On July 4, 2025, President Donald Trump signed the One Big, Beautiful Bill Act (hereinafter, âOBBBAâ or âthe Actâ) into law. OBBBA enacts sweeping changes to the Internal Revenue Code (âCodeâ), many of which will impact taxpayers at the state level, including reforms to the federal state and local tax (âSALTâ) deduction, Global Intangible Low-Taxed Income (âGILTIâ), Foreign-Derived Intangible Income (âFDIIâ), section 174 research and development expensing, and section 163(j) business interest deduction limitations. Notably, the Act does not include changes to Public Law 86-272, which had appeared in the House Bill under âOther Matters.â See our prior post on Public Law 86-272.
This post summarizes the most material SALT-related provisions in the Act and focuses on the Actâs implications for corporations, pass-through entities, and their owners.
Rewriting GILTI and FDII
The Act includes significant changes to how the federal government taxes foreign income under the (now renamed) GILTI and FDII regimes. While these are international tax provisions at their core, they carry real consequences for state tax regimes, many of which either conform to or selectively decouple from federal law.
Pre-OBBBA Law
Under pre-OBBBA law, corporations were allowed a federal income tax deduction under sectionâŻ250 of the Code equal to 50% of their GILTI. A similar 37.5% deduction applied to FDII. The state treatment of GILTI and FDII has been a patchwork. Some states conform to the federal model, although many have decoupled and adopted state-specific rules that apply to GILTI and FDII.
OBBBA Provisions
The Act structurally rewrites the GILTI and FDII regimes. In place of GILTI and FDII (but in the existing Code sections), the Act introduces âNet CFC Tested Incomeâ (NCTI) and âForeign-Derived Deduction Eligible Incomeâ (FDDEI), respectively. In addition to changing the nomenclature, the Act makes substantive changes to the new NCTI and FDDEI regimes. First, beginning in 2026, the NCTI and FDDEI deductions are reduced to 40% and 33.34%, respectively.
The Act also eliminates the 10% return on tangible assets (âQBAIâ), which had previously reduced the GILTI and FDII base. In addition, the Act changes the CFC expense allocation rules, which also has the potential to increase a taxpayerâs NCTI base. Finally, the Act reduces the existing limitation on foreign tax credits under section 960(d)(1) of the Code (the âFTC haircutâ) from 20% to 10%, while commensurately increasing a taxpayerâs gross-up amount under section 78.
State Impacts
From a state tax perspective, the changes to the GILTI (now NCTI) regime in particular have the potential to significantly increase the state income tax base. In particular, the reduction in the NCTI deduction percentage combined with the increases to the NCTI base and section 78 gross-up amount means that conforming states will see a broader base and, because states do not offer a foreign tax credit similar to the federal FTC, potentially higher taxable income starting in 2026.
That said, state conformity to the prior GILTI and FDII regimes varied widely since the Tax Cuts and Jobs Act (TCJA) was enacted. At the beginning of 2024, 21 states along with the District of Columbia and New York City levied tax on GILTI in some fashion. While many states tax only a small portion of GILTI (often, 5%), other jurisdictions, like New York City, tax at least 50% of GILTI. Furthermore, as reported, Illinois lawmakers recently passed HB2755 as part of its FY2026 budget bill, which, if enacted as is, would for the first time levy tax on 50% of a taxpayerâs GILTI income for tax years ending on or after December 31, 2025. Similarly, Massachusetts proposed changing its approach to GILTI. Currently, Massachusetts levies tax on 5% of GILTI, but recent legislation proposed an increase to 50%. This noticeable trend may increase even more significantly as states continue to face revenue shortfalls, particularly as states realize that the Actâs changes to GILTI/NCTI may create larger tax bases without the offsetting credits available at the federal level. However, as discussed in prior coverage of a similar proposal by New York State, there is a serious constitutional question as to whether states can mechanically conform to previous GILTI regime in some respects (for example, by conforming to the income inclusion and deduction provisions) but not others (for example, by failing to conform to the federal tax credit provisions), and as to how a taxpayerâs apportionment factors should appropriately reflect the economic activities generating the GILTI inclusion (for example, by limiting the sales factor denominator to net or gross GILTI and not including the gross sales of the GILTI-generating CFCs). We have been working with a number of taxpayers to address these issues in an equitable manner through apportionment and, in some cases, full tax base relief. Â
Bonus Depreciation: Full Expensing Made Permanent
The Act also delivers a major shift in the treatment of capital expenditures by making permanent the 100% bonus depreciation rules under section 168(k).
