Why Your Federal Tax Return Is Only Half the Story — And What to Do About It

Friends, let me paint you a picture. It’s early 2026. You just filed a beautiful federal return capturing every OBBBA goody including no tax on tips, no tax on overtime, 100% bonus depreciation, expanded QSBS exclusion, the works. You’re feeling pretty good about yourself. Then your state says: “Yeah… no.”

Welcome to the Great State Tax Conformity Circus of 2026. Benvenuti allo spettacolo!

I’ve been doing this a long time and I have NEVER seen a conformity landscape this chaotic. The One Big Beautiful Bill Act (OBBBA) was the biggest federal tax overhaul since the TCJA, and it dropped on July 4, 2025, like a $1.7 trillion firework. Now 50 states (plus D.C.) are scrambling to figure out how much of it they want to adopt, reject, or pretend doesn’t exist. It’s like watching 50 different Netflix shows simultaneously, each with a different plot, different villains, and no guarantee of a happy ending.

Here’s the deal: your federal return and your state return may look VERY different this year. And if you’re a multi-state business or a high-net-worth individual with interests across state lines? Hold on for the ride.

How State Conformity Actually Works (The Background)

Before we dive into the chaos, let’s make sure we’re all speaking the same language. Most states don’t write their own tax code from scratch. That would be insane (although some days it feels like they do). Instead, they piggyback on the federal Internal Revenue Code (IRC) as a starting point for calculating state taxable income. It’s a form of “delegating up,” which saves states enormous legislative and administrative resources.

But, and this is a BIG but, no state adopts the federal code exactly as written . Every state makes adjustments: adding things back, subtracting things out, or flat-out ignoring provisions they don’t like. Think of it as ordering off the federal menu but substituting sides and sending back the dessert.

The Three Flavors of Conformity

States generally fall into one of three buckets:

1. Rolling Conformity. These states automatically adopt federal tax changes as they happen. When the OBBBA was signed on July 4, 2025, these states essentially adopted it the same day. Examples include Colorado, Connecticut, Illinois, Massachusetts, New Jersey, and New York. Sounds simple, right? Not so fast! Many of these states immediately started decoupling from specific provisions they didn’t want. Think of it as saying “I do” at the altar and then immediately filing for an annulment on certain wedding vows.
2. Static (Fixed-Date) Conformity. These states conform to the IRC as of a specific date and must pass new legislation to update that date. If their conformity date is before July 4, 2025, the OBBBA doesn’t apply until they act. Examples include California (conforming to IRC as of January 1, 2015, yes, 2015! ), Georgia (January 1, 2025), North Carolina (January 1, 2023), and Texas (January 1, 2007). These states have to affirmatively vote to let the OBBBA in the door.
3. Selective/Partial Conformity, These states cherry-pick which federal provisions to follow and which to ignore. California and Washington, D.C. are notable examples. It’s the tax code equivalent of a buffet. Take what you like, leave what you don’t.

Important nuances within rolling conformity states: Maryland’s statute automatically blocks any IRC change that impacts state revenue by more than $5 million. It requires express legislative adoption. Virginia similarly freezes conformity if the revenue impact exceeds $15.9 million, and Virginia has explicitly paused conformity through January 1, 2027. So even “rolling” doesn’t always mean “automatic.”

The Current State of Play: It’s a Beautiful Mess

Here’s where it gets really interesting and by interesting, I mean potentially expensive and definitely confusing. Let me walk through the key OBBBA provisions and how states are responding.

Bonus Depreciation (Section 168(k)) — The Usual Suspect

The OBBBA permanently restored 100% bonus depreciation for qualifying property placed in service on or after January 19, 2025. At the federal level, this is HUGE. But at the state level? A majority of states historically decouple from bonus depreciation . They don’t like the front-loaded revenue hit, so they require slower depreciation schedules instead.

States that have explicitly decoupled from OBBBA bonus depreciation include Illinois (late 2025 legislation), Delaware, Pennsylvania, Michigan, and the District of Columbia. Oregon’s Senate is preparing legislation to decouple as well. States that have historically followed bonus depreciation are generally maintaining that position.

Bottom line: Do NOT assume your state allows 100% bonus depreciation just because the feds do.

Qualified Production Property (Section 168(n)) — The New Wild Card

This is a brand-new IRC section created by the OBBBA allowing 100% depreciation for nonresidential real property used in qualified production activities. Here’s the twist: because it’s new , no state had previously decoupled from it. Many rolling conformity states may have inadvertently adopted it by default,

Grant Thornton has flagged that states like Illinois and New York, which decoupled from Section 168(k), may find themselves accidentally conforming to Section 168(n) because their decoupling statutes were written specifically for 168(k), not all of Section 168. Expect legislative scrambles to close this gap. Pennsylvania has already explicitly decoupled. Maryland’s governor has proposed decoupling as well.

