State conformity: Recalling the basics
States generally conform to the IRC based on rolling conformity or fixed-date conformity. About half the states use rolling conformity and half the states are based on a fixed-date—excluding minor nuances such as selective conformity to specific federal provisions.
In the event federal tax reform is enacted, rolling conformity states will automatically conform to those new and amended provisions, unless the state specifically decouples from the relevant IRC section. Fixed-date conformity states will adopt a version of the IRC (mostly on an annual basis) during the legislative session.
Depending on when federal reform is enacted, a fixed-date conformity state may have already updated its conformity to the IRC for the 2025 tax year. This would likely be tied to a version of the IRC prior to the enactment of federal tax reform. Some states may be able to enact a subsequent update in the same legislative session, while others may not—especially those states with short legislative sessions.
Fixed-date conformity to the IRC adopted before tax reform could lead to a disconnect in state treatment for the 2025 tax year, or for however long the state does not conform to the new federal provisions. A few states that have updated their conformity to the IRC during the first or second quarter of 2025 have included language as to whether the state will automatically adopt certain provisions of the IRC enacted after a certain date. This was likely done to provide clarity on anticipated federal tax reform.
State conformity to the federal tax code must be reviewed on a state-by-state basis. There may still be selective decoupling in states that generally are considered rolling conformity, particularly with certain business provisions such as current expensing of depreciation, research and experimental expenses or the limitations on business interest expense deductions.
Timing of the state responses
Whether and how states respond to new or amended federal tax provisions depends on several factors.
State legislatures are largely out of session by mid-June. While several states remain in session all year, taxpayers should anticipate that most states that will address conformity or decoupling to a new federal tax provision will do so beginning in 2026. Even then, states may not pass relevant legislation by March 15, 2026, or April 15, 2026, requiring taxpayers to consider the state impact of federal tax reform on extensions and estimates.
Some states may not be able to respond to new federal tax law for two or more years, like with state responses to prior federal tax bills. The TCJA is one noteworthy recent example.
A state may be able to call a special session in 2025 and return to session to address federal conformity to tax reform, but that is less likely and should not be anticipated.
Federal provisions to consider for state purposes
The following are provisions that have been proposed in previous federal legislation or supported publicly by the president or members of his administration:
Section 164 state and local tax (SALT) deduction
The TCJA limited the individual taxpayer deduction for state and local tax (SALT) payments to $10,000 a year ($5,000 for a married person filing a separate return). The limitation is scheduled to sunset on Dec. 31, 2025.
In response to the TCJA’s SALT deduction limitation, 36 states and New York City enacted pass-through entity tax (PTET) workarounds to ultimately re-characterize a non-deductible individual state income tax expense as a deductible state income tax expense for federal income tax purposes.
Several federal proposals have been introduced or considered to alter the SALT deduction limitation, but those proposals would generally not alter the state workarounds. However, several of the state provisions also sunset as of Dec. 31, 2025, and therefore must be extended through legislation in those jurisdictions. As of the date of this article, those states include California, Illinois, Oregon, Utah and Virginia.
More recently, the SALT deduction discussion has focused on a potential limitation or elimination of the deduction for corporate taxpayers. Congress is contemplating the corporate SALT deduction limit as a revenue generator for other tax cuts, including those addressed above. It is not clear whether a business limitation on the SALT deduction would cover all SALT tax types or would provide a specific carve out for certain tax types, such as property taxes.
Eliminating or limiting the corporate deduction for state and local taxes would create a permanent book-to-tax difference for federal purposes, as opposed to the timing differences of costs under sections 163(j), 168(k) and 174.
This permanent difference would result in a federal tax increase and state and local taxes would become more material to the tax expense for businesses. Currently, states generally conform to section 164 but require the addback of state taxes based on net income. To the extent federal tax reform makes changes to the SALT deduction for corporations, a state-by-state analysis may be required to determine the appropriate state treatment.
Section 174 research & experimental expenses
The TCJA amended section 174 to require taxpayers to capitalize their research and experimental (R&E) costs and amortizing the costs over a five-year or 15-year period, respectively, for domestic and foreign costs paid or incurred in tax years beginning after Dec. 31, 2021. States mostly have conformed to this position, although a small number have decoupled or have provided an election for current expensing of section 174 costs.
