Section 174 Decoupling: What Every Tax Professional Needs to Know
If you are filing state tax returns this spring and assuming the rules around Section 174 capitalization are settled, think again. The landscape is shifting so fast that even state departments of revenue cannot keep up. That is the central warning from a new episode of the TaxOps podcast, where partners Jamie Overberg and Sean Espy unpack the state-by-state chaos surrounding 174 decoupling.
The result is a candid, deeply informed conversation that every tax professional, CFO, and controller navigating multi-state compliance needs to hear.
The Research Problem No One Is Talking About
Here is the uncomfortable truth: no two sources agree on how many states have decoupled from federal Section 174 capitalization rules. Jamie Overberg puts it bluntly during the episode: “Google, GPT will tell you one answer. I’ve listened to a presentation from Deloitte and they had a map. I’ve seen a map of states that have decoupled from PwC and it doesn’t match what we had.”
The count hovers somewhere between 20 and 30 states, but the number keeps moving. States have been issuing guidance late, reversing positions, and in some cases, their own departments of revenue lack clarity on where things stand. “We’ve found sometimes if you contact the DOR that says, ‘Are you guys doing this?’ They don’t even know,” Overberg notes.
For practitioners filing returns right now, this means the only reliable approach is going directly to each state’s website for the most current guidance, and even then, exercising extreme caution.
The District of Columbia Standoff
Perhaps the most dramatic example of the current volatility involves the District of Columbia. DC passed a law decoupling from both individual and corporate provisions under OBBA, a move that hit particularly hard given its concentration of tipped and overtime workers. The federal government responded by telling DC it could not opt out of OBBA. DC fired back with a lawsuit.
“I honestly don’t even know where that stands,” Overberg admits. It is a telling moment: when a seasoned tax professional cannot pin down the status of a major jurisdiction’s conformity, you know the terrain is genuinely unstable.
Arizona: A Case Study in Legislative Whiplash
Arizona offers a textbook example of how quickly things can change. The governor initially issued an executive order decoupling from both individual and corporate provisions. The legislature then wrote a bill to conform. The governor vetoed it. Negotiations followed, resulting in a compromise: decouple from corporate provisions, but conform on the individual side.
This kind of back-and-forth is playing out across the country, and it underscores why tax professionals cannot rely on a single snapshot in time.
Why States Are Decoupling (and Why Some Are Not)
The pattern is largely fiscal. “It’s kind of been the states that have the worst budget crunches that are the ones that are decoupling,” Overberg explains. States need revenue, and requiring companies to capitalize research expenditures at the state level, even when federal rules no longer demand it, generates taxable income.
Colorado offers a notable exception. Despite facing a billion-dollar budget shortfall, the state chose not to decouple. Overberg attributes this to the governor’s centrist approach and willingness to ease the burden on taxpayers, particularly lower-wage earners affected by tip and overtime taxation.
The 174 Compliance Trap
Sean Espy raises a critical point that many companies overlook: Section 174 applies wherever technical uncertainty exists, which can be anywhere. Unlike the R&D tax credit, which requires qualified research expenditures in a specific state, 174 captures a broader universe of costs, especially after 174A expanded the definition to include all software development expenses.
“The states are certainly allowing, or requiring rather, any activities outside of the state to be included in your 174,” Espy explains. For companies with operations spanning multiple jurisdictions, this creates a compliance obligation that cannot be ignored simply because they would prefer not to claim R&D.
The silver lining: now that federal capitalization is no longer required, companies are more willing to embrace R&D claims. As Overberg observes, “If they only have a 5% apportionment in Arizona, it’s not going to hurt them as much.”
State Credit Changes Worth Watching
Beyond 174 decoupling, the episode covers several significant state-level credit changes:
● California has finally adopted the Alternative Simplified Credit, though at lower rates (3% with a three-year base, 1.3% without). One catch: switching back to the regular credit method requires a formal methods change, unlike the federal election which can shift year to year.
● Michigan has restored its research credit, but with tight deadlines (April 1 this year, moving to March 15 next year) and a calendar-year-only requirement that creates complications for fiscal year filers. The state’s $100 million budget will be divided proportionally among applicants.
● Oklahoma has launched a “research rebate” that appears to be refundable, with a budget of approximately $30 million and a first-come, first-served application window of just one week.
● Texas has increased its credit rate from 5% to 8.6% and eliminated the outdated discovery test, updating its static conformity date to January 1, 2025.
● Minnesota now offers a partially refundable credit, creating potential cash benefits for companies with losses.
● Iowa has re-included supplies and lease computer costs in its credit, but now requires pre-application and certification before claiming.
The International Wrinkle
As the conversation wraps up, Espy delivers one final reminder that is easy to overlook amid the domestic chaos: Section 174 capitalization for international R&D activities still applies. Companies conducting research overseas must still account for those costs on their returns, regardless of what has changed domestically.
What This Means for Your Filing Strategy
The message from Overberg and Espy is clear: do your research, verify it against the most current state guidance, and have your numbers ready. Modeling calculations across multiple scenarios, particularly when considering interactions with AMT, FDII, and NOL limitations, is not optional. It is essential.
“We live in a wild, wild west era right now,” Overberg says. She is not exaggerating.
Listen to the full episode of the TaxOps podcast for the complete conversation between partners Jamie Overberg and Sean Espy, including detailed examples and practical guidance for navigating this unprecedented compliance landscape.
About the Hosts
Jamie Overberg — Partner, TaxOps Minimization. Jamie has more than 20 years of R&D tax credit experience, with deep expertise in credit execution, tax minimization strategies, and ASC 730/740 and FIN 48 reporting. She previously spent 13 years at Ernst & Young, including a national role in E&Y’s Washington, D.C. R&D practice.
Sean Espy — Partner, TaxOps Minimization. Sean brings more than 25 years of consulting experience across public accounting, legal, and industry, specializing in Research Credit consulting. He has represented clients before the IRS and state tax authorities in nine states and is admitted to the U.S. Tax Court and the Supreme Court of the United States.
Listen to the full conversation on Tax Intelligence, available now.
Tax Intelligence with TaxOps
This is the podcast where experienced tax professionals share clear, practical insight on today’s most complex tax issues–from SALT and federal tax strategy to ASC 740, tax minimization, and investment fun considerations. Each month, our experts break down what matters, what’s changing, and how to think strategically about tax–so you can make informed decisions with confidence. Listen today!
About TaxOps
At TaxOps, business tax is all we do. Our teams have the knowledge and focus to solve tax problems with practical tax answers. By hiring our Big Four-veteran leaders and experienced teams, you get tax strategists on your side supporting your strategy wherever business takes you. We deliver the strength, experience, and resources of a national tax brand with the hands-on client engagement of a boutique firm in federal, corporate, state and local and international tax as well as tax minimization strategies for businesses. For an introductory call, visit TaxOps.com/contact.
Read more
- Auditor Independence in the Age of Private Equity: What CFOs Need to Know
- R&D Credits for Software Companies: Scrum Teams, Qualifiers, and Section 174 After OBBBA
- Section 174 Decoupling: What Tax Pros Need To Know State By State
- TaxOps Welcomes Sean Espy as Partner, Tax Minimization
- Your Tax Footprint Is Probably Bigger Than You Think: What Finance Leaders Need to Know About State Nexus
Recent Comments