- On July 4th, the President signed H.R. 1, commonly referred to as the One Big Beautiful Bill Act (“OBBBA”) into law, making certain temporary changes implemented under the Tax Cuts and Jobs Act (“TCJA”) permanent, as well as adding a host of new tax provisions.
- Since many states explicitly or implicitly start their calculation of state taxable income with federal taxable income, and also incorporate the Internal Revenue Code of 1986, as amended (the “Code”) into their statutes, it is important to consider the effect that these changes will have on state income taxes.
- Nearly all states have a constitutional mandate to enact a balanced budget. As such, any revenue reductions contained in OBBBA – whether from tax provisions contained in the bill or reductions in federal transfers to states –may create an uncertain fiscal environment for states and could drive state revenue laws changes.
Background
On July 4th, the President signed the OBBBA into law. It extends many of the business and international tax provisions in the TCJA, makes some of the TCJA individual items permanent, and implements some changes to the taxation of tax-exempt organizations. The law also modifies the provisions of the state and local tax deduction for federal income tax purposes. The provisions, and the state and local implications thereof, are discussed below.
Federal Tax Law and The States
Conceptually, federal tax law changes impact the states in two differing ways:
- The starting point for calculating state taxable income in many states is federal taxable income so changes to federal laws that increase or decrease federal taxable income will have a similar effect on state taxable income.
- Those states that conform to the Code typically do so in one of three ways. State conformity may be static – the state statute conforms to the Code as of a fixed date; rolling - it conforms to the Code as it is updated by Congress; or selective – it only conforms to specific provisions of the Code. Regardless of the manner of conformity, states may choose not to adopt specific federal tax changes – this is referred to as decoupling.
Business Provisions
There are three principal extensions of TCJA provisions made permanent by OBBBA, generally effective for tax years 2025 and beyond. These are:
- The interest expense limitation contained in Section 163(j) of the Code will be calculated based upon tax basis earnings before interest, taxes, depreciation, and amortization (“EBITDA”). Under the TCJA, the limitation was calculated based upon tax basis EBITDA through tax year 2021, before changing to be based upon tax basis EBIT thereafter.
- 100 % bonus depreciation under Section 168(k) is now permanent under OBBBA for property acquired after January 19, 2025.
- New Section 174A permanently restores the current deduction for domestic specified research or experimental expenditures in the year incurred. Taxpayers may elect to take a deduction for the unamortized balance of domestic research and experimental expenditures previously capitalized over either a one or two-year period starting with the first tax year beginning after December 31, 2024. Taxpayers who qualify as a small business under a gross receipts test have an additional option - they may file amended tax returns to claim deductions for their previously capitalized research and experimental expenditures in the tax year they were incurred or paid.
Additionally, OBBBA temporarily creates a new deduction under Section 168(n) of the Code. Nonresidential real property meeting certain requirements used in the manufacturing, production, or refining of tangible personal property can qualify for 100% bonus deprecation for the year that the property is placed in service. This provision applies to construction starting after January 19, 2025, and before January 1, 2029, for property placed in service before January 1, 2031.
Several other business provisions of note are contained within OBBBA. The limitation on excess business losses for non-corporate taxpayers is made permanent in the legislation. Additionally, OBBBA creates a floor for corporate charitable contributions of 1% of taxable income for tax years beginning after December 31, 2025. Corporate contributions will not be deductible until they exceed the floor and continue to be subject to a 10% cap, with any contributions exceeding the cap carried forward.
OBBBA also increases the maximum amount that a taxpayer may expense under Section 179 from $1 million to $2.5 million, phasing out when total purchases exceed $4 million, indexed for inflation for tax years after 2025. Finally, the 20% Section 199A qualified business income (“QBI”) deduction becomes permanent under the law.
Forvis Mazars Insight: It is expected that the many of the state and local tax implications of OBBBA, including, but not limited to, the Section 163(j) limitation change, and permanently enacting 100% bonus depreciation should be minimal. States have largely adapted to these provisions and made policy decisions as to whether to decouple from these provisions. Conformity with the provision allowing the deduction (rather than amortization) of domestic research or experimental expenses is more nuanced, and it will be interesting to see how states react to the implicit acceleration of deductions. The same applies to the provisions of new Section 168(n) – states will have to consider the policy and fiscal implications of encouraging manufacturing businesses to locate within their borders against the loss of tax revenue due to the acceleration of deductions attributable to the real property in question.
The State and Local Tax (SALT) Deduction Cap and Pass-Through Entity (PTE) Elections
The state and local tax deduction, subject to a $10,000 cap (for married couples filing jointly) because of TCJA, was the subject of much debate during the legislative process. OBBBA settled upon a temporary increase to the SALT cap to $40,000 for married couples filing jointly in 2025, with a reduction equal to 30% of modified adjusted gross income in excess of $500,000, with a floor deduction of $10,000. These amounts are indexed for inflation by 1% annually until 2029; in 2030, the SALT cap reverts to the $10,000 limit as under TCJA.
In response to the SALT cap, most states (with the implicit blessing of the Internal Revenue Service (“IRS”) under Notice 2020-75) allowed owners of pass-through entities to avoid the implications of the SALT cap by electing to have the tax imposed at the pass-through entity level. Various versions of the legislation as it moved through the process proposed to eliminate this option for many taxpayers and reduce it for others. The OBBBA was silent with respect to PTE elections; it is likely that PTE elections will continue to be viable absent a subsequent change.
Forvis Mazars Insight: Several states that enacted PTE elections did so with expiration dates. It will be important for those states to update their laws to allow these elections to continue – California just extended their soon to expire PTE election to tax years beginning before January 1, 2031. A handful of states never allowed PTE elections – it will be interesting to see whether OBBBA provides them with the impetus to do so. Finally, the entire PTE election scheme is dependent on Notice 2020-75 – if the IRS revokes this guidance, PTE elections would no longer be viable.
International Tax Provisions
At a high level, OBBBA retains the foreign derived intangible income (“FDII”),(FDII is now referred to as Foreign Derived Deduction Eligible Income, or “FDDEI”) global intangible low-taxed income (“GILTI”), (GILTI is now referred to as Net CFC Tested Income, or “NCTI”) and base erosion and anti-abuse tax (“BEAT”) provisions implemented in TCJA. The legislation contains some rate changes with respect to these types of income and other technical changes as well.
Forvis Mazars Insight: Many states have reacted to these provisions in the Code because of TCJA, but we continue to see states look to these international provisions as potential revenue raisers (see recent changes in both Minnesota and Illinois). As with the other business tax changes previously discussed (i.e., interest expense limitations, bonus depreciation, and research expenses), we would expect any reaction to the changes in OBBBA would be narrowly tailored at most.
Individual Tax Provisions
There are a host of individual tax provisions in OBBBA of note, including, but not limited to:
- The TCJA tax rate reductions are made permanent.
- A permanent increase to the standard deduction.
- A limited, temporary deduction for interest attributable to the purchase of a qualified new vehicle, subject to income limitations.
- A limited, temporary deduction for tips, subject to income limitations.
- A limited, temporary deduction for overtime pay, subject to income limitations; and,
- A limited, temporary personal deduction for senior citizens, subject to income limitations, designed to reduce the tax impact of social security income.
Forvis Mazars Insight: Some states have already proposed or enacted some of these provisions, notably with respect to limiting tax on tips. States will likely address these changes legislatively to the extent that they do not align with state revenue needs or policy goals.
How Forvis Mazars Can Help
Forvis Mazars will continue to monitor state legislative reactions to OBBBA and stay abreast of the state income tax implications of conformity, or lack thereof, at the state level.