Which states will conform to or reject the federal overtime deduction for state income tax purposes?

1. What Washington changed — and why states now must choose

The One Big Beautiful Bill Act (OBBBA) added an above-the-line deduction for qualified overtime compensation and a separate deduction for tipped income that take effect for 2025 returns filed in 2026; the IRS requires new wage reporting and employers must track qualified overtime separately starting in 2026 ^{[1] [5] [6]}. Because state tax codes differ — some “conform” automatically to federal changes while others require a legislative act — the federal deduction will carry into state returns in only a subset of states unless those states explicitly decouple or legislate otherwise ^{[2] [5]}.

2. Who has moved to conform so far — and the exceptions

As of the reporting, Michigan is the first state to opt into the federal tips-and-overtime deductions effective for 2026 state taxes, marking rare affirmative state-level adoption ^[2]. Separately, because of the structure of many state codes, seven states—Colorado, Idaho, Iowa, Montana, North Dakota, Oregon and South Carolina—were identified as the places where the federal breaks would have carried over automatically if state law language allowed ^[2], though real-world choices have diverged: Colorado, for example, reversed an automatic carryover and explicitly decoupled from the overtime break ^{[3] [2]}.

3. Who has explicitly rejected or decoupled from the federal overtime/tip breaks

Several states and jurisdictions have taken steps to block the federal deductions from lowering state tax revenue: Colorado moved to decouple from the overtime deduction to avoid large revenue loss ^[3], Maine’s governor instructed state tax officials not to conform to the tips and overtime deductions ^[3], and the District of Columbia passed legislation reinforcing decoupling from both deductions ^[3]. Reporting also identifies Illinois as planning to require an add-back for any tip or overtime deduction on state returns because the state cannot absorb the revenue loss ^[4]. Other states — Massachusetts, Connecticut and Hawaii — have signaled they will not conform, either by default statutory differences or through policy decisions ^[4].

4. The large “wait-and-see” group and why many states hesitate

A sizable number of states are neither committed to adoption nor outright rejection and are approaching OBBBA skeptically; some—Georgia, Maryland and South Carolina—were specifically called “wait-and-see” as of late 2025 and planned to address the issue in 2026 sessions ^[4]. Fiscal pressure explains the caution: independent modeling from the Institute on Taxation and Economic Policy projected substantial state revenue losses if states link to the federal tips-and-overtime breaks, and ITEP identified a multi-hundred‑million-dollar hit across several states connected to the tipped-income deduction ^[3]. Political dynamics also matter: federal officials urged states to conform, while many state legislatures have framed decoupling as budget protection, a conflict that can align with partisan politics and local revenue priorities ^{[2] [3]}.

5. What taxpayers and employers should expect next

Practically, taxpayers in states that decouple will still benefit federally but may owe state tax on the same overtime or tip amounts; employers must prepare for new W‑2 reporting (Box 12 code “TT” for qualified overtime is planned) and should update payroll systems to separate FLSA-qualified overtime from other premiums starting in 2026 ^{[6] [7]}. Because many states’ positions remain unresolved, workers should watch state legislative actions and guidance for 2026 filing, and payroll departments should plan for divergent state treatments that will complicate withholding and year‑end reconciliation ^{[5] [8]}.