The House-approved tax reconciliation bill (H.R. 1, the Bill) (May 22, 2025), which incorporates a manager's amendment,¹ would make numerous federal tax changes that would affect businesses and their owners, some of which would be applicable as soon as tax years beginning in 2025. (See Tax Alert 2025-1111 for an overview of the Bill's provisions, as approved by the House, as well as Tax Alert 2025-1143 for an update on the Bill's international tax provisions.) Although additional changes may arise as the legislation moves through the Senate, stakeholders should familiarize themselves with the Bill, which could affect corporate and individual income taxes imposed by state governments on businesses and their owners.

State conformity to federal tax changes

Generally, most state income tax systems use federal taxable income (corporate) or adjusted gross income (individual) as a starting point for state income tax computations, so changes to the federal income determinations can affect state taxes. By contrast, states do not automatically conform to federal tax rate changes, and most do not adopt minimum tax regimes that exist outside of the general taxes imposed under IRC Sections 11 and 1 (for corporations and individuals, respectively). Only one state² currently adopts the IRC Section 59A base erosion and anti-abuse tax (BEAT), for example, so the changes to this tax would not directly affect tax computations in the other states. States also do not generally adopt the excise tax provisions under Subtitle D of the IRC; as such, proposed changes to federal excise taxes typically do not have immediate implications for state taxes, though some states may permit a deduction for any federal excise tax paid or accrued.

The Bill's state income tax implications generally would depend on how each state conforms to the IRC and to affected provisions, such as the regime for global intangible low-taxed income (GILTI) under IRC Section 951A. States conform to the IRC in various ways. Most either automatically incorporate the federal tax law as it changes (known as "rolling" conformity) or adopt the federal tax law as of a specific date (known as "fixed" conformity). There are also several "selective" conformity states, which adopt a hybrid of rolling and fixed conformity. Upon enactment of a change in the IRC, rolling-conformity states that incorporate relevant IRC sections generally would automatically adopt the changes, while states with fixed conformity statutes generally would only incorporate changes if and when they update their conformity date to a date on or after the effective date of the corresponding federal tax changes — or otherwise adopt legislation to that effect.

Because the starting point for calculating "state taxable income" is typically subject to various modifications, taxpayers must consider specific conformity to IRC provisions in addition to states' general adoption of the IRC.

Provisions that could affect business-related state income taxes

Notable provisions in the Bill that could impact state income taxes for businesses would:

• Allow 100% bonus depreciation for certain property acquired and placed in service after January 19, 2025, and before January 1, 2030 (five years less several days)
• Introduce additional changes to federal bonus depreciation
• Reinstate the EBITDA-based (earnings before interest, taxes, depreciation, and amortization) limitation under IRC Section 163(j) for tax years beginning after December 31, 2024, and before January 1, 2030
• Allow expensing for five years, rather than a five-year amortization period, for domestic research and experimental (R&E) expenditures under IRC Section 174 that are paid or incurred in tax years beginning after December 31, 2024, and before January 1, 2030
• Require taxpayers to either reduce domestic R&E expenses by the amount of their IRC Section 41 research credits for tax years beginning after December 31, 2024, and before January 1, 2030, or elect to claim a reduced IRC Section 41 research credit
• Add an aggregation rule to IRC Section 162(m), under which amounts paid by different members of a controlled group to a specified covered employee would be combined for purposes of the $1 million limit
• Limit corporate charitable deductions to the extent the aggregate of corporate charitable contributions exceeds 1% of the taxpayer's taxable income and does not exceed 10% of the taxpayer's taxable income, with certain carryforward rules applying to disallowed contributions, applicable after December 31, 2025
• Make permanent and reduce the IRC Section 951A deduction for GILTI from 50% (10.5% tax rate) to 49.2% (10.668% tax rate)³ and exclude from "tested income" any "qualified Virgin Island services income," applying narrowly to only certain US shareholders
• Make permanent and reduce the IRC Section 250 deduction for foreign-derived intangible income (FDII) from 37.5% (13.125% tax rate) to 36.5% (13.335% tax rate)
• Repeal the transferability under IRC Section 6418 of certain energy credits
• Make permanent the IRC Section 199A deduction on certain pass-through income, increasing the deduction to 23% (from 20%), and making the deduction applicable to certain interest dividends of qualified business development companies

