if all exempt organizations were subject to corporate taxation. That calculation would require completion of federal and state tax forms by the exempt organizations. ARIZONA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME Arizona statutes set out certain items that can be subtracted from federal taxable income to reach adjusted income attributable to Arizona. The tax value of these subtractions cannot be determined because these are subtracted from federal taxable income prior to apportionment of income to Arizona. It is impossible to isolate those subtractions attributable to Arizona only. • Annuity income included pursuant to §72 of the Internal Revenue Code if the first payment with respect to such annuity was received prior to 12/31/78 [A.R.S. §43-1022(8)]. • The excess of a partner's share of income required to be included under §702(a)(8) of the Internal Revenue Code over the income required to be included under chapter 14, article 2 of Title 43 [A.R.S. §43-1022(9)]. • The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of Title 43 over the losses allowable under §702(a)(8) of the Internal Revenue Code [§43- 1022(10)]. • The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to Title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the Internal Revenue Code [A.R.S. §43-1022(11)]. • The amount allowed by A.R.S. §43-1024 for amortization by a qualified defense contractor certified by the Department of Commerce under §41-1508, of a capital investment for private commercial activities [A.R.S. §43-1022(12)]. • Gain included on the sale or other disposition of a capital investment that a qualified defense contractor has elected to amortize pursuant to A.R.S. §43-1024 [A.R.S. §43-1022(13)]. • The amount allowed by §43-1025 for contributions during the taxable year of agricultural crops to charitable organizations [A.R.S. §43-1022(14)]. • The portion of any wages or salaries paid or incurred by the taxpayer for the taxable year that is equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips, and the Indian employment credit that the taxpayer received under §§45A, 45B, 51(a) and 1396 of the IRC [A.R.S. §43-1022(15)]. • An adjustment for federal bonus depreciation [A.R.S. §43-1022(28, 29)]. 28 • Arizona capital loss carryover in an amount not to exceed $1,000 for tax years beginning prior to 1/1/88 [A.R.S. §43-1122(2)]. • Expenses and interest relating to tax-exempt income disallowed pursuant to §265 of the Internal Revenue Code [A.R.S. §43-1122(3)]. • Dividends received from another corporation owned or controlled directly or indirectly by a recipient corporation [A.R.S. §43-1122(4)]. • Interest income received on obligations of the U.S. [A.R.S. §43-1122(5)]. • Dividend income from foreign corporations [A.R.S. §43-1122(6)]. • The amount of net operating loss allowed by A.R.S. §43-1123 [A.R.S. §43-1122(7)]. • State income tax refunds received which were included as income in computing federal taxable income [A.R.S. §43-1122(8)]. • Expense recapture included in income pursuant to §617 of the Internal Revenue Code for mine exploration expenses [A.R.S. §43-1122(9)]. • Deferred exploration expenses allowed by A.R.S. §43-1127 [A.R.S. §43-1122(10)]. • Exploration expenses related to the exploration of oil, gas or geothermal resources [A.R.S. §43- 1122(11)]. • Amortization of pollution control devices [A.R.S. §43-1122(12)]. • Amortization of the cost of child care facilities [A.R.S. §43-1122(13)]. • Income from a domestic international sales corporation required to be included in the income of its shareholders pursuant to §995 of the Internal Revenue Code [A.R.S. §43-1122(14)]. • The income of an insurance company that is exempt under A.R.S. §43-1201 to the extent that it is included in computing Arizona gross income on a consolidated return [A.R.S. §43- 1122(15)]. • The amount of contributions by the taxpayer during the taxable year to individual medical savings accounts pursuant to A.R.S. §43-1028 [A.R.S. §43-1122(16)]. • The amount by which capital loss carryover allowable per A.R.S. §43-1130.01 F exceeds the capital loss carryover allowable per section 13410(b)(5) of the internal revenue code [A.R.S. §43-1122(17)]. ARIZONA NET OPERATING LOSSES All corporate taxpayers are allowed to subtract from their Arizona adjusted gross income the amount of unused net operating losses attributable to Arizona for the last five years (A.R.S. §43- 1122.08). Corporations claimed Arizona-based net operating losses totaling $6.3 billion in tax year 2003. In many cases a corporation’s reported net operating loss exceeded its Arizona adjusted gross income. Subtracting the net operating loss in these cases resulted in negative taxable income. To calculate the tax value of the net operating losses, the loss was multiplied by 6.968% for those businesses with positive taxable income. For those businesses with negative taxable income, that portion of net operating loss that was used to reduce taxable income to zero was multiplied by 6.968%8. These calculations result in a maximum tax value of $64 million. About 24.8% of the 48,317 corporations that filed Arizona corporate income tax returns for tax year 2003 reported net operating losses. The table below shows the number of corporations by size of net operating loss and by whether or not there was enough taxable income to generate a tax liability other than the minimum $50 tax. 8For example, if the net operating loss was $10,000 and the negative taxable income was $9,000, adding back the loss results in $1,000 of net operating loss being used to reduce taxable income to zero. The tax rate was applied against the $1,000 to arrive at the tax value of the operating loss. 29 2003 - Size of NOL # with Tax Liability greater than $50 # with Tax Liability less than or equal to $50 Total $1 to $99 59 608 667 $100 to $999 273 1,130 1,403 $1,000 to $9,999 974 2,911 3,885 $10,000 to $49,999 775 2,466 3,241 $50,000 to $99,999 191 754 945 $100,000 to $499,999 233 927 1,160 $500,000 to $999,999 33 197 230 $1,000,000 to $9,999,999 37 314 351 Over $9,999,999 4 88 92 Total 2,579 9,395 11,974 NOL $ Value $292,096,345 $6,042,699,718 $6,334,796,063 COMMERCIAL TAX CREDITS A tax credit reduces corporate tax liability, as opposed to a subtraction, which reduces taxable income. Most tax credits that currently exist in Arizona corporate tax law are nonrefundable; any credit amount greater than a firm's tax liability will not be refunded. The unused credit is then carried forward for use in future tax years. A corporation receives a credit for expenditures in the following areas: • for increased employment in enterprise zones (A.R.S. §43-1161). • for the purchase of recycling equipment (A.R.S. §43-1164). • for employment and for property taxes paid by a qualified defense contractor (A.R.S. §43-1165, A.R.S. §43-1166). • for increased employment in military reuse zones (A.R.S. §43-1167). • for research and development expenses (A.R.S. §43-1168). • for costs in constructing a qualified environmental technology manufacturing, producing or processing facility (A.R.S. §43-1169). • 1for expenses to purchase property used to control or prevent pollution (A.R.S. §43-1170). • for expenses incurred for tangible personal property used to control or prevent pollution, relating to agriculture (A.R.S. §43-1170.01). • for construction materials incorporated into a qualifying facility (A.R.S. §43-1171). • for an agricultural water conservation system (A.R.S. §43-1172). • for corrective action costs for underground storage tanks (A.R.S. §43-1173). • for employment of TANF recipients (A.R.S. §43-1175). • for solar hot water heater plumbing stub outs and electric vehicle recharge outlets installed (A.R.S. §43-1176). • for the fair market value of a vehicle, up to $1500, donated to the wheels to work program (A.R.S. §43-1177). • for coal consumed in generating electric power (A.R.S. §43-1178). • a refundable credit for providing technological skills training to not more than 20 employees (A.R.S. §43-1179). • a refundable credit for conveying ownership or development rights of agricultural property to an agricultural preservation district (A.R.S. §43- 1180) • for donating real property or improvements to a school district (A.R.S. §43-1181) • for donations made directly to the Clean Elections Fund ( A.R.S. §16-954B) • for corporations that elected to file consolidated returns in Arizona and amended their 1986 through 1993 tax returns, thus creating a credit that could be taken over ten years. When reviewing the credit data, it is important to mention two points. First, corporate tax information for a given tax year changes over time. Late returns are filed, corporations are 30 audited, amended returns are filed, retroactive legislation is enacted, etc. Therefore, figures stated here will change next year and figures cited in previous years will not match what is presented here. Second, information cannot be revealed about certain credits claimed without breaching confidentiality. If less than three firms claim a credit or if one firm claims more than 90% of the total credit amount claimed or if providing statistics on one credit would result in confidential information being divulged about other credits, then that information cannot legally be released. Data for tax year 2003 is shown below, but it is preliminary. For tax year 2002, corporations claimed 477 commercial tax credits and used a total of $25.3 million in credits to offset taxes and get refunds where allowed. Asterisks indicate instances in which release of information would breach confidentiality laws. TYPE OF 2001 2002 2003 CREDIT # $ USED # $ USED # $ USED Enterprise zone 128 $6,456,049 127 $5,944,633 67 $3,047,546 Recycling equipment 4 21,442 4 5,145 4 3,426 Defense contracting 0 0 ** ** ** ** Military reuse zone 3 109,373 ** ** ** ** Research & development 123 9,301,385 124 10,901,624 79 21,592,007 Environmental technology facility 3 1.084,588 ** ** 0 0 Pollution control device 29 2,173,882 28 1,386,455 18 1,739,959 Agricultural pollution control equip’t ** ** ** ** 0 0 Construction materials 3 100 3 100 ** ** Agricultural water conservation system ** ** ** ** ** ** Underground storage tanks 0 0 ** ** 0 0 Alternative fuel vehicles (Nonref) ** ** 8 32,969 5 1,726 Alternative fuel vehicles (Refundable) 12 218,560 Neighborhood electric vehicles 20 69,701 16 31,172 8 19,026 Vehicle refueling apparatus & infrastructure (Nonref) ** ** ** ** ** ** Vehicle refueling apparatus & infrastructure (Refundable) 0 0 Alternative fuel delivery systems (Nonref) 3 184,431 3 1,039 ** ** Alternative fuel delivery systems (Refundable) 0 0 Employment of TANF recipients 6 57,851 7 173,550 5 461,980 Solar hot water plumbing stub outs & electric vehicle recharge outlets 0 0 0 0 0 0 Donation of motor vehicle to wheels to work program 0 0 0 0 School site donation ** ** ** ** ** ** Agricultural preservation district 0 0 0 0 0 0 Taxes paid for coal consumed in generating electrical power ** ** ** ** 0 0 Technology training 10 40,595 4 41,083 ** ** Clean election 97 2,913 102 646 111 1,563 Consolidated filer 35 3,492,320 30 2,196,494 32 2,335,704 Total 498 $24,207,863 477 $25,310,248 345 $29,902,588 31 SUMMARY OF CORPORATE INCOME TAX EXPENDITURES Revenue Gain Subtractions Allowed in Calculation of Federal Taxable Income: Compensation of Officers.......................................................................................................................NIA* Salaries