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Washington D.C.’s Evolving Tax Conformity: The OBBBA, Decoupling, and the Budget Battle

Washington D.C. has been at the center of a significant tax policy battle in 2026, centered on its decision to decouple from certain provisions of the federal One Big Beautiful Bill Act (OBBBA). The District’s efforts to align its local tax code with its own fiscal priorities led to a clash with Congress, creating uncertainty for taxpayers. The final outcome has resulted in a narrower decoupling, but one that still presents unique challenges for residents and businesses in the District.

The Initial Decoupling and Congressional Intervention

The OBBBA, signed into law in July 2025, introduced a wide range of federal tax changes, including an increased standard deduction, new deductions for tips and overtime, and significant business expensing provisions . In late 2025, the D.C. Council voted to decouple from nearly all of these key OBBBA provisions . This was a significant move that would have meant D.C. taxpayers would not benefit from these new federal tax cuts on their local returns.

However, Congress stepped in. The House and Senate voted to disapprove of D.C.’s decoupling law, effectively blocking it . This congressional action caused significant disruption and confusion. Senator Angela Alsobrooks noted the problem of changing rules after taxpayers had already started filing returns, stating, “This resolution would literally change the rules in the middle of the game… it would require revising tax forms and systems and could force taxpayers to refile” . The congressional disapproval also created a $600 million budget hole for the District .

A Revised Decoupling: The Budget Bill

In response to the congressional block, the D.C. Council passed a fresh, narrower decoupling as part of its budget bill . The new law represents a compromise and a more targeted approach.

What D.C. Still Decouples From:
The revised law maintains a decoupling from several business-related OBBBA provisions, including :

  • Business Full Expensing: D.C. will not conform to the OBBBA’s more generous rules for expensing business assets.

  • Changes to Interest Expense: The District is not adopting federal modifications to business interest deduction limitations.

  • Research and Experimentation (R&E) Expensing: Like Virginia, D.C. is decoupling from the federal provision that allows for immediate expensing of R&E costs.

  • Above-the-Line Charitable Deduction: D.C. will not allow the OBBBA’s new deduction for charitable contributions for non-itemizing taxpayers .

What D.C. Now Conforms To:
Crucially, the revised law allows D.C. taxpayers to take advantage of several individual tax benefits that were in the original decoupling bill. For the tax years 2026, 2027, and 2028, D.C. taxpayers can claim deductions for :

  • Tips

  • Overtime pay

  • Car loan interest

  • The enhanced senior deduction

This means that for these specific provisions, D.C. taxpayers will see the same benefits on their local returns as they do on their federal returns. Under federal law, these provisions are set to expire at the end of 2028 .

Fixing the Qualified Small Business Stock (QSBS) Issue

The budget bill also resolved a potentially disastrous issue regarding the tax treatment of Qualified Small Business Stock (QSBS) . The initial decoupling bill was written in a way that appeared to eliminate the QSBS exclusion entirely for D.C. taxpayers, and it was made retroactive to January 1, 2025.

This would have been a crushing tax increase for founders of small businesses who had counted on the one-time exclusion from capital gains tax when selling their stock. The National Taxpayers Union Foundation and affected taxpayers worked to alert policymakers to this likely unintended consequence. The revised budget law fixed this mistake, preventing a retroactive tax hike on small business owners .

The Federal Prohibition on Taxing Nonresident Workers

Adding another layer of complexity, Washington D.C. is subject to a unique federal prohibition. Federal law prohibits the District from taxing the income of nonresidents who work in D.C. . This creates a distinct dynamic where workers who live in Virginia or Maryland can commute into the District for employment and pay no D.C. income tax on that income. This structural limitation significantly shapes D.C.’s revenue base and tax policy.

Conclusion

The tax landscape in Washington D.C. for 2026 is the result of a legislative tug-of-war. The final outcome sees D.C. conforming to most individual tax benefits from the OBBBA, but deliberately decoupling from several major business provisions to protect its own revenue stream. This complexity is compounded by the region’s multi-state nature, where residents may have income sourced in D.C., Maryland, and Virginia. For taxpayers, especially business owners and high-net-worth individuals, this means carefully tracking where their income is earned and understanding the specific rules of each jurisdiction.