State lawmakers across the United States are facing a key decision as new legislative sessions approach: should they follow the federal government in cutting taxes on tips, overtime pay, and other income?
President Donald Trump administration is pressing states to adopt a wide range of new tax breaks introduced at the federal level. These include deductions for tips and overtime wages, interest on auto loans, business equipment purchases, and expanded benefits for seniors.
Whether those federal tax cuts automatically apply at the state level depends on how each state structures its tax laws. In some states, the changes will flow through unless lawmakers take action to block them. In many others, legislatures must actively approve the tax breaks for them to appear on state tax forms.
For workers in states that do not conform, this could mean paying no federal tax on tips or overtime pay, while still owing state income taxes on the same earnings.
States weigh costs and benefits
States that fully align with Trump’s tax cuts could deliver hundreds of millions of dollars in annual savings to residents and businesses. However, those savings could also strain state budgets already under pressure from higher costs tied to Medicaid and SNAP food assistance requirements included in the same federal law.
Most states begin their legislative sessions in January. If lawmakers want the changes to apply retroactively for 2025, they must move quickly to update tax forms before filing season. Otherwise, the tax breaks could be delayed until the 2026 tax year.
So far, only a small number of states have taken formal action.
“States are approaching this very cautiously,” said Carl Davis of the Institute on Taxation and Economic Policy, noting concerns about long-term revenue losses.
Treasury urges rapid action
The sweeping tax law signed by Trump on July 4 includes roughly $4.5 trillion in federal tax cuts over the next decade. It temporarily removes federal taxes on tips and overtime, increases the cap on state and local tax deductions, and allows businesses to immediately deduct the full cost of equipment and research.
US Treasury Secretary Scott Bessent has urged states to “immediately conform” to the federal changes, arguing that failure to do so leaves workers and businesses paying higher state taxes than necessary.
But critics argue the issue is more complex. Some analysts say tax breaks like the tip exemption may benefit certain workers while excluding others, raising questions about fairness and cost-effectiveness.
Few states take the plunge
Only a handful of states were initially positioned to automatically adopt the federal tax exemptions for tips and overtime. Michigan has since become the first state to formally opt in, applying the changes starting in 2026, while offsetting the revenue loss by blocking several federal corporate tax breaks.
Other states, including Delaware, Illinois, Pennsylvania, and Rhode Island, have moved in the opposite direction by rejecting parts of the corporate tax cuts to protect funding for education, healthcare, and social services.
As pressure mounts from the United States Department of the Treasury, state leaders now face a balancing act between offering tax relief and maintaining fiscal stability.