and wages.......................................................................................................................................NIA Incidental repairs adding no value to property........................................................................................NIA Debts becoming worthless during the tax year .......................................................................................NIA Expenses of renting or leasing a vehicle .................................................................................................. NIA Charitable or governmental organization contributions........................................................................NIA Depreciation ................................................................................................................................................NIA Certain percentage depletion rates applicable to natural deposits........................................................NIA Pension, profit-sharing, etc. contributions...............................................................................................NIA Contributions to employee benefit programs .........................................................................................NIA Certain taxes paid or accrued during the tax year ...................................................................................NIA Interest paid on certain debts.....................................................................................................................NIA Other miscellaneous deductions................................................................................................................NIA Exempt Organizations: Political subdivisions or units of the state or federal government .......................................................NIA Labor, agricultural or horticultural organizations ...................................................................................NIA Qualifying fraternal beneficiary societies.................................................................................................. NIA Cemetery companies not for profit...........................................................................................................NIA Qualifying religious, charitable, scientific, etc., corporations................................................................NIA Nonprofit business leagues ........................................................................................................................NIA Nonprofit qualifying civic leagues.............................................................................................................NIA Clubs organized for pleasure, recreation or other nonprofit purposes ...............................................NIA Corporations organized to hold title to property for exempt organization ........................................NIA Voluntary employee's beneficiary organizations .....................................................................................NIA Teachers' or public employees' retirement fund organization ..............................................................NIA Religious or apostolic organizations which pass through income........................................................NIA Voluntary employee's beneficiary organizations with a twist................................................................NIA Diversified management companies.........................................................................................................NIA Insurance companies subject to the insurance premium tax.................................................................NIA Mutual ditch, irrigation or water companies............................................................................................NIA Subchapter S corporations .........................................................................................................................NIA Arizona Subtractions from Federal Taxable Income: Annuity income included pursuant to §72 of the IRC...........................................................................NIA Excess of a partner's share of income under §702(a)(8) of IRC...........................................................NIA Excess of a partner's share of partnership losses ...................................................................................NIA Excess of adjusted basis of property held for income production.......................................................NIA Amortization by a qualified defense contractor......................................................................................NIA Gain on amortized capital investment by a qualified defense contractor ...........................................NIA Dividend income received from Arizona corporations ....................................................................... NIA* * No Information Available. 32 Arizona capital loss carryover not to exceed $1,000 prior to 1/1/88..................................................NIA Expenses/interest relating to tax-exempt income disallowed per IRC ...............................................NIA Dividends received from controlled corporation ................................................................................... NIA Interest income received on obligations of the U.S. .............................................................................. NIA Dividend income from foreign corporations ..........................................................................................NIA State income tax refunds ............................................................................................................................NIA Expense recapture for mine exploration expenses.................................................................................NIA Deferred exploration expenses allowed by §43-1127.............................................................................NIA Exploration expenses related to oil, gas or geothermal exploration ....................................................NIA Amortization of pollution control devices...............................................................................................NIA Amortization of the cost of child care facilities ......................................................................................NIA Income from domestic international sales corporation .........................................................................NIA Contributions to individual medical savings accounts ...........................................................................NIA Excess capital loss carryover......................................................................................................................NIA Net Operating Losses.................................................................................................................$64,022,000 Commercial Tax Credits: Enterprise zone employment.......................................................................................................... $3,048,000 Recycling equipment .................................................................................................................................3,000 Defense contracting ...................................................................................................................................NR9 Military reuse zone........................................................................................................................................NR Research & Development ............................................................................................................... 21,592,000 Environmental technology facility .................................................................................................................. 0 Pollution control devices................................................................................................................... 1,740,000 Agricultural pollution control equipment ...................................................................................................... 0 Construction materials .................................................................................................................................NR Agriculture water conservation system.......................................................................................................NR Underground storage tanks............................................................................................................................. 0 Alternative fuel vehicles............................................................................................................................2,000 Neighborhood electric vehicles ..............................................................................................................19,000 Vehicle refueling apparatus and infrastructure..........................................................................................NR Alternative fuel delivery systems .................................................................................................................NR Employment of TANF recipients........................................................................................................462,000 Solar hot water plumbing stub outs and electric vehicle recharge outlets ................................................ 0 Donation of motor vehicles to wheels to work program ............................................................................ 0 Taxes paid for coal consumed in generating electrical power..................................................................... 0 Agricultural preservation district ..................................................................................................................... 0 Technology training......................................................................................................................................NR School site donation.....................................................................................................................................NR Clean election .............................................................................................................................................2,000 Consolidated filer............................................................................................................................... 2,336,000 Total Commercial Tax Credits ................................................................................................$29,903,000 TOTAL QUANTIFIABLE CORPORATE INCOME TAX EXPENDITURES10 ............................................................................................................. $93,925,000 * No Information Available. 9 NR indicates that the information is not releasable due to Arizona confidentiality laws. Fewer than ten license holders took advantage of this refund. 