Income Tax in USA: Tax deductions in 2026: What Americans need to know?
In some states, new federal tax deductions will automatically apply to state income taxes unless legislatures opt out of this option. But in many other states where tax laws are written differently, the new tax deductions will not appear on state tax forms unless legislatures allow it.
In states that do not comply with federal tax changes, workers who receive tips or overtime, for example, will not pay federal taxes on those earnings but may still owe state taxes.
States that adopt all of Trump’s tax cuts could save certain residents and businesses hundreds of millions of dollars a year. But that could financially strain states that face higher costs due to new Medicaid and SNAP food assistance requirements that are also included in the massive bill Trump signed.
Most states begin their annual legislative sessions in January. To retroactively change tax breaks for 2025, lawmakers need to act quickly and tax forms need to be updated before people start filling out forms. States could also apply the changes to 2026 taxes, a less urgent decision.
So far, only a few states have voted on whether to adopt the tax cuts.
“States are generally skeptical of this,” said Carl Davis, research director at the nonprofit Institute on Taxation and Economic Policy.Trump’s treasury is pressing states to “immediately adjust”
The bill signed by Trump on July 4 includes federal tax cuts of approximately $4.5 trillion over 10 years.
It creates temporary tax deductions for tips, overtime and loan interest on new vehicles assembled in the United States. Increases tax credit for older adults. And, among other things, it temporarily raises the cap on state and local tax deductions from $10,000 to $40,000. The law also provides businesses with numerous tax breaks, including immediate write-off of 100% of equipment and research costs.
Forty-one states impose individual income taxes on wages and salaries. Forty-four states impose corporate taxes.
Treasury Secretary Scott Bessent this month called on those states to “immediately comply” with federal tax cuts and accused some Democratic-led states that did not do so of “political obstruction.” Many Republican-led states also haven’t decided whether to implement tax cuts, although Bessent didn’t mention it.
“By denying their residents access to these important tax cuts, these governors and legislators are forcing hard-working Americans to shoulder higher state tax burdens, depriving them of the benefits they are entitled to, and increasing the financial pressure on low- and moderate-income households,” Bessent said.
But some tax analysts suggest states have more to consider. For example, the tax deduction for tips could apply to about 70 occupations under the Internal Revenue Service’s proposed rule. But that would still leave out large numbers of low-wage workers, said Jared Walczak, vice president of government projects for the nonprofit Tax Foundation.
“Lawmakers need to consider whether these are worth the cost,” Walczak said.
Only a few states offer tax deductions for tips and overtime
Because of the way state tax laws are written, federal tax deductions for tips and overtime pay would only carry over to seven states (Colorado, Idaho, Iowa, Montana, North Dakota, Oregon, and South Carolina). But Colorado opted to exempt state tax deductions for overtime shortly before the federal law took effect.
Michigan this fall became the first, and so far, only state to opt for tax breaks for tip and overtime wages, effective 2026. The overtime tax exemption is expected to cost the state about $113 million during the current budget year, and the tip tax cut is expected to cost about $45 million, according to the state treasury department.
Michigan lawmakers made up for that by parsing out five federal corporate tax changes that the state treasury estimates would reduce Michigan tax revenues by $540 million this budget year.
Republican state Rep. Ann Bollin, chairwoman of the Michigan House Appropriations Committee, said the state cannot afford to embrace all tax cuts while investing in better roads, public safety and education.
“The best way forward is to have more money in people’s pockets and less regulation – and that’s where it’s headed,” he said.
Arizona could be one of the next states to take action. Democratic Gov. Katie Hobbs called on lawmakers to implement tax deductions for tips, overtime, senior living and car loans and to follow the federal government by increasing the state’s standard deduction for individual income taxpayers. Republican state House of Representatives leaders say they are ready to pass tax cuts when their session begins Jan. 12.
Many states reject corporate tax cuts
In addition to Michigan, lawmakers in Delaware, Illinois, Pennsylvania and Rhode Island have also introduced measures to block some or all of the corporate tax cuts from taking effect in their states.
Democratic state Sen. Elgie Sims, chair of the Senate Appropriations Committee, said a new Illinois law that departs from some of the corporate tax changes could save the state about $250 million. This could help ensure continued funding for schools, healthcare and vital services, he said.
Illinois Gov. J.B. Pritzker, Trump’s outspoken Democratic opponent, also cited budget concerns in rejecting the corporate tax cut provision. He said states already stand to lose money because of other provisions in Trump’s massive bill, such as a requirement to cover more of the cost of running the Supplemental Nutrition Assistance Program.
