The OBBB’s Aftermath: State Tax Chaos Looms

The final version of the One Big Beautiful Bill (OBBB) was signed by President Trump on July 4, 2025, codifying one of the most sweeping federal tax reforms since 2017. However, the fallout of the OBBB may not be so beautiful for state tax agencies and policymakers who are now faced with potential state tax revenue shortfalls. As changes to the federal tax code impact the starting point of many state tax codes, states are now forced to address conformity or other modifications in order to balance budgets – just as the majority of the state legislative sessions have closed for the year.

PTET Still Standing: States Scramble To Extend SALT Cap Workarounds

Putting state and local tax at the centerpiece of many dinner conversations, the OBBB still preserves the value of the state pass-through entity tax (PTET) as a valid workaround to the SALT deduction cap, initially put into place in the Tax Cuts and Jobs Act (TCJA). However, several state PTET regimes were enacted with fixed sunset provisions or other alignment to the federal SALT deduction cap framework, causing states to take proactive legislative steps to maintain the benefits of their PTET structures. For example, California’s PTET was set to sunset on Dec. 31, 2025. However, in anticipation of the federal extension on the SALT deduction cap, California also extended its PTET through Dec. 31, 2030, in legislation signed by Gov, Newson on June 27, 2025. Thus, while the PTET framework may appear stable at first glance, additional state-level legislative responses to the OBBB’s SALT cap provisions are likely to be debated in upcoming sessions.

Given the evolving landscape, taxpayers and their advisors must revisit PTET strategies to ensure they align with the taxpayer’s broader income and filing profile. It’s important to remember that PTET elections are not one-size-fits-all. Careful evaluation is essential for optimizing tax outcomes.

Bonus Depreciation and Other Deductions: Retroactive Shock for State Codes

Also likely to cause headaches for states are the numerous retroactive business tax deductions, such as bonus depreciation, full expensing for domestic research expenses, and a new deduction for real property classified a “qualified production property” – just to name a few. State conformity to the Internal Revenue Code (IRC) is generally categorized as rolling or static. In rolling conformity states, the tax code is tied to the IRC on a continuous basis. This means these states will automatically adopt the OBBB’s retroactive deductions without legislative action. In contrast, static conformity states only conform to the IRC as of a fixed date, and any federal tax changes made after that date do not apply unless the state legislature explicitly updates its laws. This automatic integration of retroactive federal provisions into state tax law raises fairness concerns for taxpayers.

When such changes are imposed partway through the year, they undermine predictability, disrupt planning, budgeting, and potentially create operational and compliance difficulties for businesses. The lack of foresight or opportunity to prepare for these shifts only compounds the issue. With only a few state legislative sessions still open for 2025, aligning state tax codes with the OBBB will likely become a top priority during the 2026 legislative season. In the meantime, states face the added pressure of evaluating the broader fiscal impact of the bill, including how potential reductions in federal support for other programs might strain their budgets. This raises a pressing question for taxpayers: How will states react for 2025? Will they opt to enact retroactive conformity measures, or will they choose to decouple from these federal provisions? As of now, the outlook remains uncertain, and the state tax landscape is anything but clear.

Extended Benefits, Lingering Uncertainty: TCJA Legacy Lives On in OBBB

Another area of consideration for state conformity – though perhaps less unsettling – is the set of TCJA provisions that were either enhanced or made permanent under the OBBB, such as the IRC §199A deduction and the Opportunity Zone program. Since these elements have been in place for several years, states have already had the chance to either conform to or decouple from them. As a result, it’s reasonable to expect that most states will maintain their current positions, but state budget pressures could still prompt some states to revisit these provisions, possibly leading to unanticipated state tax changes.

And this only begins to cover the scope of the tax reforms packed into the OBBB’s more than 300 pages of tax-related legislation. Federal tax practitioners are still working through the details and effects of these sweeping changes. On the state level, agencies will spend the latter half of 2025 analyzing the fiscal impact and preparing recommendations to guide legislative responses once the 2026 sessions open.

Bracing for the Filing Frenzy: Why 2025 Returns May Be Anything but Routine

With the vast majority of state legislatures currently adjourned, we can expect a surge of activity in early 2026 aimed at helping taxpayers understand how to properly calculate and file their 2025 state tax returns. It is unlikely that all uncertainty will be resolved in time for a timely 2025 filing, and tax advisors should be evaluating these changes in light of any impending 2025 state estimated tax payments and preparing clients for the possibility that filing an extension may be the most prudent course of action. This uncertainty will also impact 2025 estimated payments, and, if states take action, those estimates may need to be adjusted accordingly.

KSM’s state tax professionals are actively tracking developments and are available to help you understand how this evolving legislation may affect your specific situation. For guidance, contact your KSM advisor or fill out the form below.