10These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 33 ESTATE TAX EXPENDITURES 34 35 ESTATE TAX EXPENDITURES The Arizona estate tax is a tax on the transfer of property or interest in property that takes effect upon the owner's death. The estate tax is an amount equal to the federal credit for state death taxes. Estate taxes are deposited into the general fund. Estate tax collections totaled $31.2 million in fiscal year 2004/05. If the decedent owned realty or tangible personal property located in another state, the Arizona tax is reduced by the smaller of the amount of death tax paid to the other state or the federal credit times the percentage of total real or tangible personal property located in another state. The total deductions allowed from the federal credit in fiscal year 2003/04 was $1.5 million. This deduction is a dollar-for-dollar reduction in the estate tax liability. SUMMARY OF ESTATE TAX EXPENDITURES Revenue Gain Deduction from federal credit for state death taxes.................................................................... $1,458,721 TOTAL QUANTIFIABLE ESTATE TAX EXPENDITURES11 ............................................................................................................... $1,458,721 11These expenditures represent foregone revenues to the state general fund. 36 37 FIDUCIARY INCOME TAX EXPENDITURES 38 39 FIDUCIARY INCOME TAX EXPENDITURES Arizona imposes fiduciary income tax on trusts and estates. The taxability of the income is determined by the residence of the fiduciary, beneficiary or deceased taxpayer. For estates, the tax applies to the entire taxable income if the deceased taxpayer was an Arizona resident. The fiduciary or beneficiary residence is immaterial. In contrast, for trusts, the tax applies to the entire taxable income when the fiduciary or beneficiary is an Arizona resident. Arizona taxable income is calculated beginning with federal taxable income. By conforming Arizona law to the Internal Revenue Code, subtractions allowed under federal law in calculating federal taxable income are allowed under Arizona law. From federal taxable income, certain additions, subtractions and exemptions are allowed to reach Arizona taxable income. After calculating tax liability, fiduciary taxpayers may reduce their tax liability by using a credit for taxes paid to other states or countries or a credit for clean elections. Fiduciary income tax is deposited into the general fund. However, 15% of the tax is distributed to cities and towns two years after the year in which it was collected. For example, 15% of tax collected in fiscal year 2004/05 will be distributed to incorporated cities and towns in fiscal year 2006/07. Therefore, only 85% of the tax collected, or of the tax value of any expenditure, is actually available for the state’s use. This fact should be kept in mind when reviewing the reported tax value of the various subtractions, exemptions and credits. SUBTRACTIONS ALLOWED IN THE CALCULATION OF FEDERAL TAXABLE INCOME The starting point for calculating Arizona fiduciary income tax liability is federal taxable income, as calculated on the federal form 1041 (U.S. Fiduciary Income Tax Return). The Arizona legislature must approve legislation to conform to the definition of federal taxable income by January of each year. In conforming to the definition of federal taxable income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Deduction for interest paid by the estate or trust on amounts borrowed by the estate or trust or on debt acquired by the estate or trust. This includes any investment interest (subject to limitations), qualified residence interest and any interest payable on any unpaid portion of the estate tax attributable to the value of a reversionary or remainder interest in property. • Deductible taxes, including state income or real property tax and generation-skipping transfer tax imposed on income distributions. • Deductible fees paid to the fiduciary for administering the estate or trust during the tax year. • Other deductions, such as amortizable bond premiums, casualty and theft losses, net operating loss deduction and fiduciary's share of amortization, depreciation and depletion not claimed elsewhere. • Miscellaneous itemized deductions in excess of 2% AGI. • Income Distribution Deduction. • Estate tax paid. • $600 exemption for estates. $300 exemption for trusts in which all income must be distributed currently. $100 exemption for all other trusts unless the trust is filing for the final year (in which case no exemption is allowed). It is not possible to calculate the tax value of these subtractions. Information from the Internal Revenue Service would be required to determine the value and this information is not readily available. 40 ARIZONA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME The Arizona fiduciary income tax return lists the following specific items that can be subtracted from federal taxable income to reach adjusted gross income attributable to Arizona: • Negative Arizona fiduciary adjustment from another trust or estate. This adjustment is used if the Schedule K-1 indicates a difference between the federal and state distributable income. [A.R.S. §43- 1332(1)]. • Interest income on U.S. obligations. Interest income received on U.S. obligations, less any interest on indebtedness, or other related expenses, and deducted in arriving at Arizona gross income, which were incurred or continued to purchase or carry such obligations. [A.R.S. §43- 1022(6)] • Energy efficient residence. The amount authorized by A.R.S. §43-1031 for constructing an energy efficient residence. [A.R.S. §43-1022(27)] The remaining subtractions on the Arizona fiduciary tax form are entered in aggregate on the line "Other Subtractions from federal taxable income." The following is a list of "Other Subtractions": • Benefits, annuities and pensions. Benefits, annuities and pensions totaling not more than $2,500 received from any of the following: U.S. government service retirement and disability fund; retired or retainer pay of the U.S. uniformed services; the U.S. foreign service retirement and disability system; any other retirement system or plan established by federal law; the state retirement system or plan; the corrections officer retirement plan; the public safety personnel retirement system; the elected officials' retirement plan; an optional retirement program established by the AZ board of regents; an optional retirement program established by a community college district board; or a retirement plan established for employees of a county, city or town in Arizona. [A.R.S. §43- 1022(2)] • Refunds from other states. The amount of any income tax refunds received from states other than Arizona and included as income. [A.R.S. §43-1022(7)] • Annuity income. Annuity income included pursuant to §72 of the IRC if the first payment with respect to such annuity was received prior to 12/31/78. [A.R.S. §43-1022(8)] • Wood stoves and fireplaces. The amount authorized by A.R.S. §43-1027 for the purchases of qualified wood stoves, wood fireplaces or gas fired fireplaces. [A.R.S. §43-1022(21)] • Operating loss carryover. The amount by which an operating loss carryover or capital loss carryover, allowable pursuant to A.R.S. §43-1029 F, exceeds the net operating loss carryover or capital loss carryover allowable pursuant to section 1341(b)(5) of the internal revenue code. [A.R.S. §43-1022(23)] • Federal credits. The portion of any wages or salaries paid or incurred by the taxpayer equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips and the Indian employment credit that the taxpayer received under §§45A, 45B, 51(a) and 1396 of the IRC. [A.R.S. §43- 1022(15)] • Individual medical savings accounts. With respect to individual medical savings accounts established pursuant to A.R.S. §43-1028, the account holder may subtract the amount of contributions made by the employer, to the extent that these contributions are included in the taxpayer's federal adjusted gross income, 41 and the amount deposited by the taxpayer in the account during the year. [A.R.S. §43-1022(22)] • Contribution of agricultural crops. The amount allowed by A.R.S. §43-1025 for contributions of agricultural crops to charitable organizations [A.R.S. §43- 1022(14)]. • Installment income. The amount of income on an installment receivable which is recognized pursuant to the IRC and which has already been recognized on the death of the taxpayer for purposes of this title for tax years ending before 1/1/90. [A.R.S. §43-1022(5)] • Holocaust survivors. The amount authorized by A.R.S. §43-1030 relating to holocaust survivors. [A.R.S. §43-1022(26)] • Adjustment for bonus depreciation allowed under IRC §168(k) added to Arizona gross income. This adjustment relates to the 30% and/or 50% bonus depreciation allowed at the federal level. [A.R.S. §43-1022(28)] • Federal income from other fiduciaries. When the estate or trust is the beneficiary of another estate or trust, the beneficiary's share of the trust or estate income recognized under the Internal Revenue Code may be subtracted [A.R.S. §43- 1022(3)]. • Exemptions for blind persons, persons over 65, dependents and qualifying ancestors. Exemptions are allowed for blind persons ($1,500), persons over 65 years ($2,100), dependents ($2,300) and qualifying ancestors that live with the taxpayer and requires assistance with activities of daily living ($10,000) [A.R.S. §43-1022(1)]. • Distributions from individual retirement accounts. The amount of any distributions from an individual retirement account as provided for in §408 of the IRC or from a qualified retirement plan of a self-employed individual as provided for in §401 of the IRC to the extent that total adjustments made pursuant to this paragraph in all tax years do not exceed the total of all contributions made by the taxpayer to such plans prior to 12/31/75, which were included in computing Arizona taxable income. [A.R.S. §43-1022(4)] • Partner’s share of income. The excess of a partner's share of income required to be included under §702(a)(8) of the IRC over the income required to be included under chapter 14, article 2 of title 43. [A.R.S. §43-1022(9)] • Partner’s share of losses. The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of title 43 over the losses allowable under §702(a)(8) of the IRC. [A.R.S. §43-1022(10)] • Sale of income producing property. The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the IRC. [A.R.S. §43-1022(11)] • Amortization of capital investment. The amount allowed by §43-1024 for amortization, by a qualified defense contractor certified by the department of commerce under §41-1508, of a capital investment for private commercial activities. [A.R.S. §43-1022(12)] • Gain on capital investment. The amount of gain included on the sale or other disposition of a capital investment that a qualified defense contractor has elected to amortize pursuant to §43-1024. [§43- 1022(13)] • State lottery winnings. The amount of winnings less than $5000 in a taxable 42 year from any of the state lotteries, except that all such winnings before 3/22/83, including periodic distributions from such winnings made after 3/2/83, may be subtracted. [A.R.S. §43- 1022(16)] • Mining exploration expenses. The amount of mining exploration expenses determined pursuant to §617 of the IRC which have been deferred in a taxable year ending before 1/1/90 and for which a subtraction has not been previously made. [A.R.S. §43-1022(17)] • Social security benefits. The amount included pursuant to §86 of the IRC, relating to taxation of social security and railroad retirement benefits. [A.R.S. §43- 1022(18)] • Compensation for armed forces active service. To the extent not already excluded, compensation received for active service as a member