State lawmakers’ dilemma – To conform or to decouple with OBBBA?

After assessing the fiscal impact of OBBBA, state officials face a critical policy decision: Should the state follow the federal tax cuts, or not? This blog examines the legislative response—how state legislatures decide whether to conform to the most well known of OBBBA’s provisions for “No Tax on Tips” and “No Tax on Overtime”, and what those choices mean for taxpayers and practitioners.

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Three paths forward: The legislative choices 

When it comes to OBBBA’s “No Tax on Tips” and “No Tax on Overtime” provisions, states generally have three options:

• Full conformity: Accept the federal changes, letting tips and overtime be untaxed at the state level.
• Selective (partial) conformity: Adopt some parts of OBBBA but not others (e.g., allow the tip deduction but not overtime).
• Non-conformity/decoupling: Reject the new federal deductions entirely, keeping tips and overtime fully taxable for state purposes.

States saying yes: Embracing federal tax breaks 

Several states are embracing federal tax relief by aligning with or adapting to the OBBBA. Whether through automatic conformity, new legislation, or hybrid approaches, these states are finding ways to reduce tax burdens on tips, overtime, and bonuses while balancing budget impacts.

Rolling conformity states

States like Iowa, Montana, North Dakota, and Oregon automatically conform to federal taxable income. Unless they pass laws to decouple, these states will not tax tips and overtime in 2025.

Montana’s leadership, for example, welcomed the change because the revenue impact was manageable and aligned with the state’s history of not taxing tips.

Proactive legislative action

Some static conformity states have introduced bills to mirror OBBBA’s relief, showing how legislative priorities can override fiscal concerns:

• Arizona: Passed a bill to eliminate state income tax on tip income, with a manageable revenue loss.
• North Carolina: Proposed exempting tips, overtime, and some bonuses, though the bill had not passed by late 2025.
• New Jersey: Introduced a bill to stop taxing all tip income, with no cap, specifically to help lower-income service workers.

Partial conformity

Colorado took a hybrid approach that offers a model worth watching. They decoupled from the overtime deduction to avoid a large revenue loss but allowed the tip deduction, targeting relief to lower-wage workers while protecting the budget.

This strategic compromise might influence other states facing similar budget pressures.

States saying no: Protecting revenue over relief 

Several states have made clear they do not plan to conform to OBBBA’s provisions, prioritizing budget stability over federal alignment:

• New York: As a static conformity state, NY will require taxpayers to add back any tip or overtime deduction on the federal return, citing the need to protect over a billion dollars in annual revenue.
• California: With a projected $3.2 billion annual cost, California’s leadership signaled no intention to adopt the deductions, preferring to preserve funds for public programs.
• Illinois: Will require an add-back for any tip or overtime deduction, as the state cannot afford the revenue loss.

Other states, such as Massachusetts, Connecticut, and Hawaii, have also indicated they will not conform, either by default or through explicit policy decisions.

The middle ground: Wait-and-see and states 

Many states have not firmly committed either way as of October 2025. These “wait-and-see” states, including Georgia, Maryland, and South Carolina, plan to address OBBBA in 2026 sessions. For now, they continue to tax tips and overtime as usual, but could choose to adopt the deductions through legislation.

These states present both opportunity and uncertainty for tax professionals—changes could emerge mid-year, requiring agile client communication and planning adjustments.

What this means for tax professionals 

These varied responses create a complex compliance environment that directly impacts your daily practice and client relationships.

Working with clients in conforming states

Your clients benefit from simplified compliance. Federal and state treatment align.

When explaining this to clients, you might say: “Good news: your tip income is tax-free at both levels, so we can adjust your withholding accordingly.”

Managing complexity in decoupling states

Here’s where your expertise becomes crucial. Clients will need clear explanations about why their state tax differs from federal.

Consider this language: “While your tips aren’t taxed federally, our state requires us to add them back. This means different planning strategies for withholding and estimates.”

Navigating uncertainty in wait-and-see states

These states present both opportunity and risk. Stay connected to legislative calendars and prepare clients for potential mid-year changes.

Your proactive monitoring becomes a competitive advantage.

Communication and planning with clients 

As tax professionals, we should approach this evolving landscape strategically:

• Monitor legislative development: Track state legislative agendas for conformity or tax bills mentioning tip/overtime provisions. This intelligence helps you anticipate changes before they impact clients.
• Prepare clear client communications: Develop templates explaining whether your state is conforming or decoupling. Clients appreciate understanding why their state tax treatment differs from federal.
• Adjust planning proactively: Modify withholding and estimates based on your state’s stance. This positions you as the advisor who thinks ahead, not just responds to changes.

Stay ahead of tax legislation

State legislatures are split on OBBBA’s tax breaks. Some see a chance to help workers and are all in, others view it as a costly and unfair gimmick and are opting out. Many are in the middle, weighing options.

This state-by-state response reveals something important about modern tax policy: federal changes no longer guarantee uniform state treatment. We’re entering an era where tax professionals must navigate increasingly complex state variations, making your expertise more valuable than ever.

By early 2026, the landscape will be clearer as more legislatures act. By staying ahead of these changes, you become the trusted advisor who helps clients navigate not just current law, but the patchwork of state responses to federal policy. Your clients depend on this strategic insight to make informed financial decisions in an increasingly complex regulatory environment.

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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