Income Taxes on Business Income in Arizona

April 13, 2006

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In Arizona, you're generally free to choose to operate your business as a C corporation, S corporation, partnership, limited liability company (LLC), or sole proprietorship. However, the entity type you select for your business may, in some cases, decide whether you or your business pays income taxes on the business income.

Corporations. Domestic corporations (corporations organized in Arizona) and foreign corporations (corporations organized in a state other than Arizona) are subject to an Arizona income tax. The corporate income tax rate is 6.968 percent of taxable net income.

S corporations. If you meet the federal tax law requirements to operate as an S corporation, the IRS allows your business to "pass through" its income to the shareholders. This means that your business will not pay any IRS corporate level income tax. However, you'll have to claim your entire share of the business income on your personal federal income tax return even if you did not take any money out of the business.

In Arizona, the law extends this favorable tax treatment to state corporate income tax liability and S corporations will not be subject to the corporate income tax.

Partnerships. If you operate your business as a partnership, your partnership will not be taxed on its net income. Instead, partners must include in their Arizona taxable adjusted gross income their distributive share of partnership income.

Limited liability companies (LLCs). Arizona law recognizes businesses operating as limited liability companies (LLCs). Domestic and foreign LLCs in Arizona are classified as either partnerships or corporations for Arizona tax purposes. LLCs follow the federal rules on how they will be taxed. Accordingly, if your LLC is treated as a partnership then it will not be taxed on its net income. Instead, members must include in their Arizona taxable adjusted gross income their distributive share of LLC income.

If a business is classified as an association taxable as a corporation for federal income tax purposes, it will also be taxable as a corporation for Arizona tax purposes.