State and local tax (SALT) developments continue to influence how businesses calculate taxable income, claim deductions, manage sales tax obligations and respond to changes in tax legislation across the United States. For businesses operating in multiple states, understanding these differences is essential because federal tax treatment does not always determine the outcome for state and local tax purposes.
September 2026 brought several important developments across income tax, sales and use tax, and digital taxation. Pennsylvania clarified the application of Internal Revenue Code (IRC) Section 163(j) to its Corporate Net Income Tax, while Philadelphia explained its treatment of selected provisions under the One Big Beautiful Bill Act (OBBBA). California advanced its work on taxing software and digital products, and Texas announced proposed changes to the taxation of certain marketplace and delivery fees.
Other developments included the postponement of a sales tax increase in the District of Columbia, legal challenges to Illinois’ new digital taxes, an appeal concerning Maryland’s Digital Advertising Gross Revenues Tax, and a proposed one-time billionaire tax in California.
This article examines all eight developments covered in M2K Advisors’ September 2026 U.S. State Tax Insights alert.
1. Pennsylvania Clarifies Corporate Net Income Tax Treatment of IRC Section 163(j)
On September 10, 2026, the Pennsylvania Department of Revenue issued Corporation Tax Bulletin 2026-01 explaining how the federal limitation on business interest deductions under IRC Section 163(j) applies to Pennsylvania Corporate Net Income Tax (PCNIT) for tax years beginning on or after January 1, 2025.
Under Act No. 45 of 2025, Pennsylvania follows the Section 163(j) rules as they stood on December 31, 2024. Accordingly, the federal changes introduced under OBBBA in 2025 do not apply when calculating PCNIT.
The guidance also clarifies how corporations should calculate the interest expense limitation. Under 72 P.S. Section 7401(3)1(a), each company must calculate its limitation separately, as though it were a standalone taxpayer. Both intercompany and third-party interest must be considered.
Under 72 P.S. Section 7401(3)1(t), interest paid to a related or affiliated entity is generally added back to Pennsylvania taxable income to the extent the interest is deducted. If the limitation disallows part of the interest expense, the disallowed amount must be tracked and added back in the year it is subsequently deducted.
Illustration: Consider a Pennsylvania taxpayer with adjusted taxable income (ATI) of USD 1 million and total interest expense of USD 350,000, comprising USD 300,000 of related-party interest and USD 50,000 of third-party interest.
The 30% ATI limitation allows USD 300,000 of interest expense, leaving USD 50,000 to be carried forward. The bulletin’s illustration allocates the allowed interest pro rata between related-party and third-party interest, resulting in a Pennsylvania interest addback of USD 257,180. The disallowed interest is also allocated between the two categories for carryforward purposes.
What businesses should note: Companies with related-party financing arrangements should carefully review their Pennsylvania calculations. Federal deductions should not automatically be carried over to the state computation without considering Pennsylvania’s specific rules.
2. Philadelphia Explains Its Decoupling from Selected OBBBA Provisions
The Philadelphia Department of Revenue issued an advisory notice following Pennsylvania Act 21 of 2026, signed on July 12, 2026. The notice explains that Philadelphia does not follow certain OBBBA provisions when calculating its Business Income and Receipts Tax (BIRT) for tax year 2025 and subsequent years.
The guidance addresses three areas.
Research and experimental expenditures: Under the provisions covered by the notice, taxpayers must add back the federal deduction and deduct 20% of the original amount each year until it is fully recovered. The relevant IRC sections include Sections 59(e), 174, 174A and 481.
Qualified production property: Taxpayers must add back the federal deduction and recover the cost through regular depreciation under IRC Sections 167 and 168 rather than applying the specified federal treatment under Section 168(n).
Business interest expense limitation: The Section 163(j) calculation must follow the rules as they stood on December 31, 2024.
Taxpayers must maintain separate workpapers supporting these adjustments. They must also amend 2025 BIRT returns filed using the OBBBA treatment and amend the Net Profits Tax return if a credit is affected.
