Successful tax-loss harvesting depends on a taxpayer’s ability to deduct losses. In addition to their federal tax liability, taxpayers also need to consider state and local taxes. As we wrap up this series, I want to focus in particular on some state tax considerations that taxpayers should bear in mind for the states in which they have their primary residence and where they have assets.
Some states rely on a taxpayer’s federal adjusted gross income (for individuals) or federal taxable income (for corporations or other business entities) as the starting point to determine applicable state income tax, while others do not. Some states recognize capital transactions, while others treat them as ordinary income. Some states tax gains on capital assets at ordinary income rates, while others do not. Some states permit capital loss carryforwards, while others do not.
Two state tax questions are of particular importance for tax-loss harvesting. First, what is the state’s position on the taxation of capital assets? Second, does the state allow trading losses to be carried forward to future tax years? Answers to these questions vary from state to state and depend on the extent to which each state “conforms” with the Internal Revenue Code (Code).[1]
Which states levy taxes on individual income and how do they go about it?
In the United States, each state controls and decides whether and how to levy taxes on taxpayers in their state. Unlike the U.S. federal government, U.S. states balance their budgets on an annual basis—so, along with political considerations, these state-specific budgetary issues affect their taxing decisions.
In 2024, the majority of states[2] collected state income tax, ranging from 0.25% (lowest tax bracket) to 4.75% (highest tax bracket) in Oklahoma to 1.0% (lowest tax bracket) to 13.3% (highest tax bracket) in California.[3] Of the 41 states levying individual income taxes in 2025, seven use federal taxable income as their starting point;[4] 34 use federal adjusted gross income as their starting point;[5] and five use state definitions of income.[6] Among all the states, 10 have flat income taxes[7] without regard to the level of income earned by the taxpayer. Nine do not levy state income taxes at all.[8] Washington state started taxing capital gains in 2023.[9] New Hampshire taxed interest and dividend income prior to 2025.[10]
What is conformity?
Each U.S. state decides whether to conform to the Internal Revenue Code, or “decouple” from federal tax provisions. As the Urban-Brookings Tax Policy Center notes, most states “simply ask the filer to copy their adjusted gross income or federal taxable income from their federal tax form. They accept all the federal definitions and rules that went into that calculation unless they explicitly ‘decouple’ for a particular rule. This is why most state individual income tax expenditures (measured in revenue loss) are actually federal income tax expenditures the state has conformed with.”[11]
Can you go deeper on state tax conformity?
Yes, of course. The ways in which states handle conformity and decoupling vary greatly, and the timing of such federal conformity can impact the taxation of gains of each corporate or individual taxpayer. State-by-state approaches to federal tax conformity can generally be grouped into four categories: “date-based,” “as-amended,” “annual batch-processed,” or “select codes,” each of which I briefly describe below.
Date-based conformity
States that follow date-based conformity incorporate the Code as of a specific date. Also known as “fixed conformity states,” these states follow the date that the provisions of the Code were incorporated into their statutes, without reflecting any subsequent Code amendments. State laws must be amended to reflect subsequent Code amendments. The following states conformed to the Code as it existed immediately before the One Big Beautiful Bill Act (OBBB) in July 2025[12] (aligned with either the December 31, 2024, or January 1, 2025, version of the code) for purposes of personal income taxation: Arizona, Georgia, Hawaii, Idaho, Kentucky, Ohio, South Carolina, Vermont, Virginia and West Virginia.[13]
As-amended conformity
States that incorporate the Code on an “as amended” basis adopt the Code as of the date adopted in the state, but all future Code amendments are incorporated automatically into state law. This means that further legislative actions are not required to keep the state tax laws current with federal tax laws. Alabama, Colorado, Connecticut, Delaware, District of Columbia, Illinois, Iowa, Kansas, Louisiana, Maryland, Michigan, Missouri, Montana, Nebraska, New Mexico, New York, North Dakota, Oklahoma, Oregon, Rhode Island, and Utah use this approach for personal income taxation.[14]
Annual batch-processed conformity
States that follow annual batch-processing automatically enact a new law on an annual basis to incorporate all Code changes from the prior year. California, Indiana, Maine, Massachusetts, Minnesota, North Carolina and Wisconsin use this approach for personal income taxation.[15]
Select codes conformity
Some states cherry-pick Code sections by adopting selected Code provisions into their tax laws. They only accept the federal provisions they want, and do not adopt others. Arkansas, Mississippi, New Jersey and Pennsylvania use this approach for personal income taxation.[16]
So, what is new about state tax conformity now?
