How to Make an Arizona PTET Election: Form 120S, the 2.5% Rate, and the 60-Day Opt-Out Notice (2026)

A Tucson design-build contractor files his S-corp return on extension every September. This year his CPA mentions the Arizona PTE election two weeks before the September 15 deadline, and the contractor assumes he can check a box and pay the tax. He can check the box. But he cannot make the election, because he never sent his shareholders the notice Arizona requires 60 days in advance. That gap, not the rate and not the form, is where Arizona's pass-through entity tax trips people up. The contractor is theoretical, but the 60-day trap is real and written into the statute.

What the Arizona PTE election does

Arizona's pass-through entity tax lets an S-corp or partnership pay Arizona income tax at the entity level instead of pushing it onto the owners' personal returns. Because the entity pays and deducts the tax, it reduces federal ordinary income on Form 1120-S or Form 1065 and flows through smaller on the K-1, under IRS Notice 2020-75. That sidesteps the individual state and local tax cap in IRC §164(b)(6). The cap rose to $40,400 for 2026 under the One Big Beautiful Bill Act, with a phasedown that starts at $505,000 modified AGI and pulls high earners back toward the old $10,000 cap. The PTE workaround was untouched, so for owners over the cap or into the phaseout, moving Arizona tax onto the entity return is still the only way to deduct it in full.

The 2.5% rate, and how it is set

The Arizona PTE tax rate is 2.5% for tax years 2025 and 2026. A.R.S. §43-1014 ties the entity rate to the highest individual rate under §43-1011, and Arizona has finished phasing in its flat 2.5% individual income tax, so the entity rate and the individual rate are now the same number. On $400,000 of Arizona-source income, the entity-level tax is $10,000. The tax reaches only the Arizona-source income of the owners who participate, so a partnership with out-of-state partners pays on the Arizona slice of their shares alone.

The deadline is the return due date, not year-end

An S-corp or partnership makes the Arizona PTE election on a timely filed Form 120S or Form 165 for the year, including a valid extension. For a calendar-year entity, that means the election can be made as late as the extended due date, September 15. This is more forgiving than states like Utah, where the election dies on December 31. But the extension only buys time to file the return, not time to start the process, because of the notice requirement. The election is annual and irrevocable once made, so you cannot undo it after the fact if the math turns out worse than you expected.

The 60-day opt-out notice is the real trap

Before it makes the election, the entity must notify every partner or shareholder who is an individual, estate, or trust of its intent to elect, and give each of them at least 60 days to opt out. A partner or shareholder who opts out is left out of the election entirely, and only individuals, estates, and trusts can participate at all. Corporate and partnership owners are never included. So the practical deadline is not the September return date. It is roughly 60 days before that, because you cannot make a valid election until the opt-out window has run. For a single-owner S-corp this is a formality you send to yourself, but for a partnership with several members it is a real project that has to start in the summer, not the week the return is due.

Estimated payments on Form 120/PTE-W

If the electing entity expects an Arizona tax liability of $1,000 or more, it must make quarterly estimated payments on Form 120/PTE-W, due the 15th day of the 4th, 6th, and 9th months of the tax year and the 15th day of the month after the year closes. Skipping them exposes the entity to an underpayment penalty, even though the election itself is not final until the return is filed. This is another way Arizona differs from Utah, which asks for the whole SALT payment at once with no estimates.

The credit is nonrefundable, with a five-year carryforward

On the individual side, each participating owner claims a nonrefundable Credit for Entity-Level Income Tax equal to the Arizona tax the entity paid on their share. For 2025 and later returns, the owner reports the credit on Form 355, which carries to Form 301 and then to Form 140. Unlike Utah's refundable PTET credit, Arizona's credit is nonrefundable, so it can only offset Arizona tax. Any excess carries forward up to five years rather than being paid back in cash. Arizona also requires the owner to add back their share of the PTE tax the entity deducted federally, which keeps the state from granting the deduction twice. The addback raises Arizona taxable income, and the credit offsets the Arizona tax on it, so the two roughly cancel at the state level. The savings live entirely on the federal return.

What the federal benefit looks like

The picture below runs a theoretical Scottsdale S-corp owner, single, with $400,000 of Arizona-source K-1 income and a 35% federal marginal rate. The entity-level tax is $10,000 either way. What changes is where that $10,000 gets deducted. Paid personally, it competes for room under the SALT cap that other state and property taxes may have already filled. Paid by the entity, it comes straight off federal K-1 income with no cap at all.

Is it still worth it after the bigger SALT cap?

For Arizona owners with modified AGI under $505,000 and modest property taxes, the expanded $40,400 cap may already absorb their state tax without the workaround, and the PTE election is close to a wash. For owners above the phaseout, above the cap, or with property tax bills competing for the same $40,400, the election still moves the full 2.5% onto the federal return at value. One honest caveat: the entity deduction also reduces qualified business income, so it trims the 20% deduction under IRC §199A for owners who still qualify for it, and you should net the benefit against that. For most of the Arizona S-corp owners I work with, the answer still favors electing, as long as the notice went out in time. Run your own numbers in the EntityIQ S-Corp tax savings calculator, and if you have income from more than one state, pair this with our broader PTET deduction overview.

This article is educational and is not legal or tax advice. The owner described is theoretical, and the numbers are 2026 figures I have rounded and simplified. Please consult an Arizona CPA or EA before filing the election.