Penalty and interest for tax year 2025 will be waived on petition for taxpayers who made their 2025 payment and 2026 estimated payment by April 15, 2026.
What businesses should note: Businesses subject to Philadelphia BIRT should review their tax computations and supporting documentation. Applying federal tax provisions without considering Philadelphia’s treatment could lead to incorrect local tax calculations or a need to amend previously filed returns.
3. California Advances Its SaaS Tax Regulations Under SB 122
On September 1, 2026, the California Department of Tax and Fee Administration (CDTFA) released draft regulations to implement Senate Bill 122, which expands California’s sales and use tax to Software as a Service (SaaS) and certain digital products beginning January 1, 2027.
The draft regulations address several aspects of the legislation, including:
- The definition of digital products.
- The exclusion for custom software.
- The exclusion of platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS).
- Sourcing rules for determining the relevant location of transactions.
- Purchaser direct-pay rules for certain transactions.
- Multiple points of use and rules for determining the timing of a sale.
Although the regulations had not been formally proposed at the time covered by the alert, their release provides insight into how California may interpret and administer SB 122.
What businesses should note: Businesses supplying software and digital products should review the nature of their offerings and consider how the legislation may affect their California transactions. The distinction between covered digital products and excluded services will be important when assessing the potential tax treatment.
Businesses should also monitor subsequent regulatory developments ahead of the January 1, 2027, effective date.
4. Texas Proposes Changes to the Taxation of Marketplace and Delivery Fees
Texas moved towards narrowing its sales tax treatment of certain data processing services following concerns about the tax costs associated with marketplace fees, commissions and other charges.
On September 3, 2026, Comptroller Don Huffines hosted a small business meeting with marketplace sellers, delivery platforms and healthcare providers to discuss the impact of Texas’ sales tax treatment of data processing services.
The Comptroller noted that a broad interpretation of taxable data processing services had resulted in additional tax costs for businesses and consumers, including situations where marketplace fees and commissions were taxed in addition to the underlying taxable purchase.
On September 30, 2026, the Comptroller signed Executive Order DH-2026-01, directing the office to propose amendments to Texas Administrative Code Rule 3.330. The proposed amendments would exclude marketplace and platform fees, delivery fees and other charges relating to online product sales from the definition of taxable data processing services.
The proposed amendments were scheduled for publication on October 16, 2026, with the public comment period closing on November 15, 2026.
What businesses should note: Marketplace operators, online sellers and delivery platforms should monitor the proposed amendments and the subsequent rulemaking process. The final treatment of these charges will determine how the changes affect relevant transactions and sales tax calculations.
5. District of Columbia Postpones Its Sales Tax Increase
The D.C. Office of Tax and Revenue announced that the planned increase in the general sales tax rate from 6% to 7% has been postponed.
The increase was originally scheduled to take effect on October 1, 2026. The revised date is October 1, 2027.
The change applies to the specified sales or charges involving tangible personal property and services, subject to exceptions for certain services under the D.C. Code.
What businesses should note: Businesses making taxable sales in the District of Columbia should account for the revised effective date when planning tax system changes and compliance activities. The postponed increase should not be applied before its scheduled implementation date.
6. NetChoice Challenges Illinois’ New Social Media and Targeted Advertising Taxes
On September 11, 2026, NetChoice filed two complaints against Illinois, challenging the state’s Social Media Platform Fee and Targeted Advertising Services Tax. Both taxes are scheduled to take effect on January 1, 2027.
NetChoice’s principal argument is that the taxes are pre-empted by the federal Internet Tax Freedom Act (ITFA), which the complaints contend prevents the state from taxing digital commerce without imposing equivalent taxes on comparable non-digital transactions.
The complaints also raise First Amendment concerns. They argue that the taxes identify taxpayers based on the content they provide rather than neutral factors such as revenue or user count.