State tax conformity with federal tax law is now in a period of flux. The OBBB, signed into law in July 2025, has several implications for state and local taxation, including state income tax and state and local tax deduction limits. OBBB changed depreciation, research expenses, interest limitations, and international taxation—all having broad implications for state tax planning and compliance.[17]
The Tax Foundation makes the following points: Many provisions of the OBBB flow through to state tax codes based on their level of conformity with the Code.[18] Incorporation of OBBB’s provisions depends both on the timing of a state’s conformity and whether it incorporates, decouples from, or modifies each specific federal provision as described above.
Are there state tax implications for the kinds of taxpayers using tax-loss harvesting?
As I discussed earlier in this series[19], taxpayers employing tax-loss harvesting must be taxable entities or individuals. Tax-exempt investment accounts, such as pension and profit-sharing accounts, Section 529 Plans, 401(k) accounts, and Individual Retirement Accounts (IRAs) cannot be used for loss harvesting.
Capital losses that are reported on a Form 1040, Schedule D, are the types of losses suitable for tax-loss harvesting. While I have focused in this series on tax-loss harvesting as it relates to specific portfolio investment management strategies for stocks and securities, taxpayers need to consider their federal, state, and local tax positions when considering tax-loss harvesting from not just stocks and debt securities, but also from digital assets, real estate, and business sale proceeds.
The state tax exposures can vary depending on the asset, and on whether the taxpayer is filing as an individual, as a married couple (including same-sex couples if lawfully married under state law[20]), or as a member of a domestic partnership. Registered Domestic Partners (RDPs) are not married or treated as spouses for federal tax purposes.[21]
Division of marital income and assets
States define and divide income and assets in one of two ways if owned by spouses at the end of a marriage or at the death of one of the spouses. Most states treat marital property as “separate property,” although some treat it as “community property.”[22] Community property laws apply to married taxpayers filing in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In California, Washington and Nevada,[23] the community property rules have been extended to include not just married couples, but also include RDPs. According to the IRS, RDPs domiciled in California, Washington, and Nevada “must generally follow state community property laws and report half the combined community income of the individual and his or her RDP.” RDPs file individual tax returns because they are not “married” for federal tax purposes. They cannot file joint returns but must file with “single filing status or, if they qualify, the head of household filing status.”
Let’s look at one of the major differences between separate property and community property: the way in which loss carryovers are handled. Assume a married couple living in a separate property state has unused capital loss carryovers held in a joint account with rights of survivorship. If one spouse dies, 50 percent of the losses are eliminated.[24] In a community property state, however, when the first spouse dies, all of the community property receives a step-up or step-down in tax basis, which eliminates all capital loss carryovers on the death of the first spouse.
Assets held in investment entities
As with federal taxation, when assets are held in a corporation or a partnership, state taxes turn on the type of entity that holds the assets. Entity structure determines taxation and reporting requirements. Whether the investment entity is taxed as a partnership or a regular corporation determines whether tax-losses will flow through to the taxpayer.
It should be noted that states’ approaches to conformity with Code for purposes of business income taxation can and do differ from their approaches to conformity with Code for personal income taxation (as described above), even within each state. In navigating these issues, taxpayers always should consult with qualified professionals.
I would like to extend my gratitude to John A. Biek for his comments and exceptional assistance in the preparation of this article.
Series conclusion
As I have noted throughout this series, tax-loss harvesting is no longer a strategy reserved only for high-net-worth individuals. Technological advancements and sophisticated data tracking tools have opened it up to a wide range of taxpayers. In addition, volatile markets provide taxpayers with more harvesting opportunities.
Tax-loss harvesting activities do not need to wait until year-end to be effective. Although taxpayers often choose to wait until year-end to have a good sense of their tax liability, some taxpayers actively harvest losses throughout the year. Obviously, the choice is an individual one, but one way or another, attention must be given to the wash sales rule, the straddle rules, and other applicable tax rules. And, as the OBBB is implemented, the federal conformity decision-making processes have only just begun at state legislatures across the country.
As with all transactions, taxpayers must carefully document their activities to support their tax positions, while they track gains, losses, income, and expenses.
