The American Recovery and Reinvestment Act (known as the stimulus package) contains the Making Work Pay income tax credit which is implemented through a reduction in federal withholding.  It provides eligible individuals a refundable tax credit for tax years 2009 and 2010. Taxpayers do not get a separate check mailed to them from the IRS like last year's economic stimulus payment. The credit is the lesser of 6.2% of an individual's earned income or $400 ($800 in the case of a joint return).  The credit is phased out for workers with a modified adjusted gross income above $75,000 ($150,000 in the case of a joint return). The credit is implemented through an automatic reduction in the amount of income tax that is withheld from their paychecks. Employers were required to comply no later than April 1, 2009.

Arizona's state withholding is calculated as a percentage of federal withholding; so, this federal change will result in a reduction in state withholding as well.  The Arizona Department of Revenue is estimating the potential negative impact to the state budget at $73 million in Fiscal Year 2009, and $37 million in Fiscal Year 2010.

Due to the decrease in revenue the state would see if nothing is changed, the Legislature passed SB 1185, which will de-couple the state withholding rates from the federal rates beginning July 1, 2010 and, until the state officially decouples from the federal system, SB 1185 makes incremental changes to state withholding rates to stave off the negative hit to the state general fund.

Employees will see a slight increase in their state withholding on May 1 and will then see a slight decrease on
January 1.