Both complaints cite the Maryland Tax Court’s August 2026 ruling against Maryland’s Digital Advertising Gross Revenues Tax. However, that ruling is not binding precedent in Illinois.
At the time of the September alert, the Illinois taxes remained enacted and enforceable while the litigation proceeded, and the state had not yet responded.
What businesses should note: Businesses operating social media platforms or providing targeted advertising services should monitor the litigation as the scheduled effective date approaches. The filing of a legal challenge does not, by itself, mean that the challenged taxes have been suspended or invalidated.
7. Maryland Appeals the Ruling Invalidating Its Digital Advertising Tax
Maryland’s Digital Advertising Gross Revenues Tax (DAGRT) remains subject to legal proceedings following the state’s appeal of decisions issued by the Maryland Tax Court on August 14, 2026.
The Tax Court’s decisions invalidated the state tax, which was enacted in February 2021. Maryland filed its appeal within the 30-day period allowed for seeking judicial review.
The DAGRT applies to gross revenues from digital advertising services viewed by Maryland users. It covers businesses with at least USD 100 million in global annual gross revenues and at least USD 1 million in digital advertising revenue in Maryland.
State officials filed appeals in the Anne Arundel County Circuit Court, requesting a review of the Tax Court’s decisions. Maryland Comptroller Brooke Lierman publicly disagreed with the invalidation decisions and supported the appeals.
According to the September alert, the circuit court had yet to announce subsequent hearings and actions.
What businesses should note: Businesses potentially affected by the DAGRT should follow the judicial proceedings and assess their position based on applicable developments. The appeal means the dispute is continuing, and the ultimate outcome remains important for affected taxpayers and other states with similar tax systems.
8. California Voters to Decide on Proposition 40
California voters are scheduled to decide on Proposition 40, a proposed one-time billionaire tax, on November 3, 2026.
The measure would impose a one-time tax of up to 5% of net worth on covered individuals and trusts that were California residents on January 1, 2026. Net worth would be measured as of December 31, 2026.
Under the proposal described in the September alert, the rate for individuals would be reduced by 0.1 percentage point for every USD 2 million by which net worth falls below USD 1.1 billion, but would not fall below zero.
The tax would be due in 2027, with an option to spread payments over five years at a higher total cost.
Assets covered by the proposal include businesses, securities, art, collectibles and intellectual property. Real estate, pensions and retirement accounts are generally excluded.
The Legislative Analyst estimates that the measure could generate tens of billions of dollars in revenue over several years. This could potentially be offset by an annual decline of less than USD 1 billion in state income tax revenue if billionaires reduce their payments, including by leaving California. State administration costs could also reach tens of millions of dollars annually for several years and would be funded from the new revenue.
What businesses and taxpayers should note: The proposal remains subject to the November 3, 2026, vote. Covered individuals, trusts and relevant business owners should monitor the outcome and any subsequent guidance before drawing conclusions about its potential application.
Key Takeaways
The September 2026 developments highlight several areas that businesses should continue to monitor.
- State tax treatment may differ from federal treatment. Pennsylvania and Philadelphia demonstrate the importance of calculating state and local tax liabilities under the rules applicable to each jurisdiction.
- Digital taxation remains an important area to watch. California’s SB 122 and the proposed Illinois taxes could affect businesses providing software, digital products, social media and advertising services.
- Proposed changes require continued monitoring. Texas’ planned amendments and the postponed District of Columbia sales tax increase make effective dates and regulatory updates important considerations for tax planning.
- Litigation does not automatically remove tax obligations. The Illinois and Maryland cases illustrate why businesses should distinguish between a legal challenge, a court decision and the resulting enforcement position.
- Documentation remains important. Separate workpapers, accurate transaction records and supporting tax calculations can help businesses substantiate their positions and identify adjustments that may be required.
Conclusion
September 2026 brought significant developments across U.S. state and local taxation, covering interest expense limitations, local tax deductions, digital product taxation, marketplace fees, sales tax timelines and ongoing disputes over digital taxes.
