You bought $120,000 of equipment this year, expensed every dollar of it on your federal return, and assumed Arizona would follow along. It won't. Arizona's new conformity law adopts most of last year's federal tax overhaul — then quietly forces you to add the entire bonus depreciation deduction back to your Arizona income. If you don't plan for that second set of books, the surprise arrives as an underpayment notice, not a refund.
That disconnect is exactly what House Bill 4168 sorted out this summer. After months of vetoes and budget standoffs, Governor Katie Hobbs signed the bill on June 13, 2026, dragging Arizona's tax code into alignment with the federal One Big Beautiful Bill Act. For small business owners, the law is mostly good news with one expensive exception. Here's what changed, what didn't, and what to do about it before year-end.
What HB 4168 Actually Did
Arizona is a fixed-date conformity state, which means its tax code doesn't automatically track federal changes. Instead, the legislature periodically updates the date as of which Arizona adopts the Internal Revenue Code. Before this bill, Arizona conformed to the Code as it existed on January 1, 2025 — so the entire One Big Beautiful Bill Act, enacted July 4, 2025, simply didn't exist for Arizona tax purposes.
HB 4168 moves that conformity date to January 1, 2026, and adopts retroactive effective dates for provisions that took effect during 2025. In plain terms: Arizona now follows the federal overhaul unless the bill specifically says otherwise.
That "unless" is doing a lot of work. The practical effect is that every OBBBA provision has to be evaluated one by one for Arizona purposes. Most flow through. A handful — including the biggest equipment write-off in the bill — do not.
The Good News: What Arizona Now Follows
For tax years beginning after December 31, 2024, Arizona effectively conforms to several business-friendly OBBBA changes:
Immediate R&D expensing is back
Under new Section 174A, domestic research and experimental expenditures are immediately deductible again, ending the painful five-year amortization regime that forced software shops and product companies to capitalize costs they paid in cash. Arizona conforms to this treatment. If your business builds software, prototypes products, or runs a lab, your Arizona return gets the same immediate deduction as your federal one.
The business interest limit loosened
OBBBA restored the depreciation, amortization, and depletion addback when computing adjusted taxable income under Section 163(j), which raises the ceiling on deductible business interest. Arizona follows. Leveraged businesses — contractors financing fleets, restaurant groups carrying build-out debt — can deduct more interest on both returns.
Section 179 limits nearly doubled
The maximum Section 179 expense amount jumps to $2.5 million, with the phaseout threshold rising to $4 million (indexed for inflation after 2025), for property placed in service in tax years beginning after 2025 begins. Arizona conforms here too. For most small equipment purchases, this is the workhorse deduction — and unlike bonus depreciation, it survives the trip across the Arizona state line intact.
Tips, overtime, and car-loan relief flow through
OBBBA's temporary federal deductions for qualified tips and overtime compensation come with dollar limits, income phaseouts, and eligibility conditions. Arizona adds subtraction modifications for these amounts for 2025 and later years, to the extent they aren't already excluded. Tipped and hourly-heavy employers — restaurants, salons, shops paying overtime — should confirm the subtractions appear on their Arizona returns rather than assuming the software handled it.
The Catch: Bonus Depreciation Still Doesn't Count
Here is the exception that will cost unprepared owners real money.
Arizona has never conformed to federal bonus depreciation under Section 168(k), and HB 4168 keeps it that way. Every dollar of 100% bonus depreciation you claim on your federal return must be added back to your Arizona gross income. You then recover the cost on your Arizona return through slower regular depreciation over the asset's life.
OBBBA also created a brand-new 100% write-off — the special depreciation allowance for qualified production property under Section 168(n). This one covers newly constructed manufacturing, processing, and refining facilities: construction beginning after mid-January 2025 and before 2029, placed in service before 2031, and you can elect to expense the whole building in year one. Arizona explicitly decouples from this too, requiring an addback for tax years beginning on or after January 1, 2026.
What the addback looks like in practice
Say your Phoenix LLC places $120,000 of seven-year equipment in service in 2026 and claims 100% federal bonus depreciation. Federally, the full $120,000 comes off this year's income. For Arizona, you add the $120,000 back and instead deduct roughly $17,000 of first-year regular depreciation. At Arizona's 2.5% flat individual rate, that's about $2,500 of Arizona tax you still owe on income the federal return says you never earned.
