Gauging the impact: How states assess federal tax changes

Major federal tax legislation, like the One Big Beautiful Bill Act (OBBBA), can send shockwaves through state tax systems. Specifically, OBBBA’s “No Tax on Tips” and “No Tax on Overtime” provisions promise relief for workers, but they also threaten to shrink state tax bases and erode revenues.

For tax professionals, understanding how states analyze and respond to these changes is essential for advising clients and anticipating legislative developments.

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How states assess federal tax changes

OBBBA allows workers to deduct up to $25,000 in tips and $12,500 in overtime premium pay annually (double for joint filers) from federal taxable income between 2025 and 2028. These deductions are above-the-line and don’t affect payroll taxes like FICA.

When you’re working with clients, it’s essential to understand your state’s conformity approach, which generally falls into one of four conformity models:

• • Rolling conformity: States like Iowa automatically follow current federal law, so OBBBA’s deductions immediately reduce state taxable income unless the state acts to decouple.
  • Static (fixed-date) conformity: States such as Georgia peg their tax code to the Internal Revenue Code as of a specific date. OBBBA’s changes do not apply unless the legislature updates the conformity date.
  • Selective conformity: States like Massachusetts pick and choose which federal provisions to adopt.
  • Non-conformity: States with no income tax (e.g., Texas, Florida) or independent systems (e.g., Pennsylvania) are unaffected.

The conformity approach determines whether federal changes flow through to the state tax base automatically or require legislative action.

Projecting the fiscal impact: What the numbers tell us

Once you understand your state’s conformity model, the next step is calculating the financial impact—something your clients will definitely ask about.

The Tax Foundation estimated that if every state adopted these deductions, the overtime exemption would cost states about $11 billion per year, and the tips exemption about $1.5 billion per year.

OBBBA state impact examples

• • Large state: California projected a $3.23 billion annual loss if it adopted OBBBA’s deductions, prompting immediate concern from budget officials.
  • Mid-size state: Illinois faced a potential $598 million annual loss, a significant portion of its income tax collections.
  • Small state: Montana’s projected loss was $55 million per year, which, while smaller in absolute terms, was still notable relative to its budget.
  • No income tax states: States with no income tax, like Texas and Florida, saw no direct impact.

These numbers matter for your practice because they signal how aggressively states might move to decouple from federal changes.

Fiscal analysis: How states communicate impact 

States use a mix of internal models and external analyses to project impacts, often documenting findings in fiscal notes or budget reports. For example, Colorado’s Joint Budget Committee reported that letting overtime go untaxed would cost over $200 million in 2026, prompting urgent legislative action.

Communication with stakeholders—including tax professionals and large employers—is key. States must consider not only revenue but also who benefits from the changes, such as whether the tax cuts primarily help low-income workers or a broader group.

Implementation timeline: From federal law to state analysis 

• • Immediately after enactment (July–August 2025): States issued preliminary guidance based on their conformity model. Rolling conformity states like Colorado and Montana warned of immediate revenue losses, while static states like Georgia clarified that OBBBA’s changes would not affect 2025 filings unless laws were updated.
  • Fall 2025: Legislative committees and budget offices began briefings and data gathering, often referencing external analyses.
  • Late 2025: Some states with urgent budget issues, like Colorado, convened special sessions to address conformity. Most states deferred major decisions to their regular 2026 sessions.
  • Early 2026: States incorporated OBBBA impacts into budget and tax bills, with fiscal notes quantifying the effects of adopting or rejecting the deductions.

Case study: Alabama’s overtime exemption

Alabama had already enacted its own temporary state overtime tax exemption before OBBBA, which expired in June 2025. When OBBBA passed, Alabama’s analysts discovered that the actual revenue loss was much higher than projected—about $230 million per year, compared to an initial estimate of $34 million.

This experience highlighted the risk of underestimating taxpayer response and influenced other states to be more cautious about adopting similar exemptions. For your practice, this reinforces the importance of conservative planning when advising clients about potential state tax benefits.

What this means for tax professionals like you

• • States automatically impacted in 2025: States like Colorado and Montana had to act quickly, either signaling relief or moving to stop revenue losses. If you practice in these states, you needed to communicate changes to clients immediately for their 2025 planning.
  • States not immediately impacted: States like California and New York took a “watchful waiting” approach, analyzing numbers but not rushing to change laws. This gives you time to prepare clients for potential changes while monitoring legislative developments.
  • States willing to absorb the cost: Some states, like North Dakota and Montana, found the revenue impact manageable and allowed the federal tax break to flow through. If your state falls into this category, you can help clients optimize their tax planning around these benefits.

Stay attuned to fiscal impact studies. They often foreshadow legislative decisions. If the projected cost is low, states are more likely to conform; if high, expect moves to decouple.

Your next steps: Staying ahead of legislative changes

Before lawmakers debate conforming or decoupling, they need solid fiscal analysis—and so do you. When educating clients, you might say: “Federally, your tips may be tax-free, but our state hasn’t decided yet. We’ll know more after the upcoming legislative session.”

Action items for your practice:

1. 1. Monitor state analysis: Stay informed by reading your state’s tax bulletins and fiscal reports.
   2. Prepare for scenarios: If you see significant projected revenue losses, prepare for your state to add back those deductions.
   3. Optimize client benefits: If costs appear manageable, adjust client estimates and withholding to help them benefit from these changes.
   4. Educate clients: Use this timeline and analysis framework to set appropriate expectations.

The key is positioning yourself as the trusted advisor who understands not just federal tax law, but how federal changes create opportunities and challenges at the state level. Your clients depend on this insight to make informed financial decisions.

Get the latest on OBBBA news in our OBBBA resource hub and listen to Thomson Reuters’ Clarity podcast for more tax and accounting updates.

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