For businesses operating across multiple jurisdictions, these developments reinforce the importance of monitoring state-specific requirements rather than relying solely on federal tax treatment. Understanding the relevant rules, proposed changes and effective dates can help businesses identify potential compliance issues and prepare for upcoming requirements.
As the U.S. SALT landscape continues to evolve, businesses should keep track of official guidance and review how relevant developments may affect their operations.
Frequently Asked Questions
1. What were the major U.S. state tax developments in September 2026?
The key developments included Pennsylvania’s Section 163(j) guidance, Philadelphia’s BIRT adjustments, California’s draft SaaS tax regulations, proposed Texas data processing tax changes, the D.C. sales tax postponement, Illinois digital tax litigation, Maryland’s DAGRT appeal and California Proposition 40.
2. How does Pennsylvania treat Section 163(j) for Corporate Net Income Tax?
Pennsylvania follows the Section 163(j) rules as they stood on December 31, 2024, for the purposes described in Corporation Tax Bulletin 2026-01. The bulletin also explains how corporations should calculate the interest limitation and account for related-party interest addbacks.
3. What changes does Philadelphia make to OBBBA provisions for BIRT?
Philadelphia requires adjustments relating to research and experimental expenditures, qualified production property and the business interest expense limitation. Taxpayers must maintain supporting workpapers and amend affected 2025 returns where required.
4. When is California’s SaaS tax expansion scheduled to begin?
The expansion under SB 122 is scheduled to begin on January 1, 2027, for qualifying digital products. Businesses should review the legislation, applicable exclusions and subsequent regulatory guidance to determine the treatment of their transactions.
5. What is the proposed change to Texas data processing tax?
Executive Order DH-2026-01 directs the Comptroller’s office to propose amendments excluding specified marketplace and platform fees, delivery fees and other charges relating to online product sales from taxable data processing services. The proposed amendments were scheduled for publication on October 16, 2026.
6. Has the District of Columbia cancelled its sales tax increase?
No. The planned increase from 6% to 7% has been postponed from October 1, 2026, to October 1, 2027.
7. Why is Illinois facing legal challenges over digital taxes?
NetChoice argues that the Social Media Platform Fee and Targeted Advertising Services Tax conflict with the Internet Tax Freedom Act and raise First Amendment concerns. As reported in the September alert, the taxes remained enacted and enforceable while the litigation proceeded.
8. What is the current position on Maryland’s Digital Advertising Gross Revenues Tax?
The Maryland Tax Court issued decisions invalidating the tax on August 14, 2026. Maryland appealed the decisions, and further judicial review was pending at the time covered by the September alert.
9. What is California Proposition 40?
Proposition 40 is a proposed one-time tax on certain individuals and trusts covered by the measure. California voters are scheduled to decide on it on November 3, 2026. The proposal includes a tax of up to 5% of net worth, subject to its terms and exclusions.
How M2K Advisors Can Help
Businesses with U.S. tax obligations may need to assess how state-specific developments affect their tax calculations and compliance requirements.
M2K Advisors is an international tax advisory firm having offices in India, Singapore, USA & UAE. Our firm offers varied services in USA such as setting up companies in Delaware and other states in USA, tax advisory, tax return filing, state & local tax compliance, sales & use tax compliance, IRS audit representation, FBAR & FATCA filing. M2K Advisors is the specialist firm for businesses managing US tax obligations. Our focused expertise in M&A and cross border structuring, state & local nexus studies, and multi-state compliance makes us the most reliable partner for foreign entities and startups entering the USA market.
We shares tax insights to help businesses stay informed about developments across jurisdictions. For further information, contact knowledge@m2k.co.in.
Disclaimer: This article is intended for general informational purposes only and does not constitute tax, legal or other professional advice. Readers should refer to the applicable legislation and official guidance and consult an appropriate advisor regarding their specific circumstances.
