States weigh conforming to Trump tax cuts on tips and overtime as legislatures reconvene

States across the United States are weighing whether to conform to or decouple from President Donald Trump’s federal tax cuts, a decision that could yield hundreds of millions in annual savings for some residents and businesses but also strain state budgets that are facing higher costs tied to Medicaid and SNAP provisions.

The package signed into law in July includes temporary deductions for tips and overtime wages, a deduction for loan interest on new vehicles assembled in the United States, and changes that affect older adults and business incentives. It also temporarily raises the cap on the state and local tax deduction from $10,000 to $40,000 and allows immediate expensing of equipment purchases and research costs. The changes are part of roughly $4.5 trillion in federal tax cuts over 10 years, according to government summaries. Forty-one states levy individual income taxes on wages and salaries, and forty-four states charge corporate income taxes. Colorado opted out of the overtime-related state tax break before the federal law took effect; Michigan this fall became the first state to opt into the tips and overtime breaks, effective in 2026.

Treasury Secretary Scott Bessent urged states to conform to the federal changes, arguing that denying residents access to these tax cuts would raise state tax burdens for working families and slow relief to low- and middle-income households.

Michigan, meanwhile, became the first state to opt into the tips and overtime changes. The decision, effective in 2026, is projected to cost nearly $113 million for the overtime exemption and about $45 million for the tips break in the current budget year, according to the state treasury. Michigan lawmakers offset those losses by decoupling from five federal corporate tax changes estimated to reduce state revenues by about $540 million this budget year. Rep. Ann Bollin, chair of the House Appropriations Committee, said the state could not afford all the cuts while still investing in roads, public safety and education.

Arizona could be among the next states to act. Democratic Gov. Katie Hobbs has urged lawmakers to adopt the tips, overtime and related business breaks and to follow the federal government by also increasing the state’s standard deduction. Republican House leaders said they stand ready to pass the tax cuts when the session begins Jan. 12. In the meantime, Delaware, Illinois, Pennsylvania and Rhode Island have moved to block some or all of the corporate tax cuts from taking effect. Illinois, for example, decoupling from a portion of the corporate tax changes could save nearly $250 million, according to Democratic state Sen. Elgie Sims, while Gov. JB Pritzker has cited budget concerns and opposed the corporate cuts.

Most states begin their annual legislative sessions in January. To retroactively change tax breaks for 2025, lawmakers would need to act quickly so tax forms could be updated before filings begin; states could instead apply the changes to their 2026 taxes, a path that offers more time to plan.