Arizona’s New Withholding

Arizona has done it again.  Currently, anyone who is being paid in Arizona must select from several percentages on the A-4.  Arizona withholding is based on a percentage of federal withholding.  The percentage you pick will be multiplied times the federal withholding number on your paycheck to arrive at Arizona withholding.  If you selected 24.5%, and your federal withholding was $112, then your Arizona withholding would be .245×112 or $27.44.

This created a problem with all the federal withholding changes that have happened over the last 10 years.  Each time there was a withholding decrease, Arizona’s revenue decreased as well.  The Making Work Pay Credit last year decreased checks for everyone and was the last straw in the problem.  Arizona’s legislature had to increase the percentages on this form each time the federal government decreased withholding  just to keep withholding even. Finally, last year, the legislature directed the AZ Department of Revenue to develop a new withholding system to be put into place by July 1, 2010.

There are other glaring problems with this method.  Arizona’s tax rates are based on a formula.  By requiring employees to pick a flat percentage, they are forced to determine a marginal (or average) tax rate for their tax situation.  This can change based on events in a person’s life like marriage, divorce, new children, home purchase, a second job or a spouse begins working that didn’t before.  Any of these events change the marginal rate.  Most people never adjust their A-4.  This obviously causes frequent confusion.

Another problem is that many people simply have no federal tax liability.  With no federal withholding, there was no way to have any Arizona withholding and inevitably, these individuals would end up paying extra every year at tax time.

Yet another problem is those that move into the state mid-year.  As a Tax Preparing CPA, I found it very difficult to advise my clients when they move in mid- year which percentage to pick.  The problem still exists in the second year (first full year of residence) since they have no history to draw from in selecting their percentage.

So…..Arizona’s new method was recently announced and here is the form.  All employees must complete a new one of these by July 1, 2010.  Guess what? They solved none of the above mentioned problems and even made some new problems.  Now, the percentage you select is percent of gross pay.  This decouples the state from federal withholding changes but still does not give employees who are new a clue to which rate to select.  Now instead of new employees only being confused, any person working in the state gets to be confused and not just for half a year, but for next year as well.  There is still no basis in the actual tax rates with these percentages.

Instead of providing some rates that anyone can pick, there are still three lines for employees to select based on income level.  This should have been removed.  If you have very low tax liability but a higher than $15,000 income, you cannot select the lowest rate.  On the back of the new form, there is a worksheet provided.  Notice in line 10 of the worksheet that there is no provision in the instructions for selecting anything other than line 1 (front side) percentages.  What if the calculation result is lower than the percentages on the form?

Employees are not able to determine their “target” withholding without digging into last year’s tax return or contacting their tax preparer.  Again, changes in taxable life events make last year’s number irrelevant.  What are you supposed to choose? This value is difficult for those without a tax background to understand.

Supposedly, payroll “experts” were used to help develop this form.  Unfortunately, they chose to tweak the existing system enough to only make things more confusing.   I hope that the state will make some wholesale changes to this form to more closely match what other states are doing and what the Arizona tax system actually looks like.  It’s not bad to use withholding allowances and marital status.  We are forced to use that on the tax form.   Let’s get this right next time.

Withholding in more than one state

Special Note: Dear readers, Thanks for your patience last week. There were two problems with the blog. Due to a configuration issue, it was down for a few days. Also, I was unable to post due to a very remote cabin for a week-long vacation. Things will return to normal now will at least weekly posts on Wednesday.
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Q. I worked in Arizona for the first quarter of this year. I moved to Read more »

Arizona Withholding

Q. I’m using PaycheckCity.com to estimate my paycheck after moving to Arizona. What’s up with the percentage stuff? Why is there no filing status and allowance values like everyone else?

A. I wish I could tell you why Arizona withholds like it does. Employers in Arizona calculate withholding as a percentage of federal withholding. This is the last state that bases it’s withholding on the federal calculation. In past years as federal withholding as decreased for many people. As federal withholding declines so does state withholding if Read more »

Employers Stop Arizona Withholding

This edition is more of a rant than a question and answer time. As an Arizona employer, we are permitted by statute to not withhold Arizona tax from employee checks during the month of December. There were two reasons for this bill. One: educate the employee on just how much tax they actually pay. Two: provide extra spending money for employees during the holiday season. Employers must submit a form A1-E by July 1st to opt-out of withholding for the current year.

Here is the problem, employees will still have the same liability. Employers think they will look like the good guy when the take home pay increases in December, but they will not look so good in April when the employee is likely required to pay additional tax to match their actual liability. Now instead of having enough tax withheld during the year, you as an employer at the suggestion of the State of Arizona, can purposefully under withhold. This also reduces state coffers with less money coming in. The standard rule is that withholding and information reporting increases compliance. It’s much more difficult to get money out of an employee if you are the state than if it was properly withheld at the source.

Thankfully, the program is not gaining a lot of traction. However, each year with the Q1 reconciliation report sent to employers, this A1-E is sent too which reminds employers of the option. I hope this law can be changed some day. But for now, if you are an Arizona employer, I encourage you NOT to submit this form. Instead, do the right thing and recycle it with the rest of your discarded paper.