Pre-OBBBA Law
Originally enacted as part of the TCJA, full expensing allowed businesses to immediately deduct the entire cost of qualifying property in the year it was placed in service. However, this provision was designed to phase down beginning in 2023, with the deduction percentage gradually decreasing until it was scheduled to sunset entirely by 2027.
OBBBA Provisions
The Act reverses course. It eliminates the phase-down schedule and restores full expensing for qualified property acquired after January 19, 2025. This includes tangible property with a recovery period of 20 years or less, certain plants, and self-constructed assets. The Act also provides transitional relief for taxpayers who may prefer a more gradual approach, i.e., for property placed in service in the first taxable year ending after January 19, 2025, taxpayers may elect to apply a reduced bonus depreciation rate of 40% or 60%, depending on the type of property.
By making full expensing permanent, the Act aims to provide long-term certainty for capital investment decisions. This change is particularly beneficial for businesses in asset-intensive sectors such as manufacturing, transportation, and energy, where upfront capital costs are significant and immediate cost recovery can materially improve cash flow and investment returns.
In addition to reinstating full expensing under section 168(k), the Act introduces a new special depreciation allowance under section 168(n) for âqualified production property.â This provision allows taxpayers to fully expense certain portions of nonresidential real property used in manufacturing, production, or refining activities, provided the property is constructed and placed in service within a specified window. The allowance is elective and subject to recapture if the property is repurposed within 10 years. While narrower in scope, this new incentive is designed to further encourage domestic industrial investment.
By making full expensing permanent and layering in targeted incentives for production-related infrastructure, the Act aims to provide long-term certainty for capital investment decisions. These changes are particularly beneficial for businesses in asset-intensive sectors such as manufacturing, transportation, and energy, where upfront capital costs are significant and immediate cost recovery can materially improve cash flow and investment returns.
State Impacts
From a state tax perspective, however, the impact is more complex. Many states do not conform to federal bonus depreciation rules. Some explicitly decouple from section 168(k), requiring taxpayers to add back the federal deduction and depreciate the asset over a longer period using state-specific methods. Others conform on a rolling basis, meaning the federal change could automatically flow through unless the state takes legislative action to decouple.
As a result, the permanence of full expensing at the federal level may create new timing differences between federal and state taxable income. Taxpayers operating in multiple jurisdictions will need to carefully track these differences and monitor state legislative responses. In states that do conform, the change could significantly reduce taxable income and state tax liabilities in the year of acquisition. In non-conforming states, however, the benefit may be deferred or denied altogether.
Ultimately, while the Actâs full expensing provision is a clear win for federal tax policy aimed at encouraging investment, its state tax implications will vary widely depending on each stateâs conformity to the Code.
Section 174 – research and experimental (âR&Eâ) expenditures
Another provision that is not directly aimed at state and local taxes, but which has the potential to significantly impact state tax liabilities, is the amendment of section 174 and addition of section 174A.
Pre-OBBBA Law
Under the TCJA, R&E expenditures were required to be capitalized and amortized over a five- or fifteen-year period for domestic and foreign research activities, respectively.
OBBBA Provisions
The Act fundamentally reshapes this landscape by introducing a new section 174A, which permanently restores the ability to fully expense domestic R&E expenditures. For tax years beginning after December 31, 2024, taxpayers may immediately deduct domestic research expenses in the year incurred. This provision calls for the reinstatement of full expensing for domestic R&E beginning in 2025. Foreign R&E expenses remain subject to a 15-year capitalization and amortization period.
In addition to immediate expensing, the Act allows taxpayers to elect alternative treatment for domestic R&E expenditures. Specifically, businesses may choose to capitalize and amortize these costs over a period of not less than 60 months under section 174A(c), or they may opt for a 10-year amortization under existing section 59(e).
The Act does not impose a sunset date on these provisions. In the effective date section, the Act clearly states,â[t]he amendments made by this section shall apply to amounts paid or incurred in taxable years beginning after December 31, 2024.â There is no language in the Act that limits the application of section 174A to a specific range of years or includes any expiration or sunset clause.
