Federal Tax Changes Have State-Level Consequences

President Donald Trump speaking alongside Georgia Gov. Brian Kemp, Virginia Gov. Glenn Youngkin, Louisiana Gov. Jeff Landry, and South Carolina Gov. Henry McMaster (Photo by Scott Olson/Getty Images)

Getty Images

The experience with the tax bill enacted at the end of President Donald Trump’s first year in office previewed the sort of media coverage that can be expected of the One Big Beautiful Bill Act (OBBBA) following the new tax bill’s enactment. In fact, some members of the press even gloated about the extent to which the American people were misinformed about the Tax Cuts and Jobs Act, particularly when it comes to the share of households who benefitted from the 2017 tax bill. Fortunately for the Trump White House and congressional Republicans who enacted OBBBA without any Democrats voting in favor, dynamics have changed in the more than seven years since the TCJA’s passage.

To start with, U.S. voters are now much more skeptical about what the mainstream media reports than they were seven years ago. In 2017, Gallup found that nearly 45% of Americans trusted the media either a great deal or a fair amount. When Gallup last asked that same question in 2024, only 31% said they had a great deal or a fair amount of trust in the media.

It’s a near certainty that Democratic politicians, progressive pundits, and other OBBBA opponents will attempt to frame the new tax bill as a relief package that only or primarily benefits the rich. Though that claim is just as false with OBBBA now as it was with the TCJA, polling suggests fewer Americans are likely to believe such claims this time around.

Not only are voters more skeptical of media reports and talking points, OBBBA supporters have much more time to counter misinformation than was the case with the TCJA. President Trump signed the TCJA into law in December of 2017. Instead of having less than a year to counter misportrayals of the new tax law, as was the case with the TCJA, congressional Republicans and the White House have nearly a year and a half of runway in their efforts to defend OBBBA.

It’s still early days, but among the most frequent errors of omission about OBBBA since the bill’s July 4 enactment is the failure to even mention that not only did OBBBA restore full year one deductibility for business capital expenditures, it also reinstated full expensing of research and development costs. What’s more, OBBBA made this restoration 100% bonus depreciation permanent.

Any media report or analysis that ignores the changes that OBBBA made to business expensing is neglecting a major component of the tax bill. In fact, as the following chart from the non-partisan Tax Foundation illustrates, the enactment of permanent full business expensing is perhaps the most pro-growth aspect of OBBBA.

One factor that will serve as a recurring reminder about OBBBA’s restoration of full business expensing, along with the economic benefits that stem from its permanence, is the fact that state lawmakers in many parts of the country will be looking to pass legislation in the coming year to provide full expensing at the state-level through conformity with the applicable sections of the federal code that were updated by OBBBA.

In a new report released on July 31, Jared Walczak, Tax Foundation’s vice president of state projects, wrote that the expensing provisions in OBBBA “affect most states and possess a compelling economic justification.” He went on to add that regardless of how state lawmakers decide to conform to other aspects of OBBBA, “they should conform to these pro-growth provisions, which represent a marked improvement in the corporate tax code.”

Extending Full Business Expensing To The States Through Conformity

Eighteen states have what’s known as “rolling conformity,” for their personal income tax, which means that changes to the federal income tax code take effect automatically. When it comes to the OBBBA provision reinstating full year one deductibility for capital expenditures, 14 states have rolling conformity with that section of the federal income tax code (Section 168k), meaning they now automatically offer state-level full business expensing thanks to OBBBA’s enactment. In three states — Oklahoma, Mississippi, and Louisiana — lawmakers had already taken action to offer state-level full expensing no matter what happens with the federal code. In the remaining 33 states, lawmakers will need to pass new legislation in order to provide full business expensing at the state level.

For R&D costs that are now fully deductible at the federal level, 23 states now provide that at the state-level thanks to rolling conformity with Section 174 of the Internal Revenue Code. Ten other states were already providing full state-level R&D expensing regardless of what the federal code does and will continue doing so. In the remaining 17 states, lawmakers will need to take action if they wish to provide state-level R&D expensing through conformity.

“The § 168(k) change is slated to impact 17 states,” Walczak noted in his new report. “The higher § 179 cap is ultimately in line to flow through to 38. And the restoration of § 174 expensing and the creation of a new § 168(n) cost recovery provision will ultimately show up in virtually all states’ tax codes.”

