State Tax Considerations With the One Big Beautiful Bill Act (OBBBA)

The One Big Beautiful Bill (OBBBA), signed into law on July 4, includes many federal tax changes for both individuals and businesses. However, many of these provisions may have an impact on the state taxes paid by both as well.

In the coming months, it is expected that states may pass laws or issue guidance that specifically adopt or decouple from some of the provisions in the bill. This makes it important for multistate taxpayers to monitor states’ responses to the bill. In the meantime, here’s our take on what this means at the state and local tax (SALT) level.

Setting the Fiscal State Stage

First, it’s important to discuss the fiscal landscape states might face in the coming years as provisions of the OBBBA are phased in. The bill includes several provisions that phase in changes to Medicare, Medicaid and SNAP, impacting the level of federal funding from these programs provided to the states.

While that portion of the bill may not seem relevant in a discussion of state taxes, these changes could potentially shift additional costs to states. States may now be forced to spend more to fill the gaps resulting from these federal changes. State legislatures most certainly did not account for that new spending in any recent budget discussions. As a result, states might look for ways to limit any taxpayer benefit from the OBBBA.

Internal Revenue Conformity

Many sates rely on the federal tax code to define their own tax rules of taxable income and allowable deductions by conforming to the Internal Revenue Code (IRC). They might follow what’s known as a rolling conformity with the IRC (as opposed to those on a fixed or static conformity to a specific date of the IRC).

As of 2023, 19 states (including the District of Columbia) are on a rolling conformity with the IRC as it pertains to individual taxation. That number increases to 24 states when you look at corporate income tax conformity. These rolling conformity states will have automatically incorporated the provisions of OBBBA.

In recent years states have generally enjoyed a bit of a fiscal surplus, allowing them to reduce income and sales tax rates to attract new businesses and residents. However, this type of activity might be paused until the full scope of OBBBA changes are more clearly known. Faced with the economic uncertainty of additional state costs, states may initiate special legislative sessions to address potential budget shortfalls. These sessions could give the state legislature an opportunity to decouple from provisions in the OBBBA, even in rolling conformity states. Because this might develop over the coming months, multistate taxpayers should stay up to date on the latest law and guidance from states where they live and work.

The following items from the OBBBA are likely to have a state tax impact.

No Tax on Tips and Overtime

The OBBBA provides for a deduction of up to $25,000 a year for qualified tips for tax years 2025-2028. Additionally, taxpayers may deduct up to $12,500 ($25,000 for joint filers) per year of qualified overtime compensation received and reported for tax years 2025-2028. Both deductions phase out for taxpayers with adjusted gross income (AGI) over $150,000 ($300,000 for joint filers).

As stated earlier, adoption of these provisions will depend on the IRC conformity status of the state. Because this provision has the potential to affect a large number of taxpayers, the fiscal impact of conforming to this provision is likely to be greater from this benefit than many of the others.

For example, let’s say 200,000 taxpayers take advantage of this exemption with an average annual tip and/or overtime exemption of $10,000. That’s $2 billion excluded from taxation. At an average 5% tax rate, that equates to a $100 million cash flow reduction to the states. That funding hole may need to be fixed through potential program reductions, higher tax rates or reduced tax exemptions.

However, the exclusion for tips and overtime is politically popular. Rolling conformity states may have difficulty disallowing this provision of the OBBBA in full (not to mention the additional logistical challenges doing so may cause businesses for payroll withholding). Cash-strapped states may instead look to a reduced rate rather than an outright exemption, or a reduction of the AGI limitation. Those states on a fixed IRC conformity might also need to debate whether this provision should be adopted in whole or in part — or face a local voter backlash from earners that are likely to benefit from this provision.

SALT Limitation

The Tax Cuts and Jobs Act of 2017 included a $10,000 limit on the deduction of state and local taxes for individuals. After its passage, many states worked to pass legislation creating pass-through entity tax elections (PTET), which allowed pass-through entities to elect to be taxed at the entity level instead of that tax passing through to the owners, where the limit came into play. These elections were effectively workarounds to the $10,000 federal limit.

The OBBBA raises the deductible SALT expense limit from $10,000 to $40,000 (subject to a phase out at certain higher income levels and set to expire in 2029). It’s doubtful this change will have much impact on state budgets, since many states already disallow a deduction for state income taxes. And any individuals with property taxes greater than $10,000 per couple are likely at a high enough income level to be subject to the phase out. Additionally, since the states spent time over the last eight years developing PTET elections, it’s likely they’ve already accounted for any fiscal impact in developing those elections.

The good news in the OBBBA is that the PTET workarounds remain a viable option for owners of PTEs after much debate over the House’s initial plan to ban such options. With this blessing, it’s possible the last five state holdouts of PTET options (Delaware, Maine, North Dakota, Pennsylvania and Vermont) may move ahead with passing a PTET. States whose PTET elections are set to automatically expire in 2025 (California, Illinois, Utah and Virginia) will need to be extend those provisions or make them permanent for 2026 forward.

Section 179 Expensing

The OBBBA increased the maximum amount a taxpayer may elect to expense under section 179 to $2.5 million. The phase-out threshold, which potentially reduces the maximum deduction, is increased to $4 million.

Of course, a state’s adoption of these new provisions will depend on its conformity status. States have previously limited the impact of 179 expensing by providing a lower overall cap or by decoupling from the provision altogether. Even states that have followed the prior 179 cap increases may find this jump too high, causing them to freeze the allowable amount to the current rate. That would mean MACRS depreciation would apply to the resulting difference between the federal and state amounts, creating a new timing difference taxpayers will need to track.

Bonus Depreciation

The OBBBA reinstates the prior 100% bonus depreciation provisions for qualified property placed in service after Jan, 19, 2025. It also created a new 100% special depreciation allowance for qualified production property.

Because some form of bonus depreciation has been around for many years, we have a solid history to anticipate states’ reactions. Many states have not allowed bonus depreciation in prior years, and some have required that the federal bonus amount be taken over a certain number of years. Based on this history, it is doubtful the states will suddenly conform to this round of additional depreciation.

Other Provisions

The OBBBA also includes potential deductions and exclusions related to research and development costs, interest expense and international income. Each of these provisions will have to be evaluated against the state’s IRC conformity as well as any additional state specific legislation that may have passed impacting the provision. Given the potential fiscal landscape, it’s likely states may seek to limit some of these income exclusions and deductions.

While the OBBBA contained many taxpayer friendly provisions, those benefits might not trickle down in the states where taxpayers file returns. Because of these differences, multistate taxpayers should be aware of their state’s current conformity to the OBBBA.

Since most state legislatures have already adjourned and may not meet prior to the next annual session, it may be unclear how a state will approach conformity to the OBBBA for some time. James Moore’s state and local tax (SALT) team will continue to track the states’ legislative action in the coming months and share updates as they happen.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.