Many of the proposed changes relate to international tax provisions and would amplify the complexity of state tax reporting given existing variations in state tax treatment of these items. The Bill would also create a new IRC Section 899 aimed at increasing tax rates on "applicable persons," including individuals, foreign governments, foreign corporations, private foundations, certain trusts, and certain foreign partnerships of a foreign country that has an "unfair foreign tax"⁴ (see Tax Alert 2025-1085 discussing the provision after passage in the House Ways and Means Committee). To effectuate the policy, the Bill would increase various taxes, including withholding taxes, on applicable persons, adding another tax to the treaty rate negotiated in treaties. US-international tax treaties, by their own terms, do not apply to subnational US taxing authorities, so an increase in levies described in those agreements would have limited direct effect on state income taxes for businesses.

The Bill would also increase the $10,000 cap on the state and local tax (SALT) deduction for individuals under the Tax Cuts and Jobs Act (TCJA) to $40,000 (reduced for taxpayers with more than $500,000 in income), with the cap and income threshold set to grow 1% each year. While the SALT deduction cap does not affect businesses or their owners, the Bill specifically addresses pass-through entity tax (PTET) regimes enacted by state governments as a so-called workaround to the $10,000 TCJA limitation. The Bill would apply the SALT deduction cap to taxes paid on income from investment activities, as well as the income of certain professional services organizations (i.e., specified service trades or businesses, or SSTBs, under IRC Section 199A, such as doctors, attorneys and accountants). If enacted, these provisions could affect the federal tax benefits of state PTET regimes, which may affect how state lawmakers view the efficacy and existence of these regimes in the future.

Industry-specific provisions

The Bill includes provisions specific to certain industries. For example, manufacturers would be interested in provisions that would allow, under new IRC Section 168(n), a 100% depreciation allowance (i.e., full expensing) for certain US facilities (real property) used to produce tangible personal property. To qualify, construction must begin after January 19, 2025, and before January 1, 2029, and the facility/improvement must be placed in service before January 1, 2033. This new accelerated depreciation rule could add to existing questions around the constitutionality of state conformity to federal provisions encouraging domestic activity — specifically whether the resulting impact on state tax impermissibly discriminates against foreign commerce in violation of the Commerce Clause of the US Constitution.⁵

Manufacturers, as well as retailers, will also take note of proposed changes to Public Law (P.L.) 86-272, a federal law that prohibits states from imposing state income tax on out-of-state sellers whose in-state activities do not exceed soliciting orders of tangible personal property, subject to additional requirements. The Bill would define "solicitation of orders" to include "any business activity that facilitates the solicitation of orders even if that activity may also serve some independently valuable business function apart from solicitation." This new definition could expand public law protections to taxpayers whose business activities serve both solicitation and non-solicitation functions. This development occurs after the Multistate Tax Commission (MTC) in 2021 revised its policy statement concerning P.L. 86-272,⁶ adding a section on activities conducted over the internet, in which certain internet activities that are not "entirely ancillary to solicitation" are deemed unprotected by P.L. 86-272.⁷

Other provisions affecting state income taxes for specific industries include the 50% exclusion of adjusted basis of an IRC Section 197 amortizable asset from amortization for professional sports franchises and expanding the special expensing rules for qualified film, television, and live theatrical productions under IRC Section 181 to include aggregate qualified sound recording production costs of up to $150,000 per tax year.

Implications

The Bill's effects would arise both from how the states currently conform to federal tax law and from how state lawmakers modify their tax laws in response to the IRC changes. In this respect, state legislatures would need to understand how these federal tax developments, if enacted, would affect their state budgets. Businesses, too, should monitor and assess the Bill's potential effects on their state tax profile.