Since when is this okay?
President Donald Trump’s One Big Beautiful Bill delivered sweeping federal tax changes aimed at helping workers, retirees, and families keep more of their income. The law eliminated federal income taxes on qualifying tips and overtime pay, expanded tax relief for many seniors, and introduced a new education tax credit program.
However, because states control their own income tax systems, many have not adopted the same changes. As a result, millions of Americans continue paying state taxes on income that now receives federal tax relief.
The differences have created a patchwork of tax policies across the country, leaving workers with very different tax bills depending on where they live.
Which States Have Not Adopted the Federal Tax Changes?
Several states continue taxing nearly every major category of income affected by the federal law signed on July 4, 2025.
Among those are Connecticut, Minnesota, New Mexico, Rhode Island, and Vermont, which continue taxing income that now qualifies for federal tax deductions. These states also have not joined the Education Freedom Tax Credit program established by the legislation.
Other states have adopted only portions of the federal changes.
For example, New York still taxes tips and overtime at the state level, although Governor Kathy Hochul has proposed legislation that would exempt tip income. The state already exempts Social Security benefits from state income tax and plans to participate in the education tax credit program beginning in 2027.
California also continues taxing tips and overtime wages while opting out of the education tax credit program. However, the state does not tax Social Security benefits.
Many States Still Tax Tips
Although qualifying tips are no longer subject to federal income tax, 31 states and Washington, D.C., continue taxing tip income.
That means many restaurant servers, bartenders, and hospitality workers still owe state income taxes on gratuities, reducing the financial benefit created by the federal law.
Minnesota provides one example. The state’s progressive income tax ranges from 5.35% to 9.85%. A server earning $70,000 annually, including $25,000 in tips, could still owe roughly $1,700 in state taxes on tip income because Minnesota has not aligned its tax code with the federal deduction.
Restaurant industry groups in New Mexico have also criticized the state’s decision to continue taxing tips.
The New Mexico Restaurant Association said eliminating state taxes on tips would provide meaningful relief for service workers and encourage broader tax reform for working families.
By comparison, states that adopted the federal deduction allow workers to keep more of their earnings. In Idaho, for example, a worker receiving about $25,000 in annual tips could save approximately $1,325 through matching state tax treatment.
State Taxes on Social Security Still Vary
The federal legislation also expanded tax relief for many Americans age 65 and older by creating a temporary federal deduction of up to $6,000 through the 2028 tax year.
State tax rules, however, remain different.
Eight states continue taxing at least some Social Security income:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
Advocates for older Americans say these differences can have a meaningful financial impact, particularly for retirees living on fixed incomes while facing higher costs for housing, healthcare, groceries, and other necessities.
Eligibility rules also vary. Vermont’s exemption is limited to individuals earning less than $55,000 and couples earning under $70,000, while the federal deduction begins phasing out at higher income levels.
Overtime Pay Remains Taxable in Many States
The federal law also removed federal income taxes on qualifying overtime pay, allowing eligible workers to deduct up to $12,500 in overtime earnings from federal taxable income.
Even so, 30 states and Washington, D.C., continue taxing overtime under their own income tax laws.
States that aligned their tax codes with the federal changes, including Michigan, allow eligible workers to claim similar deductions on their state returns through 2028.
Labor organizations have also urged lawmakers to expand eligibility for transportation workers who operate under different federal overtime rules, arguing that additional workers should receive the same tax benefits.
Supporters say broader eligibility would allow more hourly employees to keep a larger share of the wages they earn through extra hours on the job.
Education Freedom Tax Credit Depends on State Participation
The One Big Beautiful Bill also created the Education Freedom Tax Credit, a federal program intended to encourage donations to scholarship organizations that support school choice initiatives.
States must choose whether to participate, and 29 states have opted into the program so far.
Under the program, taxpayers may contribute up to $1,700 to approved scholarship organizations and receive a corresponding federal tax credit. Residents of states that do not participate may still donate, but those contributions are directed toward scholarship organizations in participating states.
Supporters argue the program expands educational opportunities for students while encouraging private investment in scholarship programs. They also contend that states choosing not to participate could miss out on donations that would otherwise benefit students within their own borders.
Bottom Line
The One Big Beautiful Bill significantly reduced federal taxes on qualifying tips, overtime pay, and certain income for older Americans. But because states write their own tax laws, the full financial benefit depends on where taxpayers live.
For workers, retirees, and families in states that have not adopted the federal changes, state income taxes continue to apply even when those same earnings now receive federal tax relief. As additional state legislatures meet in the coming months, lawmakers will decide whether to align their tax codes with the new federal law or maintain their current policies.