Since the Trump administration’s latest federal tax cut was signed into law last July, my compatriots at ITEP have spilled a lot of ink documenting the harmful effects the new law can have on state tax systems—and how state lawmakers can prevent those effects. They are right to do so.
On both the individual and corporate side of the ledger, states’ reliance on federal income definitions routinely leaves state revenues vulnerable to reductions in the federal tax base, and the 2025 Trump tax cut is chock full of these. But there are a few provisions in last summer’s tax law that could actually make budget-balancing a little bit easier for states if they follow suit. Among them is a helpful modification to a provision designed to penalize excessive CEO pay.
Signed into law in 1993 by President Bill Clinton, Section 162(m) of the Internal Revenue Code created a $1 million cap on the corporate tax deduction for the salaries of each of a company’s five highest-paid employees. This is a departure from the general rule that companies can deduct salaries as a cost of doing business, but a sensible one, reflecting the belief that American taxpayers shouldn’t have to subsidize exorbitant CEO pay packages.
As originally enacted, the law was a little leaky. The definition of “salary” excluded performance-based pay like stock options, so many corporate leaders figured out very quickly that they could reduce the tax hit by structuring their pay entirely as stock options. By 2013, Oracle CEO Larry Ellison was taking a salary of just $1—and $77 million of stock options, leaving his lavish paycheck untouched by the $1 million cap.
But Congress has repeatedly tweaked Section 162(m) in ways that make it far more effective. The otherwise-awful 2017 Trump tax law eliminated the stock option loophole, and the just-as-bad 2025 Trump tax law modified 162(m) to apply more universally to the biggest and most convoluted corporations.
These changes have paid substantial dividends for the federal budget. On its enactment in 1993, the provision was officially scored as bringing in just $42 million in its first year of operation; the $1 million cap is now forecast to bring in $5.5 billion in 2026. And the 2025 tax law’s fixes alone are set to boost corporate taxes by $15 billion over the next decade.
Of course, this doesn’t mean state lawmakers should be sending the Trump administration flowers: this one ray of budgetary sunshine is embedded in a bill that is larded with expensive corporate tax giveaways. Protecting themselves from the harmful effects of these corporate tax breaks by “decoupling” from these federal provisions should be a priority for state lawmakers in 2026, for those who didn’t already do so in 2025.
But some states have overreached by choosing to decouple from every piece of the 2025 law, including the limit on CEO pay deductions. This was the choice made by California last fall. As a result, when big tech companies file their California tax returns this spring, they’ll likely be able to claim bigger deductions for CEO pay than on their federal returns.
Whether California lawmakers made a conscious decision to give a tax break to the Golden State’s tech CEOs or simply lost track of 162(m) among the tall trees of the Trump tax cuts, this is still an unforced error that other states should avoid. Disallowing excessive CEO pay deductions is a revenue-raising proposal that is in step with the times—and all states need to do to achieve this is to conform their state tax laws to follow this specific and narrow component of federal law.