of the armed forces of the U.S. for any month during any part of which the member served in a combat zone. [A.R.S. §43-1022(19) • Adoption costs. The amount of unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption not to exceed three thousand dollars. [A.R.S. §43-1022(20)] • Qualified educational expenses. Any amount of qualified educational expenses distributed from a qualified state tuition program determined pursuant to §529 of the Internal Revenue Code and that is included in income. [A.R.S. §43-1022(24)] • Installment sale subject to tax in another state. Any item of income resulting from an installment sale that has been properly subject to tax in another state in a previous year and is included in Arizona gross income in the current taxable year. [A.R.S. §43-1022(25)]. • Income from a trust established as a medical savings accounts In the cast of a trust that is established as a medical savings account pursuant to A.R.S. §43-1028, income earned by the trust is included in the trsut’s Arizona gross income. [A.R.S. §43-1332(2)]. • Arizona distribution to beneficiaries. The income of the estate or trust which is to be distributed or credited during the year to any legatee, heir or beneficiary is allowed as a subtraction from federal taxable income [A.R.S. §§43-1333]. In tax year 2003, all subtractions on fiduciary tax returns were reported in aggregate with the exception of “Income from a trust established as a medical savings account.” Income of $73,199 was reported. Using an effective tax rate of 4.38%, the tax value of this subtraction was $3,203. All other subtractions that reduced tax liability totaled $95.6 million. (This does not include subtractions that were greater than income. Those subtractions would have no tax value because they didn’t actually offset any income.) Using the effective tax rate of 4.38%, the tax value of these subtractions was $4,134 million. PREFERENTIAL TAX RATES Fiduciary income tax is calculated according to a graduated tax rate schedule as shown below: at least but less than $0 $10,000 2.87% of taxable income 10,000 25,000 3.20% of taxable income, minus $33 25,000 50,000 3.74% of taxable income, minus $168 50,000 150,000 4.72% of taxable income, minus $658 150,000 and over 5.04% of taxable income, minus $1,138 43 As can be seen from the table, lower taxable incomes are taxed at a lower rate. If all taxpayers were treated identically, the same tax rate would be applied regardless of the amount of taxable income. A question arises, however, as to what tax rate should be applied to determine the revenue impact of treating all taxpayers identically. One argument may be that since the highest tax rate is 5.04%, determining the impact of taxing all income at 5.04% would seem appropriate. However, no taxpayer currently pays 5.04% tax on all taxable income. If a flat tax rate of 5.04% was applied regardless of income level, all taxpayers would experience a tax increase. A more reasonable approach to a flat tax rate would be to apply the effective tax rate on taxable income for all fiduciary taxpayers. Applying this effective tax rate to all fiduciary taxpayers will result in the same tax collections as with the graduated tax rate structure; however, the burden of the tax will shift. Taxpayers with lower Federal Adjusted Gross Income would pay more tax and taxpayers with higher Federal Adjusted Gross Income would pay less tax. CREDITS After fiduciary income tax liability is calculated, two credits can be subtracted from the tax liability. If the estate or trust is considered to be a resident of Arizona and also a resident of another state or country, the estate or trust will be allowed a tax credit against the Arizona income tax liability for taxes paid to the other state or country. In 2003, $2.5 million was claimed as credit for taxes paid to other states or countries. Additionally, if the trust or estate makes a contribution to the Clean Elections Fund, a credit may be claimed for those contributions. The total clean elections credit claimed in 2002 by estates and trusts was $56. Both credits are a direct reduction to tax liability. 44 SUMMARY OF FIDUCIARY INCOME TAX EXPENDITURES Revenue Gain SUBTRACTIONS IN CALCULATION OF FEDERAL TAXABLE INCOME: Deduction for interest paid ......................................................................................................................NIA* Deductible taxes..........................................................................................................................................NIA Deductible fiduciary fees ............................................................................................................................NIA Other miscellaneous deductions................................................................................................................NIA Miscellaneous itemized deductions in excess of 2% AGI ..................................................................... NIA Income distribution deduction ..................................................................................................................NIA Estate tax paid.............................................................................................................................................NIA $600/$300/$100 estate/trust exemption.................................................................................................NIA SUBTRACTIONS FROM FEDERAL TAXABLE INCOME: Negative Arizona fiduciary adjustment from another trust or estate Interest income on U.S. obligations Energy efficient residence U.S./state pensions not over $2,500 Income tax refunds from other states Annuity income included pursuant to §72 of the IRC Certain IRA distributions or 401Ks Qualified wood stoves and fireplaces Installment income recognized pursuant to IRC Excess operating loss carryover Certain federal credits Medical savings accounts Contribution of agricultural crops Installment income Holocaust survivors Adjustment for bonus depreciation Federal income from other fiduciaries Exemptions for blind persons, persons over 65 years of age, dependents and qualifying ancestors Distributions from individual retirement accounts Partner’s share of income Partner’s share of losses Sale of income producing property Amortization of capital investment Gain on capital investment State lottery winnings Mining explorations expenses Social security benefits * No Information Available. 45 Compensation for armed forces active service Adoption costs Qualified educational expenses Installment sale subject to tax in another state Income from a trust established as a medical savings account..........................................................$3,000 Arizona distribution to beneficiaries Value of subtractions other than medical savings account trusts ................................... $4,184,000 TOTAL TAX VALUE OF SUBTRACTIONS FROM FEDERAL TAXABLE INCOME................................................................................................................... $4,187,000 CREDIT FOR TAXES PAID TO OTHER STATES/COUNTRIES.......................... $2,461,000 CREDIT FOR CONTRIBUTIONS TO THE CLEAN ELECTION FUND....................$56 TOTAL QUANTIFIABLE FIDUCIARY INCOME TAX EXPENDITURES12 ...............................................................................................................$6,648,000 12These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 46 47 FLIGHT PROPERTY TAX EXPENDITURES 48 49 FLIGHT PROPERTY TAX EXPENDITURES The airline companies in Arizona pay a tax on the flight property within the state. The taxable value, or net assessed value, of the flight property is determined by multiplying the full cash value of the property by an assessment ratio. The tax rate that is applied to the net assessed value is equal to the statewide average tax rate, which was $11.81 in tax year 2004. EXEMPTIONS If an airline is operating in Arizona with a maximum passenger capacity of less than 56 seats and a maximum pay load capacity of less than 18,000 pounds (A.R.S. §42-14251.10), this small flight property shall be valued at 30% of its original cost less depreciation multiplied by the assessment ratio (A.R.S. §42- 14254C). Had the taxable value been 100%, the state would have raised $2.6 million more in fiscal year 2004/05. PREFERENTIAL ASSESSMENT RATIO Arizona statutes set out the assessment ratios to be used in determining the net assessed values of the various classes of property. These assessment ratios range from 25% to 5%. For flight property, the assessment ratio is equal to the ratio which the total net assessed valuation of all taxable property in class 1, class 6 paragraph 3 and personal property in class 2 bears to the total full cash value of such property (A.R.S. §42-14255). For tax year 2004, the assessment ratio used for flight property was 21%. This is considered to be a preferential assessment ratio because it is an average of the assessment ratios in several other classes of property. If flight property had an assessment ratio equal to the highest assessment ratio imposed, 25%, tax collections would have increased by $5.6 million. SUMMARY OF FLIGHT PROPERTY TAX EXPENDITURES Revenue Gain EXEMPTION Tax value at 30% for small airplanes ...................................................................................... $2,567,719 PREFERENTIAL ASSESSMENT RATIOS: Preferential assessment ratio at 25%....................................................................................... $5,633,995 TOTAL QUANTIFIABLE FLIGHT PROPERTY TAX EXPENDITURES13 ............................................................................................................... $8,201,715 13These expenditures represent foregone revenues to the state aviation fund. 50 51 IN LIEU PROPERTY TAX EXPENDITURES 52 53 IN LIEU PROPERTY TAX EXPENDITURES Irrigation districts, power districts, electrical districts or agricultural improvement districts directly engaged in the sale of electric power or energy other than for irrigation purposes may elect to make voluntary contributions to Arizona and the political subdivisions thereof for property taxes. These districts are not legally liable for property taxes imposed by the state and the political subdivisions, so these voluntary contributions are known as in lieu property taxes. (However, according to A.R.S. §9-432B, water may not be transported from remote municipal property by a city, town or political subdivision, unless voluntary contributions have been paid.) The Department of Revenue determines the full cash value of the district electing to make in lieu property tax payments. The county assessor of each county where district electric facilities are located computes the gross contribution to be made. The district may subtract certain amounts from this gross contribution figure. A subtraction is allowed for the contribution related to that portion of the electric system related to pumping water (A.R.S. §48-242C1). A deduction of $10,000 is allowed from the gross contribution (A.R.S. §48-242C2). Certain taxes or assessments paid to any political subdivision during the preceding calendar year may be deducted from the gross contribution (A.R.S. §48-242C3). The annual average of the total water costs devoted to municipal use during the last three calendar years is also deductible from the gross contribution (A.R.S. §48-242C4). The effect of these deductions from the gross contribution amount is that the district in question pays a certain percentage of the gross contribution. The primary contributor, Salt River Project, paid approximately 81.9% of the tax that would have been levied in fiscal year 2004/05 had they been legally bound to pay property tax. Given the repeal of the state rate, the dollar expenditure that previously appeared in this report is no longer applicable. However, because the exemptions filter through to the tax base at the local level, descriptions of the exemptions remain. 