These States Refuse to Match Trump’s Tax-Free Tips and Overtime Law

Workers Still Owe State Taxes Despite Federal Relief

President Trump signed the One Big Beautiful Bill Act on July 4, 2025, creating federal tax deductions for tips, overtime, car loan interest, and seniors.

But millions of workers in states like New York, California, and Illinois will still pay state income taxes on that same income. The federal government gave them a break.

Their state governments did not, and the fight over why is getting louder by the week.

New York and Illinois Require Add-Backs

In New York and Illinois, where static conformity laws would have caused the tax cuts to automatically transfer into the state tax code, the states are requiring an add-back for any deductions related to taxes on tips or overtime in order to protect revenue streams.

That means a server in Manhattan or a factory worker in Chicago gets the federal deduction, then has to add that income right back when calculating state taxes.

According to an analysis by the Institute on Taxation and Economic Policy, conforming to the federal provisions would cost New York $844 million.

California Declines to Conform

California’s Democratic leadership has signaled no intention to adopt the deduction, citing a projected annual revenue loss of around $3. 2 billion.

Tipped employees in California must still report all tips as income on state returns and may need to add back the federal deduction when filing.

California Senate Republicans attempted to advance amendments to create a state-level tip exemption, but legislative Democrats refused to consider the issue and killed the proposal without discussion or debate.

Four States Adopted Everything Automatically

Just four states, South Carolina, North Dakota, Montana, and Idaho, are adding tax breaks for qualified tips, car loan interest, overtime premium pay, and a $6,000 enhanced deduction for senior citizens.

These states have tax codes that automatically align with federal law, so the new deductions flowed through without any action from legislators.

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, but Colorado opted out of the overtime provision.

Michigan Stands Alone as Opt-In

Michigan this fall became the 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.

What the Federal Law Actually Covers

Effective for 2025 through 2028, employees and self-employed individuals may deduct qualified tips received in occupations that customarily receive tips, up to $25,000 annually.

The new law also caps deductions on overtime income at $12,500 for single filers and $25,000 for joint filers.

Individuals may deduct interest paid on a loan used to purchase a qualified vehicle for personal use, with a maximum annual deduction of $10,000.

Individuals who are age 65 and older may claim an additional deduction of $6,000.

Treasury Secretary Calls Out Blue States

Treasury Secretary Scott Bessent said in a statement that Democrat-held states such as Colorado, New York, Illinois, and the District of Columbia are deliberately blocking their own residents from receiving the historic benefits from the tax cuts.

Bessent called the moves a blatant act of political obstructionism and said this partisan stonewalling is a direct assault on the very families and workers liberal politicians claim to champion.

The statement came in December 2025 as the administration ramped up pressure on non-conforming states.

Service Workers Push Back Hard

Rion Gallagher, a 30-year-old bartender at an Irish pub in Midtown Manhattan, told reporters her reaction to New York’s decision was blunt.

She said if tips were not taxed, workers could save more, enjoy life a little more, and maybe not have to pick up that extra shift.

In California, bartender Alex Frost said he does not understand why the state needs his tip money when California already taxes residents more than any other state.

Colorado Opted Out of Overtime

Colorado opted out of the state tax break for overtime shortly before the federal law was enacted.

States currently connected to the tipped income deduction, including Colorado, Idaho, Iowa, Michigan, Montana, North Dakota, Oregon, and South Carolina, can expect to lose $336 million collectively in 2026.

States currently linked to the overtime deduction can expect to lose $648 million in 2026. The revenue concerns have driven decisions in both red and blue states.

Arizona Signals It Will Adopt

Democratic Governor 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 January 12. Arizona could become a model for bipartisan adoption if both sides follow through.

Most States Still Undecided

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 people begin filing them.

So far, only a few states have taken votes on whether to adopt the tax breaks.

States in general are approaching this skeptically, according to Carl Davis, research director at the Institute on Taxation and Economic Policy.

What This Means for Your 2025 Taxes

Taxpayers with eligible tips can claim the deduction on 2025 tips when they file their taxes in early 2026.

Workers will still owe federal payroll taxes on tips, and they may owe state income taxes depending on which state they live in.

If you work in a state that has not conformed, you will see the federal benefit but still owe your state. Check with your state tax agency or a tax professional before filing to understand exactly what you owe.

This article was created with AI assistance and human editing.

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