Tax reform could restore current expensing of domestic R&E costs. Taxpayers with significant R&E should follow developments in their material states and carefully track any federal and state differences in deferred tax assets or liabilities created by section 174 rules.
Section 163(j) business interest expense
For tax years beginning after 2021, the TCJA amended section 163(j) to impose a limit on the deductibility of business interest expense equal to the sum of business interest income or 30% of EBIT (earnings before interest and taxes).
It is also important to remember that the adjusted tax income (ATI) limitation was temporarily increased to 50% from 30% of ATI for the 2019 and 2020 tax years under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act, P.L. 116-136). Not all states adopted the provisions of the CARES Act as it relates to section 163(j).
The federal law allows business interest expense limited under section 163(j) and nondeductible in the current year to be carried forward indefinitely. Previous federal legislation proposed restoring the limitation on business interest expense to an amount based on EBITDA (earnings before interest, taxes, depreciation, and amortization) rather than EBIT, allowing an increased deduction for interest expense for many businesses.
There are many nuances to state conformity to section 163(j), including separate entity pro forma calculations and tracking state differences from federal carryforwards amounts due to different conformity periods of states for both TCJA and CARES Act limitations. Any changes to federal section 163(j) limitations that are not immediately (or ever) adopted by states will add more complexity and could affect the calculation of current state tax expense and deferred tax assets or liabilities.
Section 168(k) bonus depreciation
The TCJA scheduled a phase out of 100% bonus depreciation under section 168(k). For example, qualifying property receives 40% bonus depreciation for 2025, with the full phase out beginning in 2027. Legislation previously proposed would have extended 100% bonus depreciation for qualified property placed in service after Dec. 31, 2022, and before Jan. 1, 2026.
Many states have decoupled from federal bonus depreciation or provide a state specific rule for calculating bonus depreciation. It is important for taxpayers to track federal and state basis differences in depreciable assets to determine current year state modifications as well as the impact of the future disposal of any depreciable assets.
More recently, and similar to section 174(j), certain states are allowing taxpayers to elect 100% bonus depreciation in the current year. Taxpayers must continue to track state developments in this area, and to maintain state specific depreciation calculations.
Reduction of federal corporate income tax rate
During his campaign, President Trump mentioned various potential rate changes, including a general reduction to the federal corporate income tax rate or a reduction of the rate for domestic manufacturers.
Generally, federal corporate tax rates do not flow through to the states. However, a reduction in federal business tax rates effectively results in an increase of the proportion of tax spend on state and local taxes.
The rate changes may also reduce the value of federal deduction for state taxes paid. Reductions in federal tax rates may provide numerous state planning opportunities, such as entity choice considerations, location planning, and credits and incentives reviews.
Repeal of federal estate tax
A handful of states continue to impose a state-level estate tax. A repeal of the federal estate tax would not be anticipated to alter the state provisions in any meaningful way. Taxpayers that could be subject to a state or federal estate tax should consider planning now.
Takeaways and planning ahead
The passage of federal tax reform will require businesses and individual taxpayers to consider how the federal changes will affect state law.
State conformity to the federal tax code is varied, must be observed on a state-by-state basis and may be different for individual and business taxpayers. While some states and localities automatically conform to changes to the IRC for income tax purposes, many others have fixed-date conformity or only conform to enumerated provisions.
Taxpayers should prepare for potential disconnects between federal and state tax codes and to closely follow developments of material provisions. Identifying where conformity could cause additional complexity, and therefore analysis, will help ensure a successful compliance season in 2026. Taxpayers should also anticipate that necessary state responses may not occur by original deadlines, requiring taxpayers to consider filing extensions.
Federal tax reform could provide new opportunities to review current business operations. A reduced domestic manufacturing rate may couple well with strategically deploying capital investment to locations where robust credits and incentives could be available for hiring and general capital expenditures.
Corporate tax rate reductions or a limitation on the SALT deduction for corporate taxpayers may call into question choice of legal entity decisions as well as a discussion or comparison of state tax base and rates. Significant federal tax changes may necessitate or prioritize planning around how and where capital investment is allocated to optimize state tax footprints.
At this stage of federal tax reform, state taxpayers should anticipate and begin to model the numerous scenarios that may materially affect overall state tax spend.
