A tax pro explained how taxpayers can handle state tax underpayments resulting from retroactive changes after the One Big Beautiful Bill (OBBB). While a few states have issued guidance and offered relief, EY’s David Machemer noted, many have not.
Retroactive tax law changes pose challenges
The federal OBBB included retroactive tax changes for the 2025 tax year, including those affecting bonus depreciation under IRC § 168(k), research and experimental expenditures under IRC § 174, and the business interest limitation under IRC § 163(j). While these changes were made at the federal level, they can serve as the starting point for state tax.
Amid budget concerns over the new OBBB provisions, many states decoupled or adjusted their conformity to the federal Tax Code this year. Over 20 states have decoupled or only partially conformed to the OBBB, Machemer said during an August 26 EY webinar. However, those changes often occurred after taxpayers already estimated their tax liability.
These taxpayers may have a tax liability greater than what was reported on an already-filed return, Machemer explained. They could be on the hook for underpayments and associated interest and penalties, he stressed.
This has “spurred a little bit of uncertainty as to what taxpayers need to do and how they handle any resulting penalty or interest that has accrued due to these changes,” Machemer added.
A few states have issued guidance, offered relief
While most states have not yet issued specific guidance on how to handle these retroactive liabilities, a few have proactively addressed the issue.
New York has provided the “most explicit” relief, according to Machemer. In Notice N-26-1, the state waived penalties and interest on certain underpayments arising solely from New York’s OBBB decoupling, provided the taxpayer pays the additional tax and files an amended return.
Other states, including Connecticut, Massachusetts, and Minnesota, have also provided some guidance, Machemer said. However, guidance may just address “the mechanics,” rather than penalties and interest. For example, Minnesota’s relief, provided in HF 2438, does not automatically waive interest on underpayments.
Machemer also offered a practical warning for those filing amended returns in states providing OBBB-related relief. “If the amended return that you need to file includes any unrelated changes beyond the decoupling modifications, the safe harbor could be jeopardized,” he said. He recommends filing a separate amended return limited only to the OBBB adjustments.
Building a reasonable cause defense
However, most states have not issued specific guidance. For taxpayers in these states, Machemer advises a multi-step strategy.
First, he recommends taxpayers recompute their state taxable income and file an amended return. Machemer then suggests filing a written penalty abatement request with the state taxing authority. The core of this request should be a “reasonable cause” argument.
Taxpayers should note that the underpayment was caused by retroactive tax law changes outside the taxpayer’s control, Machemer explained. Taxpayers should also show that they were in full compliance with the law as it existed at the time of the original filing and when estimated payments were made.
“It’s key to document the timeline,” Machemer said. “When was the original return filed? When did the state enact decoupling legislation? And really stress the impossibility of compliance at the time of filing.”
Interest is typically more challenging than penalties because interest is “statutory and more difficult to abate,” Machemer said. However, it is “still reasonable to ask for interest abatement based on the same arguments that you’re asking for the penalty abatement.”
Success may depend on state law — and once again, on demonstrating reasonable cause. Some states, such as Maryland and Illinois, have statutes that explicitly grant the authority to abate interest based on reasonable cause. Rhode Island has authority to abate “when interest is due to erroneous tax advice” — which Machemer suggested could include original, now-outdated guidance on how to file.
Practitioner takeaways
Machemer emphasized that “timing matters in all of this” and urged practitioners to be proactive. He recommended filing amended returns and any necessary appeals “sooner rather than later.” He noted that appeal deadlines are often short, running just 30 or 60 days.
“You really have to lean on the reasonable cause argument for both interest and penalty abatement,” Machemer stressed.
He suggests practitioners look to state versions of federal Tax Code sections that provide relief when there is reasonable cause for an underpayment, such as retroactive legislation. Machemer explained that states often have parallel provisions to federal law — or they may give tax authorities administrative discretion to waive penalties and interest.
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