Conformity is a choice each state makes
States build their income tax on the federal base, but each decides how closely to follow it. Some adopt the Internal Revenue Code as currently amended. Some adopt it as of a fixed date and move that date by legislation. Many decouple from specific provisions they regard as too expensive, permanently.
The 2025 federal legislation turned this ordinary technical question into a consequential one, because much of what it changed is precisely what states most often refuse to follow.
California, specifically
California is the clearest case and affects the largest number of high earners, so it is worth setting out precisely rather than in general terms.
- California uses a fixed conformity date rather than following federal law as it changes. Legislation moved that date forward to January 1, 2025, for tax years beginning on or after that date.
- The federal legislation was signed on July 4, 2025. That is six months after the date California just adopted, so the update does not reach it. California does not conform to those changes.
- Separately, and more durably, California has never conformed to federal bonus depreciation under section 168(k). Not under the 2017 Act, not under the pandemic legislation, and not now. This is a standing decoupling rather than a lag that will close.
- California immediate expensing under section 179 is capped far below the federal amount.
- California does not follow section 1202 at all. Its own exclusion was repealed in 2013, and its code states that the federal provision does not apply for California purposes.
- California has no preferential rate for capital gains. They are taxed as ordinary income, at a top rate of 13.3 percent.
California is the most prominent example rather than the only one. Several other states decouple from accelerated cost recovery, and several more use fixed conformity dates that now sit behind the federal changes. The answer differs by state and has to be looked up rather than assumed.
Why this changes what you should own, not only what it is worth
Most commentary treats non-conformity as a haircut. The benefit is smaller, model it lower, move on. That understates it, because deductions and credits reach a state return by completely different routes.
A federal deduction reduces federal taxable income, and federal taxable income is the starting point for the state calculation in most states. So in a conforming state a deduction works twice, federally and at state level, without anyone arranging for it.
A federal credit does not touch taxable income at all. It reduces federal tax after the income computation is finished, so it never reaches the state base and produces no state benefit in any state, conforming or not.
| Position type | Conforming state | Non-conforming state such as California |
|---|---|---|
| Depreciation-heavy | Federal benefit, plus a state benefit that arrives automatically | Federal benefit only. The state requires an addback and recovers over its own longer schedule |
| Federal credit | Federal benefit only | Federal benefit only. Unchanged by conformity |
| State credit | Reduces state tax directly | Reduces state tax directly. The only route to a state benefit here |
It is worth being precise about what that does and does not say. Credits have not become better in absolute terms. Depreciation has become worse, because non-conformity removes the half of its benefit that would otherwise have flowed through the state base. The ranking between them changes even though neither instrument changed.
What it means for how positions are selected
Two clients with identical incomes and identical appetites should not necessarily be shown the same structure if one lives in Texas and the other in California. The federal analysis is the same for both. The efficiency is not, and the difference is large enough to change the recommendation rather than merely annotate it.
- 01For a client in a conforming state, a depreciation-heavy position is doing more work than the federal model alone suggests, because the state benefit follows automatically.
- 02For a client in a non-conforming high-rate state, the same position is doing less work than the federal model suggests, and any illustration quoting a blended federal-and-state rate is overstating the outcome.
- 03For that client, weight the analysis toward credit-bearing positions, and toward state credit programs in particular, because those are the only instruments that reach the state liability.
- 04Remember the addback is a deferral rather than a forfeiture. The state deduction arrives later on the state schedule, which means somebody has to maintain a multi-year record that survives a change of preparer. It usually does not.
- 05Do this analysis before capital is committed. Once a position is funded, the conformity question has already been answered for you.
Where this lands
- 01Ask for the state number separately, never blended. A single combined figure conceals exactly the effect described here.
- 02Establish your state conformity position before committing capital, because it determines which category of position suits you rather than merely how much it is worth.
- 03If you hold qualifying small business stock and live in California, model the state consequence now. The federal exclusion does not carry across and the amounts are rarely small.
- 04Treat a change of residence as a planned tax event in its own right, not a fact to be dealt with when the return is prepared.
General information only. This article describes law and practice as we understand them at the time of writing. It is not tax, legal, accounting, or investment advice, it does not consider your circumstances, and it does not create an advisor-client or attorney-client relationship. Odyssey Strategic Advisors LLC is not a law firm and is not a CPA firm. Confirm any position with your own tax professional before acting on it. See our disclosures.