The Act also includes coordination rules to ensure consistency with other provisions of the Code, including the research credit under section 41, the alternative minimum tax under section 56, and the deduction limitations under section 280C. Importantly, the Act provides transition relief for taxpayers. Eligible small businesses (i.e., businesses that meet the gross receipts test under section 448(c)) may elect to expense rather than amortize these expenditures retroactively as though the capitalization requirement for 2022, 2023 and 2024 never occurred. Additionally, all taxpayers are permitted to accelerate the amortization of previously capitalized domestic R&E expenses, either by deducting the remaining unamortized amounts in the first year after the new rules take effect or by spreading them over two years. These transition rules offer meaningful relief for businesses that have been burdened by the TCJAâs capitalization requirement.
State Impacts
The state impact of the proposed research expense changes is, as with the GILTI and FDII changes, primarily driven by conformity to the Code. However, conformity in this instance is necessarily constrained by the Commerce Clause, which prohibits states from discriminating against interstate or foreign commerce. States that mechanically conform to pre-OBBBA section 174 arguably violate the Commerce Clause by providing a shorterâand thereby preferentialâamortization period to domestic versus foreign research expenditures. This conclusion is supported by the seminal case of Kraft General Foods, Inc. v. Iowa Department of Revenue & Finance, 505 US 71 (1992), in which the US Supreme Court held that Iowaâs income tax laws, which allowed taxpayers to deduct dividends from domestic subsidiaries (in conformity with the Code), but not deduct dividends from foreign subsidiaries, unconstitutionally discriminated against foreign commerce. While mechanical conformity to section 174 already poses a Commerce Clause problem, the issue will become even more pronounced if states conform to new section 174A, which will allow an immediate deduction for domestic research expenses while maintaining a 15-year amortization period for foreign research expenses. This marked disparity in the tax treatment of domestic and foreign research activities may face serious Commerce Clause scrutiny in states that attempt to take a mechanical conformity approach.
Business Interest Expense Limitation
The deductibility of business interest expenses is another area targeted by the Act that will have carryover impacts for taxpayersâ state tax liabilities.
Pre-OBBBA Law
Under the TCJA, Congress limited the section 163(j) interest expense deduction to 30% of earnings before interest and taxes (âEBITâ) for tax years beginning in 2022.
OBBBA Provisions
The Act permanently installs earnings before interest, taxes, depreciation and amortization (âEBITDAâ) as the benchmark for calculating the sectionâŻ163(j) limitation. Specifically, the Act amends sectionâŻ163(j)(8)(A)(v) by striking the phrase âin the case of taxable years beginning before January 1, 2022,â thereby eliminating the sunset provision that would have required a switch to EBIT. This change increases the amount of interest that businesses can deduct, particularly capital-intensive firms that benefit from depreciation and amortization add-backs.
The above amendments under the Act apply to taxable years beginning after December 31, 2024, and the Act authorizes the Treasury to issue guidance for short taxable years that begin after that date but end before the date of enactment.
In addition to the above, the Act constricts the definition of Adjusted Taxable Income (ATI) to exclude certain foreign income inclusions. Specifically, for tax years beginning after December 31, 2025, ATI will not include:
- Gross income under sections 951(a) (Subpart F), 951A(a) (GILTI), and 78 (deemed paid foreign tax credits),
- And the related deductions under sections 245A(a) (for certain dividends) and 250(a)(1)(B) (for GILTI/NCTI), to the extent attributable to those inclusions.
This change effectively decreases ATI for multinational corporations, potentially allowing for lower interest deductions under section 163(j).
The Act also introduces a new coordination rule between the section 163(j) limitation and interest capitalization provisions. Under this rule:
- The section 163(j) limitation applies to all business interest, regardless of whether it would otherwise be deducted or capitalized. However, interest capitalized under sections 263A(f) or 263(g) is excluded from the definition of âbusiness interestâ for section 163(j) purposes.
- The amount allowed after initial limitation is first applied to interest that would otherwise be capitalized, with any remaining amount applied to deductible interest.
- Disallowed interest carried forward under section 163(j)(2) is not subject to future capitalization rules.
These above changes apply to taxable years beginning after December 31, 2025, and the Act authorizes the Treasury to issue guidance for short taxable years that begin after that date but end before the date of enactment.
State Impact
From a state tax perspective, the return to an EBITDA based limitation could meaningfully lower taxable income in states that conform to section 163(j). Certain states follow the federal interest expense limitation either automatically as a rolling conformity state or with limited modifications as a selective conformity state. Therefore, restoring depreciation and amortization to the calculation of adjusted taxable income would expand the deductible interest base in those jurisdictions. For capital-intensive industries (such as manufacturing, utilities, etc.) this change could provide significant relief.
