How Arizona income tax works: federal AGI, the federal-sized deduction, 2.5%

Arizona taxes income at one rate, 2.5%, with no brackets and no city or county income tax. Form 140 begins with federal adjusted gross income, adds a few items back, subtracts a longer list, takes a standard deduction that is the same dollar figure as the federal one, allows a $2,100 exemption for each person 65 or older, and multiplies what is left by 2.5%. Then come the credits, and this is where Arizona is unlike anywhere else: a household can redirect a large share of its state tax, dollar for dollar, to a public school, a private school tuition organization or a certified charity, and the state treats the gift as payment of the tax. For 2026 Arizona has also adopted the July 2025 federal law, so tips, overtime pay and the $6,000 senior deduction come off the Arizona return too.

Two consequences follow. Every above-the-line federal adjustment (IRA and HSA deposits, student loan interest, half of self-employment tax) reduces Arizona tax automatically. And because Arizona writes its own subtractions for the below-the-line federal deductions it chooses to honor, the state return is not a copy of the federal one: tips and overtime are subtracted, car-loan interest was subtracted for 2025 only, and the 20% qualified business income deduction never was.

Who files

A full-year resident reports all income on Form 140 and takes a credit on Form 309 for tax paid to another state on income taxed by both. A part-year resident files Form 140PY; a nonresident files Form 140NR on Arizona-source income only; both are in Moving to Arizona. The short forms, 140A and 140EZ, cannot carry the tips, overtime or senior subtractions, so anyone claiming those files the full Form 140. The filing threshold is gross income at or above the standard deduction, $15,750 single, $23,625 head of household or $31,500 joint for 2025. File below it anyway if Arizona tax was withheld or you qualify for a refundable credit.

Where it starts: federal AGI

The first income line of Form 140 is federal adjusted gross income, line 11 of Form 1040: income after the Schedule 1 adjustments but before the standard deduction and everything beneath it. The federal deductions for tips, overtime, seniors and car-loan interest are not in the starting number. Arizona decides, item by item, which to give back through subtractions of its own.

The additions

For most households there is one addition or none.

Municipal bond interest from other states. Federally tax-exempt interest on other states’ bonds is taxed by Arizona; Arizona’s own municipal bonds stay exempt. A brokerage 1099 that lumps tax-exempt interest together has to be split.

Depreciation. Arizona adds back all federal depreciation and subtracts its own recalculated figure. For assets placed in service after 2016 the two match, bonus depreciation included, so for most small businesses the lines cancel (verify). New for 2026, HB 4168 refuses the federal section 168(n) allowance for qualified production property, so that piece stays added back.

The subtractions

This is the longer list, and where money is left on the table.

Car-loan interest is deliberately missing: Arizona subtracted it for 2025 only. Inherited or gifted assets take the original owner’s acquisition date for the capital gain subtraction, which is denied if that date cannot be shown.

Tips, overtime and seniors. On the 2025 return these three ran through a separate Middle Class Tax Cuts Package worksheet that copied the federal Schedule 1-A amounts and carried the total to the Other Subtractions line. The Department has not published the 2026 Form 140, so where they land is to come; the law is settled, the line number is not. The subtractions equal the federal deductions, so the federal caps and phase-outs apply here too, and someone who qualifies for nothing federally gets nothing in Arizona.

The capital gain haircut. Arizona subtracts 25% of the net long-term gain on assets bought after December 31, 2011, which puts the effective rate on those gains at 1.875%. Dividends, interest and short-term gains are taxed at the full 2.5%. The computation needs the gain split by acquisition date, which a brokerage 1099-B usually shows. See Capital gains.

The standard deduction, or itemizing for Arizona only

Arizona’s standard deduction is the federal one. The statute sets $15,750 single or separate, $23,625 head of household and $31,500 joint for 2025 and indexes them by the federal method, so the 2026 figures should match the federal $16,100, $24,150 and $32,200 (to come). Non-itemizers also get something the federal return does not offer: for 2026 the standard deduction rises by the full amount of charitable gifts, up to $1,000 single or $2,000 joint, replacing the 2025 rule of 34% of gifts with no cap. Gifts used for an Arizona credit cannot be counted.

Or you can itemize on Arizona Schedule A even if you took the federal standard deduction, which pays off for a homeowner with a large mortgage or heavy medical bills. Arizona starts from the federal Schedule A and adjusts: state income tax is added back, medical expenses are allowed without the federal 7.5%-of-AGI floor, gifts claimed for an Arizona credit come out, and for 2026 the state and local tax piece is capped at $10,000 regardless of the federal $40,000 cap. See The SALT cap.

Exemptions

There is no personal exemption. The return allows $2,100 for each taxpayer or spouse 65 or older, $1,500 for each who is blind, and $10,000 for a parent or grandparent 65 or older who lives with you and needs help with daily living. Children are not exemptions in Arizona; they are credits.

The rate

Federal AGI, plus additions, minus subtractions, is Arizona adjusted gross income. Minus the deduction and the exemptions, it is Arizona taxable income. Times 2.5%, it is the tax. Wages, pensions, IRA withdrawals, interest, dividends, rent, gambling winnings and unemployment are all taxed at the same rate. No Arizona city, county or school district levies an income tax; they levy transaction privilege (sales) taxes instead.

The credits

Arizona credits come in three groups: the small ones for dependents and low income, the refundable ones for low-income seniors and households, and the gift credits that let a taxpayer choose where the tax goes. The gift credits and Form 309 are summarized on Form 301.

The QCO, QFCO and school tuition credits accept gifts made from January 1 through April 15, 2027 on the 2026 return, at the 2026 maximums. Unused gift credits carry forward five years; the credit for taxes paid to another state does not carry at all.

Two rules make or break the gift credits: the organization must be on the Department’s certified list, with its code or the school’s CTDS number on the form, and the same dollars cannot be used twice. How a family stacks them is in Credits and breaks for Arizona families.

Withholding and estimated payments

Arizona withholding is a flat percentage of wages that the employee picks on Form A-4, from 0.5% to 3.5% in half-point steps, plus an optional extra amount; with no form on file the employer withholds 2.0%. The one Arizona mistake is choosing 2.0% when the effective rate after the deduction is close to 2.5%, which leaves a two-income household with no children owing in April. Pensions can have Arizona tax withheld on Form A-4P. See Withholding and the W-4.

Estimated payments are required only when Arizona gross income (federal AGI for a resident) exceeds $75,000 ($150,000 joint) in both the prior and current year. The safe harbor is 90% of this year’s tax or 100% of last year’s, in four installments due April 15, June 15, September 15 and January 15, on Form 140ES or at AZTaxes.gov. See Estimated payments.

How to file

Returns are due April 15, 2027. An extension to October 15 is automatic with Form 204, or with a federal extension and box 82F; it extends the filing, not the payment, and at least 90% of the tax must be paid by April 15 to avoid the extension penalty. Payments, refund status and free filing options are at AZTaxes.gov. An amended return is Form 140X. Dates, forms and links are in Arizona calendar and forms.

What trips people up

• Tips, overtime or the senior deduction left off because the software did not run the Arizona worksheet, or the return went on a 140A or 140EZ.
• Car-loan interest subtracted for 2026 on the strength of the 2025 rule.
• A gift to a charity not on the certified QCO list, or a Form 322 without the school’s CTDS number.
• A 529 contribution nobody mentioned, because the federal return did not ask.
• The extension treated as an extension to pay.