State taxation and OBBBA: Issues and opportunities

The One Big Beautiful Bill Act (OBBBA) brings new opportunities to fast-track US investment and fuel growth, but these changes don’t automatically translate to state and local tax benefits. First, if you’re working on a domestic building project, consider pursuing state and local incentives to offset the new state tax burdens being created. Second, your tax team needs to understand the potential positive and negative consequences in the states and localities where you operate, especially permanent tax costs, to evaluate whether these federal tax changes could magnify or erode the value you’re expecting.

To capture the full benefit, you’ll need to understand how states conform to these new provisions and when they don’t.

OBBBA’s changes to certain energy credits make it critical for you not to overlook potential benefits other federal and state credits and incentives provide. OBBBA’s restrictions on energy credits for foreign entities of concern (FEOC) will reverberate through supply chains, likely spurring additional domestic investment as companies adapt to an environment with higher tariffs and additional risk considerations.

How can companies capture the full value of federal and state credits while managing conformity gaps?

When it comes to federal credits, don’t assume state treatment follows suit. Conformity varies widely, and the tax implications can be significant. Also, keep in mind that while Section 6418 may exclude the gain from the sale of a tax credit for federal tax purposes, states may tax that gain even if the underlying business activity occurred elsewhere.

Your decisions under Section 174A on R&E expensing will also affect your ability to capture the federal research credit under Section 41. States have their own research credits that can provide a significant additional benefit but vary widely and conformity is often limited to in-state investment. Recent guidance clarifies the options available to companies engaged in research activities and procedures to change methods of accounting to comply with the new domestic R&E expenditures treatment.

State-level policy considerations historically drive decisions on a particular state’s conformity to the Internal Revenue Code (IRC). States consider whether a federal provision advances local policy goals, what it means for in-state investment and how it could affect forecasted state revenue. State tax structures, constitutional restrictions and conformity rules (e.g., “rolling” or “fixed date” conformity) also influence how and when a state may respond to federal changes. Some states automatically adopt federal tax law changes, but others must pass legislation to conform, creating uncertainty for your team.

Here are some key questions to consider:

• What state and local incentives have you pursued?
• How does each state where you operate adopt the IRC and does it conform to OBBBA?
• Has there been any legislation proposed or enacted on state tax conformity?
• Are there carve-outs, recapture risks or other state-specific limitations?

OBBBA introduces several new opportunities and considerations for companies. It permanently extends 100% bonus depreciation under Section 168(k), allowing companies to take immediate deductions for qualified property and enhance cash tax savings. It also creates a new elective 100% depreciation allowance under Section 168(n) for qualified production property (QPP), an unprecedented opportunity for companies to claim immediate deductions for certain nonresidential real property that would otherwise be depreciated over 39 years. Actions to take now include:

• Review current and planned capital expenditures to evaluate eligibility for 100% bonus depreciation.
• Analyze the impact of elections to opt out of 100% bonus depreciation or apply a transitional 40% rate.

Likewise, new Section 174A also permanently reinstates immediate deductions for domestic research or experimental (R&E) expenditures, including software development costs, for tax years beginning after December 31, 2024. Now, companies have the option of deducting these costs immediately or electing to capitalize and amortize them over five to 10 years and new methods to recover amounts that were capitalized in previous years. Finally, the business interest expense limitation under Section 163(j) has been amended to allow businesses to reassess their debt financing and treatment of interest expense considering the permanent extension of the depreciation, amortization or depletion addback as well as changes to ordering rules. To benefit from these provisions:

• Evaluate R&E activities and related expenditures to determine the most advantageous treatment of those costs, keeping in mind other strategies that can be used.
• Reexamine business interest expense strategies to comply with the amended Section 163(j) limitations.

As you assess these provisions, it’s not enough to focus on current and planned capital expenditures. You’ll also need to analyze the potential downstream tax effects that flow from your decisions. Among other issues, when weighing your expensing options, consider:

• The corporate alternative minimum tax.
• Attribute usages, including the 80% net operating loss and Section 382 limitations.
• Interest expense limitation and ordering rules.
• New limitations on corporate charitable contributions.

How do OBBBA elections affect foreign income, credits, and state-level taxable income?

Your expensing decisions could also influence foreign income calculations, including the base erosion and anti-abuse tax (BEAT), foreign-derived deduction eligible income (FDDEI, formerly foreign-derived intangible income or FDII), net CFC tested income (NCTI, formerly global intangible low-taxed income or GILTI) and foreign tax credits.

Future operational changes may affect expected tax consequences, such as recapture provisions under Section 168(n) if you no longer use qualifying property in a qualified production activity. Cost segregation studies can help you track expenses across the right categories—supporting your elections and limiting the potential recapture risk.

How can a state-by-state conformity model help companies identify permanent tax savings?  

Many states historically decoupled from or require an addback for bonus depreciation under Section 168(k). With the introduction of Section 168(n), states now will need to treat this elective 100% depreciation allowance separately and consider the implications for encouraging in-state manufacturing activities. These differences will become more pronounced as OBBBA allows elections such as the 40% depreciation allowance in 2025.

You’ll need to examine how each state conforms and state-specific depreciation rules. Cost segregation can support both planning and compliance efforts to maximize the total tax benefit of these provisions and document the results.

The treatment of domestic R&E expenditures under Section 174A also will raise state income tax conformity considerations. It’s unclear how states such as Alabama, with their own R&E provisions, will respond to the new federal elections.

OBBBA’s differential treatment of domestic and foreign R&E expenditures also raises the constitutional question of whether the different treatment of domestic and foreign business activity and investment is discriminatory for state income tax purposes. This could possibly violate the “dormant” Commerce Clause. This also was an issue under the Tax Cuts and Jobs Act (TCJA), but OBBBA’s immediate expensing of domestic R&E expenditures makes this difference starker.

You’ll also want to model the impact of state income tax conformity to the Section 163(j) limitation, weighing temporary benefits versus permanent tax costs. These include differences from the federal consolidated group computation of the limitation, specific decoupling from the limitation and modifications to the limitation such as in Virginia.

Don’t overlook how specific states treat foreign income and conformity to the TCJA and OBBBA provisions.

Recent changes highlight the diverse approaches.

• Illinois now includes 50% of GILTI, treating it as a dividend.
• Colorado has added back FDDEI and expanded “tax haven” inclusion in reaction to OBBBA.
• Michigan has decoupled from qualified production property expensing under Section 168(n) and the domestic R&E expensing option under Section 174A, while continuing to conform to pre-OBBBA versions of Sections 163(j), 174 and 179 for tax years beginning after December 31, 2024. The legislation also maintains decoupling from Section 168(k) for tax years beginning before December 31, 2024.

There are foreign income consequences to model even in nonconforming states. California, for instance, recently updated its fixed date conformity to the IRC as of January 1, 2025 (pre-OBBBA), but it looks to Section 952 on a rolling conformity basis for its water’s-edge CFC inclusion calculation. As such, California would likely follow the Section 954(c)(6) look-through provision that OBBBA permanently extended for its CFC inclusion calculation.

Bottom line: Even in states that appear nonconforming, the ripple effects of OBBBA provisions can surface in unexpected ways.

As you plan your strategy in response to OBBBA, consider the entire credits and incentives landscape. States continue to develop programs to attract increased US investment, including statutory credits and negotiated incentives. You stand to gain the most value for your business by considering these potential tax benefits up front.

Understanding the differences state conformity creates can help you anticipate where risks may arise and where opportunities remain intact. A careful, state-by-state analysis will help you anticipate where differences matter most. It’s time to start modeling your state positions to protect your bottom line and capture the upside where it exists.