54 55 INDIVIDUAL INCOME TAX EXPENDITURES 56 57 INDIVIDUAL INCOME TAX EXPENDITURES For tax year 2003 tax returns filed in calendar year 2004, the Arizona Department of Revenue collected over $2.16 billion in resident individual income taxes before credits. In the same tax year, the state allowed exemptions, deductions, exclusions, and credits worth as much as $1.73 billion in tax liability. This report details the value of each of these exemptions, deductions, exclusions, credits and preferential rates. The figures presented in this report were determined using the Individual Income Tax Simulation Model, containing a 2003 database. This model contains 48,525 resident returns, selected using stratified sampling techniques. The information on the back of Arizona Individual Income Tax Form 140 and on Schedule A was entered for the sample returns, making the detailed information presented below available. Please remember these figures are for tax year 2003. All tax expenditures in this report refer to tax law in existence in 2003, filed in 2004. Examination of the detail presented in this section reveals that summing the tax value of certain tax expenditures individually does not produce the total value of removing all of those same tax expenditures at one time. (The sum of the parts is less than the whole.) Disallowing exemptions, subtractions or deductions can have the effect of changing the tax rate applied to a portion of a taxpayer's taxable income. For example, the taxpayer may have had taxable income of $40,000 prior to the removal of the tax exemption device, resulting in a tax rate of 3.74% on part of this income. Removal of deductions may result in pushing the taxpayer's taxable income to $55,000, resulting in a tax rate of 4.72% on part of this income. Removal of all exemptions, subtractions and deductions may make taxable income high enough to hit the 5.04% tax rate. Therefore, adding back income that was previously untaxed can push the taxpayer into two or three higher tax brackets. In other areas of this report, it can be seen that adding the impacts of individual deductions together results in a larger impact than what the figure for removal of the entire section indicates. (The sum of the parts is greater than the whole.) For example, if the components of the Taxes Paid Deduction on the Schedule A were added together, the total would be $148 million. However, removal of the entire Taxes Paid Deduction section results in a value of $145 million. In this case, removal of individual pieces may lower the Schedule A total and may or may not push the taxpayer into a higher tax bracket. Removal of the entire section, however, may push the Schedule A total below the standard deduction level. If this happens, the standard deduction amount is substituted for the Schedule A amount. Therefore, there is a constant deduction level (equal to the standard deduction) below which the taxpayer will not fall, regardless of how much of the Schedule A is removed. This constant deduction level serves to buffer the impact of losing the Schedule A deductions and could potentially keep the taxpayer from moving into a higher tax bracket. Net income tax (corporate, individual and fiduciary) collections are deposited in the general fund after 15% of net income tax collections received two years prior is disbursed to cities and towns. In other 58 words, 15% of net individual plus corporate plus fiduciary income tax received in Fiscal Year 2004/05 will be distributed to incorporated cities/towns in Fiscal Year 2006/07. When reviewing the tax value of individual income tax expenditures, therefore, the assumption can be made that 85% of the tax value is general fund revenue, although the remaining 15% is not actually disbursed for two years in the future. SUBTRACTIONS ALLOWED IN CALCULATING FEDERAL ADJUSTED GROSS INCOME The starting point for the calculation of Arizona individual income tax liability is federal adjusted gross income, as calculated on the federal form 1040, 1040A and 1040EZ U.S. Individual Income Tax returns. The Arizona legislature must approve legislation annually to conform to the definition of federal adjusted gross income as of January of the current year. In conforming to the definition of federal adjusted gross income, Arizona accepts the subtractions from gross income allowed by the federal government. These subtractions include: • Qualified expenses for eligible educators of up to $250. • Qualified tuition and fees of up to $3,000 under certain conditions. • Individual Retirement Account contributions for individuals with qualifying incomes. • Interest paid on student loans for qualified higher education expenses for individuals with qualifying incomes. • Moving expenses in connection with a job or business, with certain requirements. • One-half of self-employment tax paid. • Self-employed health insurance payments. • Self-employed SEP, SIMPLE, and Qualified Plans. • Penalty on early withdrawal of savings. • Alimony paid. • Archer MSA deduction. • Performing arts-related expenses that meet certain conditions. • Jury duty pay given to your employer. • Deductible expenses related to income from the rental of personal property. • Reforestation amortization. • Repayment of supplemental unemployment benefits under the Trade Act of 1974. • Contributions to section 501(c)(18) pension plans. • Deduction for clean-fuel vehicles. • Contributions by certain chaplains to section 403(b) plans. • Employee business expenses of fee-basis for state or local government officials. It is only possible to estimate the tax value of those subtractions that appear on the front of the federal 1040 tax return as subtractions to gross income. 59 SUBTRACTION 2003 (Millions) Educator expense/tuition fees subtraction $2.71 Individual Retirement Account for qualifying individuals 5.11 Student loan interest deduction 2.07 Moving expenses 0.48 One-half of self-employment tax 8.25 Self-employed health insurance deduction 8.36 KEOGH retirement plan and self-employed SEP deduction 10.31 Penalty on early withdrawal of savings 0.03 Alimony paid 6.17 TOTAL VALUE OF SUBTRACTIONS $43.86 EXEMPTIONS Like the federal government, Arizona grants exemptions for taxpayers meeting certain conditions. In Arizona, the amount of exemption varies according to type. Personal Exemption The personal exemption is the most broad-based of all exemptions: every taxpayer (and spouse) is eligible for one (A.R.S. §43- 1043). Single taxpayers and those who are married but filing separately were allowed exemptions of $2,100 for tax year 2003. Married couples filing jointly with no children and unmarried head of household taxpayers were allowed $4,200 exemptions. The higher personal exemption allowed unmarried head of household filers is a preferential personal exemption amount, double the amount normally allowed for one person. Married couples filing jointly with at least one dependent are allowed a personal exemption of $6,300; married filing separate taxpayers with at least one dependent are allowed an exemption of half this amount, $3,150. This higher personal exemption for married couples with children is also a preferential personal exemption. Age 65 or Older Exemption Taxpayers age 65 or older were eligible for an additional exemption equal to $2,100 for primary filer and for eligible spouse in 2003 (A.R.S. §43-1023E).. Dependent Exemption Arizona taxpayers may claim a dependent exemption for children and certain other relatives for whom they provide more than 50% support (A.R.S. §43-1023B). The dependent exemption was $2,300 in 2003. Blind Exemption Taxpayers who have corrected vision of no better than 20/200 or have a field of vision no wider than 20 degrees are eligible for a blind exemption (A.R.S. §43-1023A1). The exemption amount was $1,500 in 2003. 60 Qualifying Parents and Ancestors Exemption Arizona residents may claim a $10,000 exemption for each qualifying parent and ancestor. (A.R.S. §43-1023C) A qualifying parent or ancestor may be a parent, a parent's ancestor or a spouse's parent or spouse's parent ancestor. The qualifying parent or ancestor must have lived in the taxpayer's residence for the entire taxable year, was 65 years old or older and the taxpayer paid more than one-half of the support and maintenance costs of the parent or ancestor during the taxable year. Additionally, the parent or ancestor must have required assistance with activities of daily living. TYPE OF EXEMPTION 2003 (Millions) Personal exemption $200.24 Preferential personal exemption for Unmarried Head of Household filers 11.21 Preferential personal exemption for married filers claiming at least one dependent 26.75 Age 65 or older exemption 19.10 Dependent exemption 81.83 Blind exemption 0.20 Qualifying parent or ancestor exemption 1.59 TOTAL VALUE OF EXEMPTIONS $350.70 ARIZONA SUBTRACTIONS FROM INCOME Arizona taxpayers can subtract certain amounts from their gross income. The largest subtraction in 2003 was for Social Security or Railroad Retirement benefits included on the federal Form 1040 (A.R.S. §43-1022.18). Arizona also allowed these amounts to be subtracted: the first $2,500 of a federal, State or local retirement annuity (A.R.S. §43-1022.2), the first $5,000 in Arizona lottery winnings (A.R.S. §43-1022.16), interest on U.S. obligations (A.R.S. §43-1022.6), agricultural crops contributed to Arizona charitable organizations (A.R.S. §43-1022.14), deposits or employee contributions into medical savings accounts (A.R.S. §43- 1022.22), the amount of income tax refunds received from states other than Arizona and which were included as income in computing federal adjusted gross income (A.R.S. §43-1022.7) and an amount equal to the “bonus” depreciation allowable pursuant to the internal revenue code (A.R.S. §43-1022.28, 29, 30).. In addition, there were a myriad of "other subtractions" including, but not limited to: • A beneficiary's share of the fiduciary adjustment to the extent that the amount decreases the beneficiary’s Arizona gross income (A.R.S. §43-1022.3). • Distributions from an individual retirement account as provided for in §408 of the internal revenue code or from a qualified retirement plan of a self-employed individual (A.R.S. §43-1022.4). • Income on an installment receivable which is recognizable pursuant to the internal revenue code and which has already been recognized on the death of the taxpayer for purposes of this title for tax years ending before 1/90 (A.R.S. §43-1022.5). • Annuity income included in income pursuant to §72 of the internal revenue code if the first payment with respect to such annuity was received prior to 12/31/78 (A.R.S. §43-1022.8). 