New Alabama Law Exempts Overtime Pay from State Taxation

Beginning Jan. 1, 2024, hourly paid employees in Alabama will not pay any state income tax on their overtime pay. The new law effectively gives hourly employees a 5 percent pay raise (the state income tax rate), but it also creates new administrative and reporting requirements for their employers.

Alabama passed Act No. 2023-41 in June 2023. The law was intended to provide tax relief for Alabama hourly workers dealing with high inflation. Alabama legislators also touted the new law as providing a potential competitive advantage for Alabama employers when hiring new workers.

This new law applies only to overtime paid before June 30, 2025, unless the state legislature takes action to extend the law before that date. The state only provided for this initial effective period so that it could assess the impact on state revenue. Unless the law is extended, any overtime pay earned before June 30, 2025, but which is not paid until after that date, will still be subject to taxation.

The new law imposes mandatory reporting obligations on Alabama employers. For the tax year beginning Jan. 1, 2023, employers are required to report the following information to the Alabama Department of Revenue by no later than Jan. 31, 2024:

• The total amount of compensation reported by full-time hourly wage employees for all work performed in excess of 40 hours each week.
• The total number of employees for which compensation was paid.
  

After Jan. 1, 2024, employers also are required to supplement their initial report on either a monthly or quarterly basis.

Under the federal Fair Labor Standards Act, only the time the employee is actually working counts toward determining overtime, which is defined as work performed in excess of 40 hours in a workweek. Any paid time off, such as vacation or sick pay, is not exempt from state taxation under the new law. Similarly, commission or bonus payments also remain subject to state taxation.

The new state law applies to both private and public employers. Any overtime paid to an otherwise salaried, non-exempt employee remains subject to state taxation, as the law specifically applies only to hourly workers.

The Alabama Department of Revenue has issued reporting guidance and FAQs to help employers navigate the new law.

Alabama employers should familiarize themselves with this new state tax law and make appropriate arrangements to comply beginning on Jan. 1, 2024.

Michael E. Turner is an attorney with Phelps Dunbar in Birmingham, Ala. © 2023 Phelps Dunbar. All rights reserved. Reprinted with permission via Lexology.