The deduction isn't lost — Arizona lets you subtract the recalculated state depreciation each year until the asset is fully recovered. But the timing difference means you need two depreciation schedules: one federal, one Arizona. Tax software tracks this if you set it up; a spreadsheet you update once at filing time usually doesn't.
Section 179 is the Arizona-friendly workaround
Because Arizona conforms to the expanded Section 179 limits, expensing equipment under Section 179 instead of bonus depreciation gives you the same first-year federal deduction with no Arizona addback. For purchases under the $2.5 million cap — which covers nearly every small business — Section 179 is now strictly better than bonus depreciation for Arizona owners. The catch: Section 179 is limited to taxable income from the active business and can't create a loss, while bonus depreciation can. Model both before you elect.
The SALT Twist for 2026
One more decoupling to know about. For 2025, Arizona generally follows the federal cap on state and local tax itemized deductions. But for tax years beginning on or after January 1, 2026, Arizona caps the SALT deduction at a flat $10,000 regardless of what the higher federal OBBBA cap allows.
If you itemize and your property taxes plus state income tax exceed $10,000, your Arizona deduction will be smaller than your federal one starting with the 2026 return. Pass-through owners already using Arizona's entity-level tax election as a SALT-cap workaround should revisit the math with their CPA, since the state and federal caps now move independently.
What This Means for Your Books
Conformity bills read like abstract legislation, but this one creates concrete bookkeeping chores. Put these on your year-end list:
Keep federal and Arizona depreciation schedules separate. The bonus depreciation addback only works if you can produce the Arizona-basis number years later when assets are sold or fully depreciated. Record each asset's federal method and Arizona method side by side at purchase time, not at filing time.
Revisit estimated payments. If your safe-harbor estimates assumed Arizona would mirror your federal bonus deduction, you're underpaying the state. Arizona's rate is only 2.5%, so the dollar gap is modest — but penalties and interest still apply.
Check whether 2025 needs amending. Because HB 4168 adopts retroactive effective dates for 2025-effective OBBBA provisions, some 2025 Arizona returns filed before June may have missed conforming deductions like immediate R&D expensing or the higher Section 179 limits. If you filed early, ask your preparer whether an amended return pays.
Track tips and overtime subtractions explicitly. The new Arizona subtractions for qualified tips and overtime only help if the amounts are identified and claimed. Make sure payroll reports break out qualifying tips and overtime pay so the numbers flow to the return.
Document Section 179 elections deliberately. With Section 179 now the superior choice for most Arizona purchases, the election deserves a conscious decision each year — including the taxable-income limitation analysis — rather than a default software setting.
Common Mistakes to Avoid
Assuming federal software handles Arizona automatically. Most packages support the Arizona depreciation adjustments, but the addback often requires the state module to know bonus depreciation was claimed. Review the Arizona adjustments schedule before signing — a missing addback is an underpayment waiting to be noticed.
Forgetting the new 168(n) addback. Qualified production property is new to everyone, including some preparers. If your business is building or buying into a manufacturing facility that qualifies for the federal 100% allowance, confirm the Arizona addback is on the 2026 return. The statute specifically requires it.
Ignoring the SALT cap split. Bunching property tax payments or timing state estimates for federal benefit can backfire on the Arizona side once the caps diverge in 2026. Run both calculations before accelerating payments.
Treating conformity as permanent. Arizona's conformity date is already frozen again at January 1, 2026. Any federal change enacted after that date doesn't apply until the next conformity bill — which, given this year's veto drama, may not arrive on schedule. Build your multi-year plans on Arizona law as written, not federal law as hoped.
Keep Your Arizona and Federal Books Aligned
Arizona's conformity update is a net win — R&D expensing, bigger Section 179 limits, and looser interest caps all flow through — but the bonus depreciation decoupling means your federal and state numbers now tell two different stories about the same equipment. Tracking both stories accurately is exactly what clean, deliberate bookkeeping is for.
Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data — no black boxes, no vendor lock-in. Get started for free and see why developers and finance professionals are switching to plain-text accounting.