61 • The excess of a partner's share of income required to be included under §702(a)(8) of the internal revenue code over the income required to be included under Chapter 14, article 2 of title 43 (A.R.S. §43-1022.9). • The excess of a partner's share of partnership losses determined pursuant to chapter 14, article 2 of title 43 over the losses allowable under §702(a)(8) of the internal revenue code (A.R.S. §43- 1022.10). • The amount by which the adjusted basis of all property which is held for the production of income and which is sold or otherwise disposed of during the taxable year other than depreciable property used in a trade or business, computed pursuant to title 43 and the income tax act of 1954, as amended, exceeds the adjusted basis of such property computed pursuant to the internal revenue code (A.R.S. §43-1022.11). • The amount allowed for amortization, by a qualified defense contractor, of a capital investment for private commercial activities or the amount of gain included in income on the sale or disposition of a capital investment that a qualified contractor has elected to amortize (A.R.S. §43-1022.12, 13) • Any wages paid for the taxable year that is equal to the amount of the federal work opportunity credit, the empowerment zone employment credit, the credit for employer paid social security taxes on employee cash tips and the Indian employment credit (A.R.S. §43-1022.15). • Exploration expenses determined pursuant to §617 of the internal revenue code, which have been deferred in a taxable year ending before 1/90 and for which a subtraction has not been previously made (A.R.S. §43-1022.17). • To the extent not already excluded from gross income under §112 of the internal revenue code, compensation received for active service as a member of the armed forces of the U.S. for any month during any part of which the member served in a combat zone (A.R.S. §43-1022.19). • Unreimbursed medical and hospital costs, adoption counseling, legal and agency fees and other nonrecurring costs of adoption, not to exceed $3,000 (A.R.S. §43- 1022.20). • Authorized amounts for purchase of, and nonoptional equipment directly related to the operation of, qualified wood stoves, wood fireplaces or gas fired fireplaces (A.R.S. §43-1022.21). • Excess net operating loss carryover or capital loss carryover (A.R.S. §43- 1022.23). • Qualified educational expenses distributed from a qualified state tuition program that is included in income (A.R.S. §43- 1022.24). • Income resulting from an installment sale properly subjected to income tax in another state (A.R.S. §43-1022.25). • An amount authorized relating to holocaust survivors (A.R.S. §43- 1022.26). • An amount authorized relating to constructing an energy efficient residence (A.R.S. §43-1022.27). 62 TYPE OF ARIZONA SUBTRACTION 2003 (Millions) Interest on U.S. obligations $7.35 Exclusion for federal, Arizona or local pensions 7.19 Exempt Arizona lottery winnings 0.09 Social Security or Railroad Retirement benefits included in income 59.97 Adjustment for bonus depreciation 2.67 Certain wages of Native Americans 14.43 Income tax refunds from other states 0.75 Construction of an energy efficient residence 0.04 Other subtractions (from back of 140) 6.41 Deposits and employee contributions into medical savings accounts 0.15 Elective subtraction of 2003 federal retirement contributions 0.40 TOTAL VALUE OF ARIZONA SUBTRACTIONS $100.19 DEDUCTIONS Arizona taxpayers can deduct the part of their income used to pay for certain expenses, such as taxes or medical bills, by either listing (itemizing) deductions or taking a standard deduction. Arizona allows the same itemized deductions as the federal government, with three exceptions. Medical deductions are fully deductible in Arizona; gambling losses are adjusted to consider the lottery subtraction; and a property tax adjustment is made to offset a property tax credit claimed. Standard Deduction In 2003, the standard deduction was $4,050 for single and married filing separate filers and $8,100 for married filing joint and unmarried head of household filers (A.R.S. §43-1041). Removing the standard deduction would result in additional tax revenue of $161.82 million. The higher standard deduction amount allowed for unmarried head of household filers is a preferential deduction amount, double the amount normally allowed one person (A.R.S. §43-1041A2). The value of this preferential standard deduction was $15.12 million in 2003. Itemized Deductions (Schedule A): The provisions allowed on the Schedule A are in A.R.S. §43-1042 as described below. When calculating the impact of disallowing portions of the Schedule A and the entire Schedule A, the standard deduction replaces the Schedule A total if the Schedule A total drops below the standard deduction amount. In other words, if the Schedule A total dropped below $4,050 or $8,100 (the standard deduction amounts based on filing status) the standard deduction amount was used. Medical Deduction The medical deduction on the federal Schedule A equals medical expenses greater than 7.5% of the taxpayer's federal adjusted gross income. This deduction is adjusted on the Arizona return to allow all medical expenses incurred. The value of the 2003 medical deductions was $85.77 million. Taxes Paid Deduction Deductions allowed for taxes included state and local income taxes, real estate taxes and other taxes, including personal property taxes. 63 TYPE OF TAX DEDUCTION 2003 (Millions) State and local income taxes $91.77 Real estate taxes 43.92 Personal property taxes and Other taxes 11.99 VALUE OF TAXES PAID DEDUCTIONS $145.03 Interest Expense Deduction The interest expense deduction is the largest of all the itemized deductions. Deductible interest includes home mortgage interest, points paid on the purchase of a home and some investment interest. TYPE OF INTEREST EXPENSE DEDUCTION 2003 (Millions) Home mortgage interest $206.57 Deductible points 2.13 Deductible investment interest 9.82 VALUE OF INTEREST EXPENSE DEDUCTION $217.93 Charitable Contribution Deduction Deductions were allowed for contributions made to religious, charitable, educational, scientific or literary organizations. The contributions could be cash, property or out-or-pocket expenses incurred while doing volunteer work. TYPE OF CHARITABLE CONTRIBUTION DEDUCTION 2003 (Millions) Cash contributions $59.68 Contributions other than cash 17.56 Carryover from prior year 4.83 VALUE OF CHARITABLE CONTRIBUTION DEDUCTION $82.02 Casualty and Theft Losses Losses on non-business property arising from theft, vandalism, fire, storm, and car, boat and other accidents or similar causes are deductible. Money kept in a financial institution that was lost because of insolvency or bankruptcy of the institution was also deductible in some cases. However, only those losses that exceeded 10% of Federal Adjusted Gross Income were deductible. The value of this type of deduction was $0.78 million in 2003. Job Expenses and Most Other Miscellaneous Deductions This deduction includes unreimbursed job expenses, tax return preparation fees, safe deposit box rental, certain legal and accounting fees, etc., which exceed 2% of Federal Adjusted Gross Income. The value of this deduction in 2003 was $34.37 million. Other Miscellaneous Deductions These fully deductible miscellaneous deductions include gambling losses to the extent of gambling winnings, federal estate tax on income in respect of a decedent, amortizable bond premiums on bonds acquired before 10/23/86, etc. Any gambling losses taken on the 64 federal Schedule A were adjusted for Arizona to offset the subtraction for Arizona lottery winnings. Without this adjustment, a double deduction could have been allowed for gambling losses associated with the Arizona lottery. An adjustment is also made to the Arizona itemized deductions for the amount of property taxes included on the federal Schedule A for those qualified defense contractors who claim a credit. This deduction was worth $15.28 million in 2003. TYPE OF DEDUCTION 2003 (Millions) Standard Deduction $161.82 Preferential standard deduction for unmarried head of household filers 15.12 Itemized Deductions: Medical and dental expenses 85.77 Taxes paid 145.03 Interest expense 217.93 Charitable contributions 82.02 Casualty or theft losses 0.78 Job expenses and most other miscellaneous deductions 34.37 Other miscellaneous deductions (nonlimited) 15.28 Value of All Itemized Deductions $421.85 VALUE OF STANDARD AND ITEMIZED DEDUCTIONS $788.03 PREFERENTIAL TAX RATES Individual income tax for single and married filing separate filers is calculated according to a graduated tax rate schedule as presented below (double this for married filing joint and unmarried head of household filers): at least but less than $0 $10,000 2.87% of the amount 10,000 25,000 3.2% of the amount, less $33 25,000 50,000 3.74% of the amount, less $168 50,000 150,000 4.72% of the amount, less $658 150,000 and over 5.04% of the amount, less $1,138 Lower taxable incomes are taxed at a lower level, or, in other words, are treated preferentially. If all taxpayers were treated identically, the same tax rate would be applied regardless of the level of taxable income. A question arises, however, as to what tax rate should be applied to determine the revenue impact of treating all taxpayers identically. One argument may be that since the highest tax rate is 5.04%, determining the impact of taxing all income at 5.04% would be appropriate. Using this reasoning, an additional $871.6 million would have been collected from individual income tax if a flat 5.04% tax rate had been used. 65 However, no taxpayer is currently taxed solely at 5.04%; only that income greater than $150,000 is taxed at this rate. If a flat tax rate were applied to individual income, the logical tax rate applied would be the effective tax rate of all individual income taxpayers. Dividing total tax liability on individual income tax returns by the total Arizona taxable income results in an effective tax rate 3.57%. Applying this tax rate to all taxpayers results in the same individual income tax collections as with the graduated tax rate structure, but the burden of the tax will change. Taxpayers with lower Federal Adjusted Gross Income will pay more tax and taxpayers with higher Federal Adjusted Gross Income would pay less tax. CREDITS A tax credit differs from an exemption, subtraction or deduction in that it directly reduces tax liability, not taxable income. A $100 deduction, for example, would reduce tax liability by, at most, $5.04 ($100 times the maximum tax rate of 5.04%). On the other hand a $100 credit reduces tax liability by the full $100. Family Tax Credit Single and married filing separately filers with a federal adjusted gross income of $10,000 or less, and married filing jointly filers with a federal adjusted gross income of $31,000 or less with dependents, may claim the family tax credit (A.R.S. §43- 1073). The amount of the credit is set at $40 per person in the household, and is capped at $240 for married filing jointly and unmarried head of household filers, and $120 for single and married filing separately filers. Property Tax Credit The property tax credit program provides tax relief to the state's low-income elderly. Under this program, full-year residents age 65 or older with a household income of less than $5,500 are eligible for credits ranging from $56 to $502 (A.R.S. §43- 1072). The property tax credit is refundable, meaning that those eligible for the credit receive money even if they had no income tax liability. Clean Elections Credit A credit is allowed for donations made