How to Claim the Alabama Credit for Taxes Paid to Other States

The Alabama credit for taxes paid to other states prevents the same income from being taxed by both Alabama and another state, a situation known as double taxation. By claiming this credit, taxpayers can reduce their Alabama income tax liability by the amount of tax they have already paid to another state on the same income.

Determining Eligibility for the Credit

To qualify for this credit, an individual must be an Alabama resident for all or part of the tax year. The income in question must have been taxed by both Alabama and another state or U.S. territory. The tax paid to the other jurisdiction must be a net income tax, meaning that other taxes like property, sales, or gross receipts taxes do not qualify.

The credit applies to income from active sources, such as wages, salaries, or profits from a business conducted in another state. This includes income passed through from entities like S corporations or partnerships where the income was taxed by another state. For part-year residents, the credit is only available for income earned and taxed in both states during the period of Alabama residency.

Certain types of income are excluded. Taxes paid on investment income like interest and dividends are generally not eligible, unless that income is part of a business’s operations in the other state. The credit also does not apply to taxes on capital gains from intangible property, like stocks or bonds, or taxes paid to foreign countries, the U.S. federal government, or local jurisdictions.

Required Information and Documentation

Taxpayers must gather specific documents before calculating the credit. The primary documentation is a complete, signed copy of the income tax return filed with the other state, which serves as proof of the income earned and tax paid.

The calculation is performed on Alabama Schedule OC, “Credit for Taxes Paid to Other States.” This form is the official worksheet for determining the allowable credit amount. Taxpayers will need to transfer specific figures from their other state’s tax return onto Schedule OC.

Key information required from the other state’s return includes the adjusted gross income (AGI) earned in that state and the final net tax liability paid. It is important to use the actual tax amount paid, not just the amount withheld.

Calculating the Alabama Credit

The calculation is governed by a “lesser of” rule that limits the final credit amount. The allowable credit is the smaller of two figures: the actual net income tax liability paid to the other state, or the amount of Alabama tax due on that same income. This ensures the credit does not exceed the tax Alabama would have otherwise collected.

The process begins on Schedule OC by identifying the income taxed by the other state. For example, if an Alabama resident earned a $30,000 salary in a neighboring state and paid $1,200 in income tax to that state, the $30,000 is the starting point. The taxpayer then calculates the amount of Alabama tax that would be due on that specific income.

Suppose the calculation shows the Alabama tax on the $30,000 would be $1,400. The taxpayer compares this to the $1,200 tax paid to the other state. Since the $1,200 paid is less than the $1,400 of Alabama tax, the allowable credit is limited to $1,200. If the Alabama tax had been $1,000, the credit would be capped at $1,000, even though $1,200 was paid. If taxes were paid to multiple states, a separate Schedule OC must be completed for each one.

Claiming the Credit on Your Tax Return

Once the credit amount is calculated on Schedule OC, the final step is to report it on the Alabama individual income tax return, Form 40. The taxpayer transfers the final credit amount from Schedule OC to the corresponding line for this credit on Form 40.

To finalize the claim, a completed Schedule OC and a complete, signed copy of the other state’s income tax return must be attached to the Alabama tax return. Failure to include both of these documents can result in the disallowance of the credit and potential delays in processing the return.

The credit must be claimed for the same tax year in which the income was taxed by the other state. For instance, if filing a 2025 Alabama return, the credit must be for taxes paid to another state on income earned during 2025. The credit is applied against the tax liability for the year the income was earned.