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ARIZONA STATE SENATE
Fifty-Seventh Legislature, Second Regular Session
VETOED
AMENDED
FACT SHEET FOR H.B. 2785/S.B. 1638
conformity; internal revenue code; deductions.
Purpose
Retroactive to January 1, 2025, conforms Arizona tax statutes to the U.S. Internal Revenue Code (U.S. IRC) as of January 1, 2026, to reflect changes adopted by the U.S. Congress during 2025. Establishes individual income tax subtractions for tips, overtime compensation, seniors and vehicle loan interest and modifies individual income tax deductions.
Background
The Arizona Legislature periodically updates the statutory definition of the U.S. IRC to include any federal provisions that became effective in the preceding calendar year as a means of paralleling the computation of Arizona income tax and other statutory references throughout the Arizona Revised Statutes to the amended U.S. IRC. Tax conformity with the U.S. IRC is deemed necessary because the calculation of Arizona corporate income tax liability begins with federal taxable income. Similarly, federal adjusted gross income (FAGI) is the starting point for individual income tax assessment.
On July 4, 2025, major federal tax changes were enacted through H.R. 1, commonly referred to as the One Big Beautiful Bill. Due to tax code conformity, these federal changes have the potential to impact state revenues. H.R. 1 includes changes that impact federal taxable income and FAGI which the state could conform to by updating the statutory definition of the U.S. IRC (standard conformity). However, H.R. 1 also includes provisions that are not automatically incorporated when updating the definition of U.S. IRC.
According to the Arizona Department of Revenue (ADOR), the estimated impact to the state General Fund associated with standard conformity would be a reduction of $369.88 million in FY 2026, $144.57 million in FY 2027 and $154.28 million in FY 2028. S.B. 1638 includes provisions beyond standard conformity and the fiscal impact is unknown at this time.
Provisions
Conformity
1. Updates the statutory definition of Internal Revenue Code to include all provisions in effect as of January 1, 2026, with the specific adoption of all retroactive effective dates, excluding any changes to the U.S. IRC enacted after January 1, 2026.
Individual Income Tax Subtractions
2. Establishes the following individual income tax subtractions to the extent not already excluded from Arizona gross income under the U.S. IRC:
a) the amount of qualified tips received during the taxable year that is deducted under the federal income tax deduction for qualified tips;
b) the amount of qualified overtime compensation received during the taxable year that is deducted under the federal income tax deduction for qualified overtime compensation;
c) the amount of qualified passenger vehicle loan interest that is deducted under the federal income tax deduction for qualified passenger vehicle loan interest; and
d) the amount deducted for a qualified senior, who turns 65 years old during the taxable year, under the federal income tax deduction for seniors.
Individual Income Tax Deductions
3. Replaces the Arizona-specific standard deduction by coupling with the federal standard deduction, including the annual inflation adjustment, for the taxpayer's filing status in effect on January 1, 2026.
4. Allows, for taxable years beginning January 1, 2026, a taxpayer that takes the standard deduction to increase the deduction by an amount equal to the total amount of the taxpayer's charitable contributions, rather than up to 25 percent of qualifying contributions, and caps the contributions at:
a) $1,000 for a single person or married person filing separately; and
b) $2,000 for a married couple filing jointly.
Miscellaneous
5. Clarifies the income included in the income tax subtraction for foreign dividends
6. Makes technical and conforming changes.
7. Becomes effective on the general effective date, retroactive to January 1, 2025.
Amendments Adopted by Committee
1. Clarifies the income included in the income tax subtraction for foreign dividends
2. Makes technical changes.
Governor's Veto Message
The Governor indicates in her veto message that her position on tax conformity remains clear and that anything more than what was introduced by the Governor in EO 2015-15 should be negotiated through the budget process.
House Action Senate Action
WM 2/4/26 DPA 5-4-0-0 FIN 2/5/26 DPA 4-3-0
3rd Read 2/11/26 32-36-2 3rd Read 2/11/26 17-13-0
Vetoed by the Governor 2/12/26
Prepared by Senate Research
February 13, 2026
MG/hk