directly to the Clean Elections Fund or a clean election donation made on the individual income tax return. The credit is not to exceed 20% of the tax liability or $550 for single filers ($1,100 for married filing jointly) whichever is greater. The maximum credit is adjusted biennially (A.R.S. §16-954B). Credit for Increased Excise Taxes Paid A refundable credit is allowed against income tax to mitigate the increase in transaction privilege tax rates for education (A.R.S. §43- 1072.01). To qualify, claimants must have federal adjusted gross income of $25,000 or less for married filing jointly or $12,500 or less for single filers. The credit shall not exceed $25 for each person who is a resident and for whom a personal or dependent exemption is allowed with a maximum credit of $100 per household. Other Credits Other credits are filed on a separate Schedule CR. In many instances, the credit claimed exceeds the tax liability on the return. With those credits that are non-refundable, the unused portion of the credit is superfluous. For this reason, in order to generate the true expenditure associated with credits, each credit claim must be reviewed. Credit for Taxes Paid to Other States or Countries In the past, the majority of the credits claimed on the Schedule CR, in terms of dollars and volume, were for taxes paid to other states or countries (A.R.S. §43-1071). Enterprise Zone Credits Enterprise zone credits are income tax credits provided for non-retail businesses located in an enterprise zone established under Arizona law who have a net increase in employment of qualified 66 employees (A.R.S. §43-1074). A maximum of $500 per each net new employee can be claimed in the first or partial year of employment. In the second year of continuous employment, a maximum of $1,000 per net new employee can be claimed. The limit in the third year of continuous employment is $1,500 per net new employee. Research and Development Credit A.R.S. §43-1074.01 provides a tax credit for research and development expenses. The amount of credit is computed based on the excess of the qualified research expenses for the taxable year over the base amount. Recycling Equipment Credit The recycling equipment credit is an income tax credit for businesses or individuals that acquire and place in service recycling equipment in the state (A.R.S. §43-1076). This credit is equal to 10% of the installed cost of the recycling equipment but not to exceed 25% of the tax liability for that tax year or $5,000. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Defense Contracting Credit Defense contracting credits are provided to qualified defense contractors for net increases in full-time employment positions under the United States Department of Defense contracts and for net increases in private commercial full-time employment within Arizona by a qualified defense contractor (A.R.S. §43-1077). An income tax credit is also allowed equal to a portion of the amount paid as property taxes during the taxable year by a qualified defense contractor on property that is classified as Class 3 (A.R.S. §43-1078). Military Reuse Zone Credit The military reuse zone credit is a tax credit for net increases in employment by the taxpayer of full-time employees working in a military reuse zone who are primarily engaged in manufacturing, assembling or fabricating aviation or aerospace products (A.R.S. §43-1079). The amount of the credit is determined by a dollar amount allowed for net new employee positions other than dislocated military base employees and by a dollar amount allowed for net new dislocated military base employee positions. Environmental Technology Credit An income tax credit is provided for expenses incurred in constructing a qualified environmental technology manufacturing, producing or processing facility (A.R.S. §43-1080). The amount of the credit is equal to 10% of the amount spent during the taxable year to construct the facility. Pollution Control Device Credit The pollution control device credit is a tax credit for expenses incurred to purchase real or personal property that is used in Arizona in the taxpayer's trade or business to control or prevent pollution (A.R.S. §43-1081). The amount of the credit is equal to the lesser of 10% of the purchase price or $500,000. Agricultural Pollution Control Equipment Credit A credit is allowed for expenses that a taxpayer (involved in the commercial production of livestock, livestock products or agricultural, horticultural, viticultural or floricultural corps or products) incurs to purchase tangible personal property that is primarily used in the taxpayer’s trade or business in the state to control or prevent pollution (A.R.S. §43-1081.01). Construction Materials Credit A.R.S. §43-1082 provides a tax credit of 5% of the purchase price of new construction materials incorporated into a qualifying facility located in Arizona if the facility has a total cost of $5 million. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Solar Energy Device Credit A solar energy credit is provided for an individual who installs a solar energy device in his or her residence in Arizona. The credit for buying or installing such a device is 25% of the cost, including installation, or $1,000, whichever is less (A.R.S. §43-1083). 67 Agricultural Water Conservation System Credit A credit is allowed for expenses incurred by a taxpayer to purchase and install an agricultural water conservation system (A.R.S. §43-1084). The agricultural water conservation system must be primarily designed to substantially conserve water on land that is used to produce agricultural products, raise, harvest or grow trees, or sustain livestock. The amount of the credit is 75% of the qualifying expenses. Underground Storage Tanks Credit Taxpayers that incur expenses for corrective actions taken with respect to the release of a regulated substance from an underground storage tank are allowed an income tax credit. The credit is 10% of the amount spent for corrective actions during the taxable year, if certified by the Department of Environmental Quality. (A.R.S. §43-1085) Alternative Fuel Vehicles Credit An income tax credit was provided for the purchase of one or more new alternative fuel vehicles for use in this state or for expense incurred for converting one or more conventional vehicles to operate on alternative fuel (A.R.S. §43-1086). This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Vehicle Refueling Apparatus Credit A.R.S. §43-1086.01 provided a credit for the purchase of a vehicle refueling apparatus including storage tanks, for installation on one or more properties in Arizona. This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Alternative Fuel Delivery System Credit A credit was allowed for construction costs or operating costs for constructing or operating an alternative fuel delivery system in Arizona (A.R.S. §43-1086.02). This credit is now only available to the extent that the taxpayer had unused carry forward from prior years. Employment of TANF Recipients Credit A.R.S. §43-1087 provides for an income tax credit for net increases in qualified employment of recipients of temporary assistance for needy families who are Arizona residents. A maximum of $500 per each net new employee can be claimed in the first year of employment, $1,000 in second year of employment and $1,500 in the third year. Contributions to Charities that Provide Assistance to the Working Poor Credit Up to $200 in voluntary cash contributions to a charitable organization that spends at least 50% of its budget on services to Arizona residents who receive TANF benefits or low income Arizona residents (income of less than 150% of the federal poverty level) can be taken as an income tax credit (A.R.S. §43-1088). Private School Tuition Organization Credit The private school tuition organization credit is allowed for cash contributions to a school tuition organization, up to $500 for single/married filing separate and $625 for married filing joint/unmarried head of household filers. (A.R.S. §43-1089). Public School Extra Curricular Activity Fee Credit A.R.S. §43-1089.01 allows an income tax credit for the amount of fees paid to a public school located in Arizona for the support of extra curricular activities, up to $200 for single/married filing separate and $250 for married filing joint/unmarried head of household filers. School Site Donation Credit A.R.S. §43-1089.02 provides a credit for donation of real property and improvements to a school district or charter school for use as a school or a site for the construction of a school. The amount of the credit is 30% of the value of real property and improvements donated. 68 Solar Hot Water Heater Plumbing Stub Outs and Electric Vehicle Recharge Outlets Credit A credit is allowed for costs incurred of installing an electric vehicle recharge outlet and for including solar hot water heater plumbing stub outs in one or more houses in Arizona constructed by the taxpayer. (A.R.S. §43-1090) Agricultural Preservation District Credit A refundable credit is allowed for a taxpayer who conveys ownership or development rights of Class Two property to an agricultural preservation district (A.R.S. §43-1081.02). The amount of the credit is either the appraised value of the property or the difference between the appraised value of the undeveloped land and the appraised value of the land for development purposes. The credit cannot exceed $33,000 in a calendar year. Technology Training Credit A refundable credit is allowed for providing technological skills training to employees (A.R.S. §43-1088.01). The credit is equal to 50% of the cost of training in taxable year, not to exceed $1,500 per employee, for a maximum of 20 employees. TYPE OF CREDIT # of claimants 2003 (Millions) Family tax credit 417,451 $7.45 Property tax credit 15,028 5.30 Clean elections credit 32,042 0.73 Credit for increased excise taxes paid 548,831 29.58 Credit for taxes paid to other states or countries 25,722 62.48 Enterprise zone credit 202 1.71 Research and development credit 121 1.10 Recycling equipment credit 4 0.00 Defense contracting credit 0 0.00 Military reuse zone credit 0 0.00 Environmental technology credit 0 0.00 Pollution control device credit 9 0.03 Agricultural pollution control equipment credit NR14 NR Construction materials credit NR NR Solar energy device credit 1,171 0.48 Agricultural water conservation system credit 154 1.61 Underground storage tanks credit 0 0.00 Alternative fuel vehicles credit 50 0.06 Alternative fuel vehicle credit – neighborhood electric vehicle portion 1,203 1.58 Vehicle refueling apparatus credit 5 0.01 Alternative fuel delivery system credit 0 $0.00 Employment of TANF recipients credit NR15 NR Contributions to charities that provide assistance to the working poor credit 17,467 3.26 14 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 15 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 69 TYPE OF CREDIT # of claimants 2003 (Millions) Private school tuition organization credit 58,122 29.45 Public school extra curricular activity credit 201,407 27.75 School site donation credit 45 2.05 Solar hot water heater plumbing stub outs and electric vehicle recharge outlets credit NR NR Agricultural preservation district credit (refundable) 0 0.00 Technology training credit (refundable) 0 0.00 TOTAL VALUE OF ALL CREDITS (credit used and refunded) 16 1,319,043 $174.66 16 Figures for all credits shown here are subject to change due to the verification process. 