Arizona’s $400M Budget Warning: Fallout from Federal SALT Cap Conformity

Arizona lawmakers are confronting a major budget dilemma following passage of the federal One Big Beautiful Bill. At the heart of the issue: the new $40,000 cap on state and local tax (SALT) deductions—a federal change that could cost Arizona up to $400 million if adopted at the state level.

As states begin to align with the new federal tax code, Arizona now finds itself in the spotlight as a test case for how state conformity can carry significant revenue consequences.

What Happened

According to the Arizona Joint Legislative Budget Committee (JLBC), conforming to the federal SALT deduction cap would reduce state tax revenues by hundreds of millions over the next fiscal year. The forecast comes as the state finalizes its $17.6 billion budget for FY 2026.

Arizona traditionally conforms to most elements of the federal tax code each year to simplify compliance for residents and businesses. But this year’s conformity bill has opened a Pandora’s box of fiscal concerns.

Breakdown: SALT Cap Changes Under the Big Beautiful Bill

Feature	Previous Law	New Law (Federal)	AZ Conformity Impact
SALT Deduction Cap	$10,000 (since TCJA)	$40,000 (starts 2025)	Up to $400M lost in revenue
Applicability	Itemized filers	High-income joint filers	Primarily upper-middle class

While the federal government absorbs the cost of this expanded cap through deficit spending, Arizona—like many states—must maintain a balanced budget. That means every dollar lost in conformity must be offset by cuts, new taxes, or borrowing.

What Lawmakers Are Debating

Arizona legislators are now weighing three possible paths:

1. Full Conformity: Automatically adopt the new $40,000 SALT cap in full, triggering the forecasted shortfall.

2. Partial Conformity: Pick and choose provisions to conform to (e.g., adopt business credits but decouple from SALT cap).

3. No Conformity (Decoupling): Maintain existing state SALT deduction rules independent of the federal changes.

   
   

A partial conformity approach already being considered in other states like New York and Georgia would allow Arizona to preserve revenue while still aligning with favorable provisions, like bonus depreciation or the expanded Child Tax Credit.

Who Is Affected

Group	Impact
High-income households	May lose state deduction benefits if AZ decouples
State budget planners	Must plug a potential $400M shortfall
CPAs and tax advisors	Need to model multiple scenarios during 2025 season
Small business owners	Indirectly impacted via reduced state funding for credits or services

What Tax Professionals Should Watch

Tax advisors in Arizona and across the country should be monitoring the following:

• Final conformity bill language from Arizona’s legislature in late July or August.

• State-specific guidance on how conformity will affect itemized deductions and credits.

• Client exposure modeling, particularly for high-earning households in urban counties with high property or income tax burdens.

  
  

How Bizora AI Can Help

Bizora AI is already integrating state conformity tracking into its compliance engine. With it, tax professionals can:

- Generate SALT deduction simulations for Arizona clients under multiple scenarios

- Monitor conformity legislation in real time across all 50 states

- Draft state-specific planning memos based on updated thresholds and revenue forecasts

As states race to interpret and implement provisions from the One Big Beautiful Bill, tools like Bizora AI ensure your practice stays ahead of the curve.

Final Thoughts

Arizona’s situation highlights a broader trend: federal tax reform often pushes hard decisions onto the states. As conformity debates heat up, tax professionals must stay agile, model quickly, and advise confidently.

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