New Tip And Overtime Income Exemptions

For a taxpayer whose job “traditionally and customarily received tips on or before December 31, 2024,” the first $25,000 in tip income is now exempt from federal income tax under OBBBA, as is the first $25,000 in overtime pay. This deduction is available to itemizers, as well as non-itemizers who take the standard deduction. “Only states that begin their income tax calculations with federal taxable income rather than adjusted gross income—Colorado, North Dakota, Oregon, and (subject to a conformity date update) South Carolina—would incorporate this exemption automatically,” the Tax Foundation points out.

While we can expect legislators in some states to adopt the new deduction for tips or overtime pay at the state-level, lawmakers in Colorado have already taken action to claw back some of the tax relief provided by this new federal tax break by preemptively decoupling from OBBBA’s new exemption for overtime pay.

A petition drive is underway to put a measure on the 2026 ballot that would give Colorado voters the chance to undo the tax hike on overtime pay. The same group running that ballot initiative petition drive, Advance Colorado, also filed a lawsuit in July seeking to strike down the state tax hike on overtime pay. The plaintiffs argue that it was enacted in violation of Colorado’s Taxpayer’s Bill of Rights, a constitutional amendment approved by voters in 1992 that subjects all state tax hikes to voter approval. Some are now concerned that Colorado legislators will use an upcoming special session to speed up implementation of the state tax hike on overtime pay and to also decouple from OBBBA’s new exemption for tip income.

“It remains to be seen whether lawmakers in other states will follow Colorado’s lead,” this author noted in a recent column in the Denver Post. “Even if Illinois, New York, Oregon, and other blue states follow suit, however, there is a good chance Colorado voters will end up undoing the state tax hike that served as a model for such proposals.”

GILTI Changes Prompt Need For State-level Decoupling

Among the changes included in OBBBA that will have some of the most consequential conformity implications for state lawmakers to grapple with in the coming year is the bill’s retooling of the tax on global intangible low-taxed income (GILTI). GILTI is no more, as OBBBA changed the name to “net CFC-tested income” (NCTI) and added new rules.

While the result of this change at the federal level is a tax cut, at the state level it could lead to higher tax burden and double taxation. The Tax Foundation’s Jared Walczak explains why governors and lawmakers in many states will seek to decouple from this change to federal tax law.

“Whereas the conversion of the global intangible low-taxed income (GILTI) regime to the new net CFC-tested income (NCTI) regime contains both revenue raisers and tax savings that represent a net tax cut at the federal level, these provisions are haphazardly incorporated into the tax codes of states that have heretofore included GILTI,” writes Walczak. “The result is not just an increase in state tax liability, but an inversion of the intent of the federal reforms. The changes to the federal base have their own pitfalls and shortcomings, but they are still largely designed to align with GILTI’s purpose—a guardrail against profit shifting to low-tax countries after the US moved to a largely territorial tax system—while, perversely, states would increasingly do the opposite, increasing taxes on multinational businesses when they owe more tax abroad.”

QSBS boost from $10 to $15M

There are other tax changes in OBBBA that will have conformity implications for state lawmakers, such as the increase in capital gains tax exemption for Qualified Small Business Stock (QSBS). OBBBA raises that exemption limit from $10 million to $15 million. Whether states with an income tax will also adopt this change depends on conformity.

“Not all states follow federal QSBS rule,” Mitchell Baldridge posted to X on July 12, adding that “Some states may update their law to match – worth monitoring.” In that post, Baldridge echoed Tax Foundation’s Walczak in stressing that “conformity matters.”

In a 2024 report looking into the reasons why states do and do not conform to various sections of the federal code, researchers at the Tax Policy Center noted that the 41 states with an income tax “often ‘conform’ with federal tax rules and definitions, including the definition of income, to simplify filing and enforcement for taxpayers and tax administrators.” In a 2018 report looking at how states were conforming to the federal code following enactment of the TCJA, Walczak explained that while some states “adopt large swaths of the federal tax code by reference; others use it as a starting point, then tinker endlessly; and still others incorporate federal provisions and definitions more sparingly.”

Enactment of OBBBA is only part of the battle for its supporters. They must now convince voters that it is beneficial on net, rebutting misinformation about the bill in the process. Governors and state lawmakers, meanwhile, must decide how they want their state tax code to interact with a new federal code. OBBBA is now law of the land, but the debate over what it does, who benefits from it, and how states should respond has only begun.