70 SUMMARY OF INDIVIDUAL INCOME TAX EXPENDITURES Tax Year 2003 FEDERAL SUBTRACTIONS FROM INCOME: Educator expenses/tuition fees deduction ............................................................. $2,713,000 Individual Retirement Account for qualifying individuals...................................... 5,108,000 Student Loan Interest deduction................................................................................ 2,068,000 Moving expenses ............................................................................................................. 480,000 One-half of self-employment tax ............................................................................... 8,249,000 Self-employed health insurance deduction ............................................................... 8,359,000 Keogh retirement plan and self-employed SEP deduction .................................. 10,307,000 Penalty on early withdrawal of savings........................................................................... 30,000 Alimony paid ............................................................................................................ 6,166,000 TOTAL VALUE OF FEDERAL SUBTRACTIONS FROM INCOME....................................................................................$43,861,000 EXEMPTIONS: Personal exemptions ..............................................................................................$200,236,000 Preferential personal exemption for unmarried head of household ................... 11,206,000 Preferential personal exemption for married filers with one or more dependents.................................................................................................................. 26,753,000 Age 65 or over exemptions ....................................................................................... 19,104,000 Dependent exemptions.............................................................................................. 81,828,000 Blind exemptions ............................................................................................................. 197,000 Qualifying parent or ancestor exemption........................................................... 1,587,000 TOTAL VALUE OF EXEMPTIONS.......................................................... $350,697,000 SUBTRACTIONS FROM INCOME: Interest on US obligations......................................................................................... $7,349,000 Exclusion for federal, Arizona state or local pensions............................................ 7,186,000 Exempt Arizona state lottery winnings .......................................................................... 87,000 Social Security or Railroad Retirement benefits included on federal form 1040 ............................................................................................................... 59,974,000 Bonus depreciation adjustment .................................................................................. 2,667,000 Certain wages of Native Americans......................................................................... 14,434,000 Income tax refunds from other states .......................................................................... 753,000 Constructing energy efficient residences........................................................................ 39,000 Other Subtractions ....................................................................................................... 6,413,000 Deposits and employee contributions into medical savings accounts..................... 149,000 Elective subtraction of 2003 federal retirement contributions ....................... 397,000 TOTAL VALUE OF SUBTRACTIONS...................................................... $100,188,000 71 DEDUCTIONS: Standard deduction.................................................................................................$161,815,000 Preferential standard deduction for unmarried head of household .................... 15,116,000 Itemized deductions: Medical & dental expenses ........................................................................................ 85,768,000 Taxes paid: State and local income taxes ................................................... 91,772,000 Real estate taxes ........................................................................ 43,924,000 Personal property and Other Taxes....................................... 11,996,000 Total value of taxes paid deduction ................................................................$145,027,000 Interest Expense: Home Mortgage Interest .......................................................206,570,000 Deductible Points ....................................................................... 2,130,000 Deductible Investment Interest............................................ 9,821,000 Total Value of Interest Expense .....................................................................$217,933,000 Charitable Contributions: Cash Contribution .................................................................... 59,684,000 Contributions Other Than Cash ............................................ 17,563,000 Carryover From Prior Year..................................................... 4,831,000 Total Value of Charitable Contributions ...........................................................$82,016,000 Casualty & Theft Losses................................................................................................... 784,000 Job Expenses and Most Other Miscellaneous Deductions ....................................34,368,000 Nonlimited Miscellaneous Deductions ................................................................ 15,276,000 Total Value of Itemized Deductions .....................................................................$421,849,000 TOTAL VALUE OF STANDARD AND ITEMIZED DEDUCTIONS................................................................ $788,025,000 CREDITS: Family tax credit............................................................................................................$7,446,000 Property tax credit ..........................................................................................................5,302,000 Clean elections fund credit............................................................................................... 727,000 Credit for increased excise taxes paid........................................................................29,582,000 Credit for taxes paid to other states or countries.....................................................62,485,000 Enterprise zone credit....................................................................................................1,714,000 Research and development credit ................................................................................1,109,000 Recycling equipment credit .................................................................................................. 2,000 Defense contracting credit ...........................................................................................................0 Military reuse zone credit .............................................................................................................0 Environmental technology credit................................................................................................0 Pollution control device credit........................................................................................... 31,000 Agricultural pollution control equipment credit ................................................................NR17 Construction materials credit...................................................................................................NR Solar energy device credit ................................................................................................. 480,000 Agricultural water conservation system credit............................................................1,611,000 Underground storage tanks credit...............................................................................................0 Alternative fuel vehicles credit........................................................................................... 61,000 17 Too few taxpayers have claimed this credit to allow for a release of data without violating confidentiality laws. 72 Neighborhood electric vehicle credit.........................................................................$1,583,000 Vehicle refueling apparatus credit ....................................................................................... 9,000 Alternative fuel delivery system credit........................................................................................0 Employment of TANF recipients credit.............................................................................NR18 Contributions to charities providing assistance to working poor credit.................3,259,000 Private school tuition organization credit .................................................................29,445,000 Public school extra curricular activity fee credit ......................................................27,754,000 School site donation credit............................................................................................2,049,000 Solar water heater plumbing stub outs and electric vehicle recharge outlets credit............................................................................................................................NR Agricultural preservation district credit (refundable) ...............................................................0 Technology training credit (refundable)............................................................... 0 TOTAL VALUE OF CREDITS....................................................................... $174,664,000 VALUE OF INDIVIDUAL INCOME TAX EXPENDITURES19 ............................................................................................................$1,727,012,000 18 Too few taxpayers have claimed this credit to allow for a release of the cost without violating confidentiality laws. 19These expenditures represent foregone revenues to the state general fund and to the urban revenue sharing fund, which is distributed to incorporated cities and towns. 73 INSURANCE PREMIUM TAX EXPENDITURES 74 75 INSURANCE PREMIUM TAX EXPENDITURES20 20Any figures presented for Insurance Premium Tax Expenditures were provided by the Department of Insurance. Each admitted insurer doing business in the state is required to annually report its total direct premium income to the Arizona Department of Insurance (A.R.S. § 20-224). Total direct premium income excludes “...applicable cancellations, returned premiums, the amount of reduction in or refund of premiums allowed to industrial life policyholders for payment of premiums direct to an office of the insurer, all policy dividends, refunds, savings coupons and other similar returns paid or credited to policyholders within this state and not reapplied as premiums for new, additional or extended insurance.” Direct premium income also excludes “considerations received on annuity contracts,” as well as the “unabsorbed portion of any premium deposit.” No information is available on the value of these exclusions from |