This is one to watch VERY closely , especially for manufacturers and production companies making significant capital investments.

No Tax on Tips & No Tax on Overtime — The Political Hot Potatoes

These were the headline-grabbing provisions of the OBBBA, and states are split right down the middle:

State Response

Examples

Notes

Conforming (Yes)

Iowa, Montana, North Dakota, Oregon (rolling); Arizona, North Carolina (legislative action)

Revenue impact manageable or politically popular

Decoupled (No)

New York, California, Illinois, Massachusetts, Connecticut, Hawaii, D.C., Colorado (overtime only)

Revenue losses too large ($1B+ for NY, $3.2B for CA)

Wait-and-See

Georgia, Maryland, South Carolina, Indiana, Wisconsin

Addressing in 2026 legislative sessions

Not Applicable

New Jersey (not based on federal AGI for gross income tax)

State has independent tax structure

New York will require taxpayers to add back any federal tip or overtime deduction on their state return using new codes on Form IT-225. D.C. has fully decoupled from both. Colorado took a clever hybrid approach: they decoupled from the overtime deduction but allowed the tip deduction, targeting relief to lower-wage workers while protecting the budget.

Indiana’s Senate recently passed a bill that would temporarily couple to the tips and overtime exemption for 2026, at a cost of $250 million in state revenue. Michigan’s governor has proposed eliminating state tax on tips and overtime through 2028. Wisconsin is considering opting in to a state-level tip deduction.

R&D Expensing (Section 174A) — The Headache Factory

The OBBBA reinstated full expensing for domestic R&D expenditures, but created a new Section 174A for 2025 and beyond while leaving old Section 174 in the code for prior years. This creates a compliance nightmare because different states are pegged to different versions:

• Rolling states (Illinois, New York) generally adopted new Section 174A
• Static states (Florida, North Carolina) still follow the 2022-2024 version requiring capitalization and amortization
• California conforms to pre-TCJA Section 174 (full expensing was already allowed!)
• Pennsylvania, Rhode Island, Delaware have explicitly decoupled from the new treatment

The retroactive R&D expensing for 2022-2024 may trigger state amended returns in conforming states, with varying deadlines (30, 60, or 90 days after the federal amended return). Partnerships and S-corps face additional layers of complexity.

QSBS (Section 1202) — Not All States Play Ball

The expanded QSBS exclusion ($15M limit, $75M asset threshold, shorter holding periods) is incredibly powerful at the federal level. But friends, some states don’t offer QSB gain exclusions at all . Oregon’s Senate is actively preparing legislation to decouple from the expanded QSBS exclusion. D.C. has fully decoupled, calling it “a clear giveaway to multimillionaire and billionaire venture capitalists”. Massachusetts is also eyeing decoupling.

If you’re planning an exit strategy around QSBS stacking, you must factor in state-level treatment or you could be in for a very rude surprise.

Section 199A (QBI Deduction) — Permanent But Not Universal

The QBI deduction is now permanent at the federal level, but as CohnReznick notes, many rolling, static, and partial conformity states do not conform to Section 199A provisions . States that start their calculations from federal taxable income (which is after QBI) will effectively follow it, but states that use their own calculation methods or start from AGI won’t necessarily honor this deduction.

The Timing: When Will We Know What Each State Is Doing?

Here’s the frustrating reality: we won’t have complete clarity for months. The 2026 state legislative sessions are the critical window. Here’s the general timeline:

• States that acted in late 2025 (before the current filing season): California, Colorado, Delaware, D.C., Illinois, Michigan, Pennsylvania, Rhode Island, Vermont, Virginia — these states have largely established their initial conformity positions.
• States acting NOW (January-March 2026) : Arizona, Idaho, Indiana, Maine, Maryland, Massachusetts, New York, Oregon, and others are actively debating conformity bills during current legislative sessions. Arizona’s governor vetoed a full-conformity budget bill, and the state’s current tax forms don’t even match the tax system. Filers may need to amend.
• States that won’t act until later in 2026 : Many states have sessions running through spring or summer. Georgia, South Carolina, Wisconsin, and others are still in “wait-and-see” mode.
• States that won’t act until 2027 : Montana has no regular session in even-numbered years. Virginia has explicitly frozen conformity until January 1, 2027.
• States with ongoing uncertainty : Arkansas’s session doesn’t start until April. Several states may revisit initial positions as revenue data comes in.

The National Conference of State Legislatures has noted the “wide variation in state approaches,” producing “a patchwork of conformity outcomes nationwide”. The Tax Foundation, COST, and individual state Departments of Revenue are all publishing maps and trackers. Bookmark them and check them regularly.

The Revenue Crunch Driving Decisions

Let’s be honest about why states are decoupling: money. The OBBBA’s tax cuts are projected to cost states hundreds of millions or even billions in lost revenue if they fully conform.

