What Is the Alabama Overtime Tax Exemption?
A guide to Alabama's temporary overtime tax exemption for hourly workers, explaining its impact on state income tax withholding and annual reporting.
Alabama has implemented a temporary change to its state tax law regarding overtime pay under Act 2023-421. The legislation creates an exemption for certain overtime wages from the state’s income tax, allowing specific workers to retain a larger portion of their earnings from extra hours. The law is effective for overtime wages paid from January 1, 2024, through June 30, 2025. This exemption is specific to Alabama’s state income tax and does not alter an employee’s federal tax obligations.
Employee and Wage Eligibility Criteria
Eligibility for the Alabama overtime tax exemption is divided into two distinct periods. From January 1, 2024, through September 30, 2024, the exemption applied exclusively to “full-time hourly wage paid employees.” This meant that to be eligible, a person had to be compensated on an hourly basis and work at least 40 hours per week.
Beginning October 1, 2024, an amending act expanded eligibility to align with the federal Fair Labor Standards Act (FLSA). Under this new rule, the exemption also applies to certain full-time salaried, non-exempt employees. This typically includes salaried workers whose earnings fall below specific federal thresholds. As of July 1, 2024, that threshold was $43,888, and it increased to $58,656 on January 1, 2025.
The exemption applies only to the wages earned for hours worked in excess of 40 in a single workweek. For example, if a qualified employee works 48 hours in a week, the pay for the first 40 hours is subject to state income tax as usual. Only the compensation for the additional eight hours of overtime is exempt from Alabama’s state income tax.
Employer Payroll and Reporting Obligations
Employers in Alabama have specific duties to ensure compliance with the overtime tax exemption law. Their primary responsibility is to adjust their payroll systems to correctly handle the tax withholding for eligible employees. For any qualifying overtime payments, employers must cease withholding Alabama state income tax, which requires isolating overtime wages from regular wages. Some payroll systems created new pay codes to specifically designate these exempt overtime payments.
Beyond payroll adjustments, employers are subject to mandatory reporting requirements. They must track and report data to the Alabama Department of Revenue, including the total amount of exempt overtime paid and the total number of employees who received these tax-free wages. This information is submitted through the state’s online tax portal, My Alabama Taxes (MAT). These reporting obligations are performed on a monthly or quarterly basis, and the state uses this data to monitor the fiscal impact of the tax exemption.
Impact on Employee Annual Tax Filing
When an eligible employee files their annual Alabama income tax return, they must account for the exempt overtime income. The process begins with the employee’s Form W-2, where the amount in Box 16 (state wages) should be lower than the amount in Box 1 (federal wages), reflecting the excluded overtime pay.
On the Alabama individual income tax return, this exempt income must be properly reported to ensure it is not taxed. The income is subtracted from the taxpayer’s federal adjusted gross income (AGI) on the state form. Specifically, the taxpayer will report this adjustment on Schedule OC, “Other Adjustments,” which reduces their Alabama taxable income.
If an employer failed to exclude the overtime from state withholding, the employee can still claim the exemption on their tax return. This would result in a larger tax refund or a smaller tax liability, as they would be claiming back the state tax that was incorrectly withheld during the year.