JEFFERSON CITY, Mo. – A pressing issue awaits state legislators across the United States: the taxation of tips. This debate will unfold as they gather for their upcoming sessions.
The administration of President Donald Trump is advocating for states to mirror its approach by introducing an array of new tax incentives for both individuals and businesses. These include deductions for tips, overtime wages, car loans, and business equipment.
In several states, these federal tax incentives will seamlessly integrate into state tax systems unless legislative bodies decide otherwise. Conversely, in states with distinct tax legislation, these benefits will only be reflected on state tax documents if lawmakers choose to adopt them.
In jurisdictions that do not align with federal tax reforms, individuals earning tips or overtime may find themselves exempt from federal taxes on these earnings but still liable for state taxes.
If states decide to fully adopt Trump’s tax cuts, they could potentially offer significant annual savings to residents and businesses. However, this move could place a financial burden on the states, which are also facing increased expenses due to new Medicaid and SNAP food assistance mandates included in the extensive legislation signed by Trump.
Most state legislative bodies will convene in January. To implement any retroactive tax changes for 2025, swift action is necessary to update tax forms before the filing season begins. Alternatively, states might choose to apply these changes to their 2026 taxes, allowing for a more measured approach.
So far, only a few states have taken votes on whether to adopt the tax breaks.
“States in general are approaching this skeptically,” said Carl Davis, research director at the nonprofit Institute on Taxation and Economic Policy.
Trump’s treasury presses states to `immediately conform’
A bill Trump signed on July 4 contains about $4.5 trillion of federal tax cuts over 10 years.
It creates temporary tax deductions for tips, overtime and loan interest on new vehicles assembled in the U.S. It boosts a tax deduction for older adults. And it temporarily raises cap on state and local tax deductions from $10,000 to $40,000, among other things. The law also provides numerous tax breaks to businesses, including the ability to immediately write off 100% of the cost of equipment and research.
Forty-one states levy individual income taxes on wages and salaries. Forty-four states charge corporate income taxes.
Treasury Secretary Scott Bessent this month called on those states “to immediately conform” to the federal tax cuts and accused some Democratic-led states that haven’t done so of engaging in “political obstructionism.” Though Bessent didn’t mention it, many Republican-led states also have not decided whether to implement the tax deductions.
“By denying their residents access to these important tax cuts, these governors and legislators are forcing hardworking Americans to shoulder higher state tax burdens, robbing them of the relief they deserve and exacerbating the financial squeeze on low- and middle-income households,” Bessent said.
But some tax analysts contend there’s more for states to consider. The tax break on tips, for example, could apply to nearly 70 occupation fields under a proposed rule from the Internal Revenue Service. But that would still exclude numerous low-wage workers, said Jared Walczak, vice president of state projects at the nonprofit Tax Foundation.
“Lawmakers need to consider whether these are worth the cost,” Walczak said.
Only a few states offer tax breaks for tips and overtime
Because of the way state tax laws are written, the federal tax breaks for tips and overtime wages would have carried over to just seven states — Colorado, Idaho, Iowa, Montana, North Dakota, Oregon and South Carolina. But Colorado opted out of the state tax break for overtime shortly before the federal law was enacted.
Michigan this fall became first — and, so far, only — state to opt into the tax breaks for tips and overtime wages, effective in 2026. The overtime tax exemption is projected to cost the state nearly $113 million and the tips tax break about $45 million during its current budget year, according to the state treasury department.
Michigan lawmakers offset that by decoupling from five federal corporate tax changes the state’s treasury estimated would have reduced Michigan tax revenues by $540 million this budget year.
Republican state Rep. Ann Bollin, chair of the Michigan House Appropriations Committee, said the state could not afford to embrace all the tax cuts while still investing in better roads, public safety and education.
“The best path forward is to have more money in people’s pockets and have less regulation — and this kind of moved in that direction,” she said.
Arizona could be among the next states to act. Democratic Gov. Katie Hobbs has called upon lawmakers to adopt the tax breaks for tips, overtime, seniors and vehicle loans, and follow the federal government by also increasing the state’s standard deduction for individual income taxpayers. Republican state House leaders said they stand ready to pass the tax cuts when their session begins Jan. 12.
Several states have rejected corporate tax breaks
In addition to Michigan, lawmakers in Delaware, Illinois, Pennsylvania and Rhode Island have passed measures to block some or all of the corporate tax cuts from taking effect in their states.
A new Illinois law decoupling from a portion of the corporate tax changes could save the state nearly $250 million, said Democratic state Sen. Elgie Sims, chair of the Senate Appropriations Committee. He said that could help ensure continued funding for schools, health care and vital services.
Illinois Gov. JB Pritzker, an outspoken Democratic opponent of Trump, also cited budget concerns for rejecting the corporate tax cut provision. He said states already stand to lose money because of other provisions in Trump’s big bill, such as a requirement to cover more of the costs of running the Supplemental Nutrition Assistance Program.
“The decoupling is an effort to try to hold back the onslaught from the federal government to make sure that we can support programs like the one we’re announcing today,” Pritzker told reporters at a December event publicizing a grant to address homelessness in central Illinois.
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Associated Press writer John O’Connor in Springfield, Illinois, contributed to this report.
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