Interaction Between Federal and State Tax Systems
Many states, including Delaware, calculate state taxable income by starting with federal taxable income. As a result, changes to the federal tax code often flow through to state tax calculations automatically unless the state enacts legislation to modify or decouple from those changes.
The OBBBA introduced changes that accelerate certain business deductions. Because accelerated deductions reduce taxable income in earlier years, automatic conformity would have reduced Delaware’s tax revenues in the short term. HB 255 reflects the state’s decision to selectively decouple from specific federal provisions rather than adopt them in full.
Key Federal Provisions Under the OBBBA
Enacted on July 4, 2025, the OBBBA is a broad federal tax and spending law. Several provisions affecting business deductions are particularly relevant to Delaware’s response.
- Research and Experimentation (R&E) Expenses
The OBBBA allows certain domestic research and experimentation expenses to be deducted more quickly than under prior law. Earlier federal rules under the Tax Cuts and Jobs Act (TCJA) required pre-2025 costs to be capitalized and amortized over time. The revised approach permits faster deduction of these costs, which can reduce taxable income. - Expensing of Business Property
The law expands full expensing, commonly referred to as 100% bonus depreciation, for qualifying business property. Under this approach, eligible assets may be deducted in full in the year they are placed in service rather than depreciated over multiple years. - Depreciation of Qualified Production Property
The OBBBA also introduces a special depreciation allowance for certain qualified production property, such as manufacturing facilities. This provision allows a significant portion of eligible costs to be deducted in the year the property is placed in service.
Collectively, these provisions accelerate deductions without changing the total amount deducted over time.
Importance of Deduction Timing
The timing of deductions affects when tax benefits are realized. Immediate deductions reduce current taxable income and tax liability, while depreciation or amortization spreads deductions across future years.
At the federal level, accelerated deductions are often used to encourage investment and economic activity. For states that conform to federal tax rules, however, faster deductions can result in reduced tax revenues in the short term, even if those revenues may recover over time.
Delaware’s Response Under HB 255
HB 255 addresses the timing effects of the OBBBA for Delaware income tax purposes. The bill does not change tax rates or eliminate deductions. Instead, it modifies how certain federal provisions apply at the state level.
The bill applies to both C corporations and individuals with business income, such as owners of partnerships or S corporations.
- R&E Expenses
For R&E expenses incurred before 2025, HB 255 requires Delaware taxpayers to continue using pre-OBBBA deduction timing. As a result, businesses may deduct these expenses immediately for federal purposes while spreading the deductions over time for Delaware purposes. - Expensing of Business Property
HB 255 decouples Delaware from federal rules allowing full expensing of certain business property placed in service after specified dates. Assets that are fully expensed federally may instead be depreciated over several years on the Delaware return, subject to the pre-OBBBA bonus depreciation phase-out rules under the previous federal tax law. - Qualified Production Property
The bill also decouples Delaware from the federal special depreciation allowance for qualified production property, requiring depreciation over several decades for state tax purposes.
Different effective dates apply depending on the type of taxpayer, with certain provisions applying immediately to C corporations and others applying to individuals with business income beginning in 2026.
Rationale for Decoupling
Supporters of HB 255 characterized the bill as a revenue timing measure. Because Delaware’s tax base is closely tied to federal taxable income, full conformity with the OBBBA’s accelerated deductions would have reduced state revenues in the short term. State projections indicated that the impact could be significant over several years.
By slowing the timing of deductions, HB 255 aims to moderate the short-term revenue effects while still allowing deductions over time.
Considerations for Businesses
Some businesses and tax professionals raised concerns about the potential economic and administrative effects of decoupling.
Accelerated deductions are often viewed as incentives for investment, and the differences discussed above between federal and state rules could discourage investment at the state level.
Although HB 255 does not affect federal deductions, it may reduce the combined federal and state tax benefit associated with investments in Delaware, particularly in the early years.
Differences between federal and state tax rules also increase compliance complexity. Businesses may need to maintain separate depreciation and amortization schedules for federal and state filings. This can increase recordkeeping requirements, especially for businesses operating in multiple states.
HB 255 adds divergence points between federal and Delaware tax rules, contributing to these administrative considerations.
Looking Ahead
Several outcomes will become clearer over time, including the revenue effects of HB 255 and whether the law influences business investment decisions. Future federal tax changes may also prompt additional state-level responses.
Conclusion
The OBBBA and Delaware HB 255 address similar business tax issues but reflect different policy priorities. The OBBBA emphasizes accelerated deductions at the federal level, while HB 255 focuses on managing the timing of state tax revenues. Both rely on timing differences rather than eliminating deductions entirely.
These laws illustrate how federal tax changes can lead states to reassess conformity and make targeted adjustments. For state businesses and policymakers, the key issue is not whether deductions are allowed, but when those deductions are recognized for tax purposes.
Kevin Gobeil, CPA is a Principal with Santora CPA Group.
Published in the Spring issue of Delaware Banker.