• Idaho estimates at least $284 million in annual revenue loss from full conformity, potentially $435+ million if they also conform to bonus depreciation.
• Massachusetts projects a $460 million revenue hit from OBBBA conformity, with an additional $660 million if business provisions are fully adopted over five years.
• Delaware decoupled from corporate provisions to save an estimated $328 million through 2028.
• South Carolina estimates a $500 million revenue reduction in the coming fiscal year.
• Oregon is addressing a projected $650 million budget gap partly driven by conformity.
• Pennsylvania saved over $1 billion annually by decoupling from major corporate provisions.

Many of these states are simultaneously dealing with federal funding cuts (Medicaid, SNAP, disaster relief) and economic pressure from tariff uncertainty. The fiscal math is forcing hard choices.

Pass-Through Entity Tax (PTET) — Still Alive and Kicking

One critical piece of good news: the OBBBA preserved the pass-through entity tax (PTET) regimes that have been the workaround to the SALT deduction cap. The original House bill proposed restrictions on PTET, but the final law made no changes, and IRS Notice 2020-75 remains fully in effect.

With the SALT cap raised to $40,000 but still capped (and phasing out above $500,000 MAGI), PTETs remain attractive for many business owners. However, watch these sunset dates:

• Illinois : PTET expires for tax years ending after January 1, 2026
• Virginia : PTET expires for tax years ending after January 1, 2027
• California : Extended through 2030
• Colorado & Massachusetts : In place as long as the federal SALT cap exists

Action Items: How to Navigate the Uncertainty

Alright, enough doom and gloom. Let’s talk about what you actually do about all this. Here’s the practical playbook:

1. Map Your State Exposure TODAY

If you or your business operates in multiple states (or if your clients do), create a matrix of every state where you file and its conformity status for each key provision : bonus depreciation, QPP, R&D, tips/overtime, QSBS, QBI, interest limitations. Don’t assume uniform treatment. It doesn’t exist.

1. Model Best/Worst/Likely Scenarios

Model three scenarios for each material state — full conformity, full decoupling, and the most likely outcome based on current legislative signals. This isn’t academic. It affects your estimated tax payments, extension payments, and cash flow projections RIGHT NOW.

1. Don’t Wait to File Federal but Be Cautious on State

File your federal return and capture every OBBBA benefit. For state returns in uncertain states, consider filing extensions. Many states allow extensions that give you until October 2026, which should provide time for legislative clarity. But be careful! Estimated payment obligations typically aren’t extended , so you may need to pay based on your best reasonable estimate.

1. Watch for Add-Back Requirements

In decoupled states, you’ll need to add back federal deductions on your state return. New York is adding specific codes for tips and overtime add-backs. Other states will have their own mechanisms. Make sure your tax software is updated and your preparer knows the state-specific adjustments.

1. Plan R&D Amended Returns Carefully

If Section 174A retroactive expensing benefits you for 2022-2024, know that conforming states may require state amended returns within tight windows after you file your federal amended return. Map out the state deadlines BEFORE you amend your federal return.

1. Revisit Your PTET Elections

With the SALT cap now at $40,000 and PTET still available, run the numbers for 2025 and 2026. In states where PTET is expiring (Illinois, Virginia), take action before the window closes. In states where it continues, make sure you’re making timely elections and required payments. California’s new penalty for missing the June 15 payment (12.5% credit reduction) is a perfect example of why precision matters.

1. Factor State Treatment Into Exit Planning

If you’re planning a business sale and banking on QSBS, Opportunity Zone, or Section 1231 benefits, verify that your state honors those provisions. A $15 million federal QSBS exclusion means nothing if your state taxes the full gain at 10%+. This is especially critical for multi-state transactions where the gain may be apportioned across several jurisdictions with different conformity positions.

1. Stay Connected to Legislative Calendars

This is not a “set it and forget it” year. Subscribe to your state’s Department of Revenue updates, follow ITEP’s State Tax Watch tracker, check the NCSL’s conformity tracking page, and review the COST state conformity maps. Better yet, let us do the monitoring for you.

The Bottom Line

The OBBBA was a historic piece of federal tax legislation. But as the great Tip O’Neill said, “All politics is local” and all taxation is, too. The federal return is only one piece of the puzzle. Your state return is where the real complexity lives this year, and the landscape is shifting in real time as 50 legislatures grapple with how much of the federal tax cuts they can or want to absorb.

The shortage of qualified strategic tax planners who understand both the federal opportunities and the state implications has never been more apparent. This isn’t compliance work, this is strategy. This is where we live.

If you’re staring at your multi-state situation wondering whether Arizona will ever get its tax forms right, whether Oregon will decouple from QSBS, or whether Virginia will finally update its conformity date, you’re not alone. Reach out to us at [email protected] and let’s build your roadmap through this conformity maze together. Because navigating 50 states without a guide? That’s not tax planning, that’s tax gambling.