The exclusion of Subpart F income, GILTI, and Section 78 gross-up amounts from ATI under the revised section 163(j) may reduce federal interest deduction capacity for multinational taxpayers. However, the state impact will vary significantly depending on each state’s conformity to the Code. Some states conform to the Code on a rolling basis and may adopt these changes automatically, while others with static or selective conformity may continue to include these foreign income items in their ATI calculations, potentially resulting in a higher state-level interest deduction. Additionally, the new coordination rule between section 163(j) and interest capitalization provisions may affect the timing and character of interest deductions in states that conform to section 163(j).
However, states may choose to either not conform or selectively decouple from the favorable section 163(j) changes. Selective decoupling in the 163(j) context, in particular, was fairly common when Congress temporarily increased the limitation through the Coronavirus Aid, Relief, and Economic Security Act (âCARES Actâ) to 50% of EBITDA for the 2019 and 2020 tax years. Only 20 states and the District of Columbia conformed to the modified expense deduction in 2021. Taxpayers will need to monitor state conformity closely to avoid mismatches between federal and state interest expense deductions.
SALT Deduction Cap and Workaround
One of the most high-profile areas of reform targeted by the Act is the federal SALT deduction. The ability of individual taxpayers to deduct state and local taxes has been limited since the passage of the TCJA in 2017, and the Act makes immediate and significant changes in this area.
Pre-OBBBA Law
Post-TCJA, individual taxpayers who itemized were only able to deduct $10,000 ($5,000 for married taxpayers filing separately) of state and local income, real property, and personal property taxes for federal income tax purposes. This cap, known as the âSALT Cap,â has been one of the more politically contentious features of the TCJA and was set to expire after 2025. There was an important carveout, however, for taxes paid in connection with a trade or business, which opened the door for workaround strategies, such as state pass-through entity tax (PTET) regimes. PTET regimes have been embraced by over 30 states in recent years and allow owners of pass-through entities to circumvent the SALT Cap by shifting the state income tax burden from the individual owners to the pass-through entity. Unlike individual income tax payments, PTET payments are not subject to the SALT Cap.
OBBBA Provisions
The Act does not repeal the SALT Cap but instead temporarily increases the deduction limit and introduces an income-based phase-down mechanism. Under the Act, the SALT Cap is increased to $40,000 for tax year 2025 and slightly adjusted to $40,400 for 2026. For tax years 2027 through 2029, the cap is indexed upward annually. However, beginning in 2030, the cap reverts to the original $10,000 limit established under the TCJA. Importantly, for married individuals filing separately, the cap is set at half the applicable limitation amount, i.e., $20,000 in 2025, $20,200 in 2026, and so on.
A key feature of the Act is the introduction of an income-based phase-down. For taxpayers with modified adjusted gross income (âMAGIâ) exceeding $500,000 (or $505,000 in 2026, with inflation adjustments thereafter), the allowable SALT deduction is reduced by 30% of the excess income over the threshold. However, the deduction cannot fall below $10,000, ensuring a minimum benefit remains available. The Act also defines MAGI to include income excluded under sections 911, 931, or 933 (such as foreign earned income and income from US territories).
Notably, the Act does not address PTETs at all. The amendments apply to tax years beginning after December 31, 2024.
State Impacts
While the temporary increase to the SALT Cap in the Act may benefit many taxpayers (particularly those in high-tax states) the Actâs income-based phase-down introduces new complexity. Importantly, the Act does not include any provisions addressing the deductibility of PTET payments. As a result, the current workaround remains intact, at least for now. Taxpayers in high-taxed states that adopted PTET regimes (e.g., California, New York, New Jersey, Illinois, etc.) will need to evaluate whether continuing with their PTET election makes sense.
Conclusion
While much of the focus of the Act has been on what this legislation means for federal and international tax purposes, the lawâs impact on taxpayersâ state tax obligations should not be overlooked. In particular, taxpayers should consider the impact that the Act may have on their state GILTI (now NCTI) inclusions, R&E expense deductions, and state PTET elections, and may want to proactively take measures to protect against reflexive increases in state tax liabilities. Taxpayers should also closely monitor the statesâ conformity to the Code or decoupling measures that states are likely to consider and adopt in the coming state legislative sessions. Baker McKenzieâs SALT team is actively monitoring state reactions and developments in light of the Act and can advise clients on the state tax impact that the Actâs changes may have on their particular business.
Contact the Authors: Maria Eberle, Niki Ford, Matt Musano
