State Conformity Planning Considerations Following Passage of the OBBBA

The passage of the One Big Beautiful Bill Act (OBBBA) introduced significant federal tax changes, and the ripple effects on state income taxes will be significant. Whether a taxpayer operates in one state or all 50, how and when each state conforms to the Internal Revenue Code (IRC) will directly affect state corporate income tax liabilities.

States have their own method of conforming to the IRC, making it challenging for companies operating in multiple states to keep up. States with rolling conformity automatically incorporate federal changes, so they must specifically decouple from any federal provisions, including those in the OBBBA. States with fixed-date conformity will have to update their conformity dates or rules to implement any OBBBA changes, and they are even more likely to make state-specific deviations as part of the process. Finally, some states use selective conformity, which involves picking and choosing which federal provisions to adopt.

Some key OBBBA provisions states are likely to respond to include:

• Section 163(j): Many states will be motivated to decouple from the OBBBA provision restoring the more favorable calculation of the limitation on the interest deduction under Section 163(j), which could be costly to states. As a result, a taxpayer could have a larger interest deduction for federal tax purposes, but a smaller one in states that decouple from this federal change.
• Section 174 expensing: The restoration of expensing of domestic research costs would harmonize the federal and state treatment for the few states that have already decoupled from the pre-OBBBA rules requiring five-year capitalization. States that follow the capitalization rules might need to consider whether to revert to expensing and whether they will incorporate the federal transition rules for accelerating unused deductions. Some states might continue to decouple from the more favorable federal expensing provisions or from the federal transition rules, creating a disconnect between federal and state treatment.
• Bonus depreciation: Many states already decouple from bonus depreciation for revenue reasons and will be unaffected by the restoration of the 100% rate under Section 168(k). All states will have to decide whether to conform to the new expensing provision for building property used in specified production activities because this provision was created under new Section 168(n) and not incorporated as part of the current bonus depreciation rules under Section 168(k).
• Base erosion and anti-abuse tax: The BEAT rate will increase from 10% to 10.5%, but taxpayers retain planning options such as interest capitalization and the election to waive deductions under Treas. Reg. §1.59A-3(c)(6). On its face, BEAT should not apply to the computation of state corporate income tax because it is a federal alternative tax computation. Even though BEAT is an alternative federal tax computation, if a corporate taxpayer elects to forgo expenses deducted against its federal taxable income, any state that conforms to the OBBBA likely will conform to the elections and force the taxpayer to also reduce its expenses for state income tax purposes. Companies should consider the state income tax implications of elections that affect their federal taxable income as a result of these ancillary state income tax effects.
• Section 250 deduction: The calculation of foreign-derived intangible income (now foreign-derived deduction-eligible income or FDDEI) and global intangible low-taxed income (now net controlled foreign corporation tested income or NCTI) has been changed, as have the deduction amounts for those items under Section 250. States will need to consider whether to conform or decouple from those federal changes.  
  
  

Because several OBBBA provisions took effect January 1, 2025, states now face pressure to respond. With many state legislative sessions already adjourned for the year, taxpayers must be prepared for shifting rules if states reconvene their sessions. 

Colorado has already responded to the OBBBA, and California bill S.B. 711, which awaits Gov. Gavin Newsom’s signature, will update California’s IRC conformity date to January 1, 2025, and decouple from numerous IRC provisions. Alabama has issued administrative guidance clarifying how the OBBBA changes to IRC Section 174 apply in the state. More states are expected to follow suit via legislative action or administrative guidance addressing how they will treat the OBBBA changes.