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Arizona tax withholding rate change would avert money delays

PHOENIX – Arizona lawmakers plan emergency legislation to stave off an unintended consequence of the federal stimulus law: lower income tax collections because the state keys its withholding to federal rates.

The federal government dropped withholding rates Wednesday in an effort to stimulate consumer spending. The amount in Arizona taxes ultimately due isn’t affected, but lower withholding rates will keep that money from state coffers for up to a year.

Changes proposed for legislative action Thursday would restore state rates to those in effect before the federal change took effect, lawmakers said. It doesn’t change a worker’s state tax obligation.

“The effect will be that there will be no difference to the taxpayer at the end of the tax year,” said Senate Majority Leader Chuck Gray, R-Mesa. “It’s not an increase in taxes and we’re trying to hold them harmless as much as possible with even the withholding.”

The House and Senate plan action Thursday on the proposed withholding rate decoupling, which would take effect May 1. The Senate on Wednesday suspended advance-notice rules to allow the quick action.

Under the legislative proposal, the state would initially raise its ratio of withholding compared with the federal schedule by 1 to 2 percentage points. Arizona tax officials would then create their own withholding tables by next year to require withholding money based on the size of paychecks. Other states do it that way already.

The state change would not affect the federal government’s reduced withholding, which took effect Wednesday to implement the “Making Work Pay” tax credit. For most workers, the federal change means about $10 more in weekly paychecks. The maximum for the year per worker is $400, or $800 per married couple.

The state Department of Revenue has estimated that reduced withholding would cost the state $73 million in the current fiscal year, which ends June 30, and about half that amount in the next fiscal year. The state would recoup all of that money in the following fiscal year when taxpayers file their tax returns.

Even after a $1.6 billion budget fix in January, the state faces a new shortfall projected at roughly $500 million in the current budget. There’s also a $2.9 billion shortfall anticipated in the next fiscal year.

With the proposed change, “there is no difference in how much an individual will pay in taxes or how much the state will collect in taxes. The amount is the same,” said Rep. Debbie Lesko, a Glendale Republican who is vice chairman of the House Ways and Means Committee. “It’s basically just a timing issue so that we are not collecting less right now and then getting it next year. We really need the money now.”

House Ways and Means Chairman Rick Murphy, R-Glendale, said it’s not only the state that would benefit by the proposed change. Taxpayers who set their withholding to avoiding having money due when their file their returns could be unpleasantly surprised in April 2010 by reduced state withholding through the rest of 2009.

“That’s a surprise that I don’t want people to have,” Murphy said.

The Revenue Department said Arizona is the only state that directly links its state withholding to federal rates, and an analyst for the Washington-based Federation of Tax Administrators said Wednesday he was unaware of any other state following Arizona’s current practice.

Arizona needs to permanently decouple its withholding “to make sure that every time the new federal government has a new whim that our withholding rates don’t start to fluctuate constantly,” Gray said.

“We’re the only state in the union that is doing this antiquated fashion of following the federal government around with our withholding rates.”

Arizona employers had to change employees’ withholding by Wednesday to accommodate the federal change. State decoupling would require more work by employers, but leaders of several major business groups recently told The Associated Press that it didn’t seem too big a burden and that they recognized that the state was short of money.

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