Arizona follows the section 1202 100% tax exclusion on capital gains from the sale of QSBS. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also state income taxes if all of the guidelines are followed. Also, The state of Arizona offers a Small Business Capital Investment Incentive Program, which is a tax credit to stimulate investments in qualified small businesses in Arizona. What is the Arizona Small Business Capital Investment Incentive Program?
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Arizona QSBS Exemptions
Arizona follows the section 1202 100% tax exclusion on capital gains from the sale of QSBS. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also state income taxes if all of the guidelines are followed.
Arizona conforms on a “static” basis, having conformed to the federal treatment of partial exclusion for gain from certain small business stock at the Corporate level (effective for taxable years beginning from and after Dec. 31, 2020). See Ariz. Rev. Stat. Ann. § 43-105(A),as amended by 2021 Ariz. S.B. 1752. At an individual level, Arizona conformed to the federal treatment of partial exclusion for gain from certain small business stock (effective for the taxable years beginning from and after December 31, 2013). See Ariz. Rev. Stat. Ann. § 43-1022(36). The individual taxpayer must include the net capital gain included in the federal adjusted gross income derived from the total investment in the “qualified business.” See Ariz. Rev. Stat. Ann. § 41-1518.
Arizona Capital Gains Tax Rates
According to the Arizona Department of Revenue, “Capital gains included on an individual’s federal adjusted gross income are included on his or her gross income and taxed at the individual’s regular tax rate.” For single taxpayers the income and capital gains rates are:
- 2.59% for $0 to $27,272
- 3.34% for $27,273 to $54,544
- 4.17% for $54,545 to $163,632
- 4.5% for $163,633 and over
In comparison, federal capital gains tax rates only have 3 brackets for single taxpayers which tend to be lower that the income tax rates and are as such:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Notable Arizona Businesses
Several notable companies in Arizona are included in our “potentially QSBS eligible” Company Directory, such as:
Entrepreneurship in Arizona
The Arizona Commerce Authority offers Small Business Services which distribute information on business licensing and resources for all stages of business development. They also advocate for small businesses by developing programs and policies that address the needs of business owners. Their partnership with entrepreneurs, small business owners and government officials calls them to create opportunities for “Arizona’s small, minority-owned, women-owned, and disadvantaged business enterprises.”
They also host the Arizona Innovation Challenge which is a business plan competition designed to “advance innovation and technology commercialization opportunities” throughout the state by offering support to early-state entrepreneurs.
Key Industries in Arizona
Among other industries, the following industries in particular thrive in the state:
- Aerospace and Defense
- Technology and Innovation
- Bioscience and Healthcare
- Business and Financial Services
- Film and Digital Media
Other Small Business Tax Credits in the State of Arizona
The state of Arizona offers a Small Business Capital Investment Incentive Program, which is a tax credit to stimulate investments in qualified small businesses in Arizona.
“The principal objective of the Angel Investment program is to expand early stage investments in targeted Arizona small businesses. The program accomplishes this goal by eliminating Arizona capital gains tax liabilities associated with the disposition of investments in small businesses certified by the ACA.“
Arizona Opportunity Zones
On March 21, 2018, Arizona nominated 168 Opportunity Zones.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Arizona made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Arizona is currently ranked third in attracting opportunity fund capital. Refer to this map for the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Arizona has many resources for an individual looking to invest in Opportunity Zones within the state. An individual can connect with experts, explore funds, and find investments here.
Additional Information on Arizona Capital Investment Incentive Program
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.