How Alabama income tax works: its own income, the federal tax deduction, 5%

Alabama does not start from the federal return. Form 40 adds up Alabama’s own list of income, takes off its own adjustments, and arrives at Alabama adjusted gross income on line 10. From there it allows four deductions: a standard deduction (or Alabama itemized deductions), the federal income tax you owe for the year, a personal exemption of $1,500 or $3,000, and a dependent exemption of $1,000, $500 or $300 per child depending on income. What is left is taxed at 2% on the first $500, 4% on the next $2,500 and 5% above $3,000, doubled on a joint return. The brackets are so small that almost every working household pays 5% on most of its income; the federal tax deduction is what makes the real rate lower.

Three consequences follow. A federal deduction never reaches the Alabama return unless the Alabama Code points at the section that created it, so the new federal deductions for tips, overtime and seniors do nothing here. Every federal tax cut raises Alabama tax by about 5% of the saving, because a smaller federal bill means a smaller line 12. And a household can itemize in Alabama while taking the standard deduction federally, and many should.

Who files

A person domiciled in Alabama is a resident and reports all income, wherever earned, with a credit on Schedule CR for income tax paid to another state on the same income. A part-year resident files Form 40 for the months of residence; a nonresident with Alabama-source income files Form 40NR; see Moving to Alabama. Form 40A is a short form for full-year residents with wages, a little interest and no itemizing, adjustments or credits. The filing thresholds are gross income of $4,500 single, $8,200 head of family, $11,500 married filing jointly and $5,750 married filing separately, the 2025 figures; the 2026 instructions are to come, though the law has not changed. Exempt income, including Social Security and pensions, does not count. File below the threshold anyway if Alabama tax was withheld.

Where it starts: Alabama’s own income

Lines 5 through 8 of Form 40 list income the Alabama way: wages, interest and dividends, and “other income” carried from page 2, where business income, capital gains, rents and taxable retirement distributions are itemized. Most figures match the federal return, because the Alabama Code cross-references the federal sections that define them. But the match is section by section. If the Alabama Code cites the federal section, the federal rule applies; if not, the rule does not exist here. That is why the Department of Revenue’s analysis of the 2025 federal law lists the federal tips, overtime and senior deductions as “tied to federal: no,” and the $40,000 state-and-local-tax cap, car loan interest, mortgage insurance premiums and 100% bonus depreciation as “yes.”

Some income the federal return taxes is left out entirely: Social Security, Railroad Retirement, unemployment compensation, state tax refunds, military retirement pay, and payments from any defined benefit pension, public or private. Alabama does tax 401(k), 403(b), 457 and IRA distributions, less $6,000 per person at 65; see Alabama for retirees. Capital gains are ordinary income with no lower rate for long-term gains. The exclusion of gain on a principal residence follows the federal pattern.

The adjustments on page 2 that reach Alabama AGI on line 10 are mostly the familiar ones, IRA and HSA contributions, self-employed health insurance and retirement deposits, plus a few of Alabama’s own: CollegeCounts 529 contributions up to $5,000 per taxpayer, or $10,000 joint if both spouses contribute; First Time and Second Chance Home Buyer Savings Account deposits up to $5,000 single or $10,000 joint on Schedule HBC; and, new for 2026, up to $1,000 of qualified overtime compensation per taxpayer, defined as federal law defines it, under HB527, signed April 16, 2026, for 2026 through 2028, whether or not you itemize. It is worth $50. Alabama’s earlier exemption of all overtime pay ended June 30, 2025. Where the Department will put the new line on the 2026 Form 40 is to come.

The standard deduction, which shrinks

Line 11 is the standard deduction or Alabama itemized deductions. The standard deduction is not one figure: it depends on filing status and Alabama AGI, and falls as income rises, from a chart in the instructions. The 2026 chart is to come; the law is unchanged, so the 2025 figures will hold unless the Legislature acts in its January-to-May 2027 session.

Between the two points the deduction steps down every $500 of AGI ($250 for married filing separately). A joint return at $30,000 of Alabama AGI gets $6,925; at $35,500 and any income above, $5,000.

Because the floor is $5,000 for a couple and $2,500 for everyone else, itemizing in Alabama is often worth it even for people who take the $32,200 federal standard deduction. Alabama Schedule A allows medical expenses above 4% of Alabama AGI (the federal floor is 7.5%), real estate and personal property taxes, the Social Security and Medicare tax withheld from your wages, self-employment tax, city occupational taxes on the W-2, mortgage interest including mortgage insurance premiums and, for 2025 through 2028, vehicle loan interest, charitable gifts above a 0.5%-of-AGI floor, casualty losses in declared disasters, gambling losses up to winnings, and job and miscellaneous expenses above 2% of AGI, which Alabama kept. Alabama income tax itself is never allowed; the federal tax deduction stands in its place. The federal $40,000 cap on state and local taxes applies, computed on Alabama AGI. A couple earning $90,000 has about $6,900 of FICA on the W-2, which alone beats the $5,000 standard deduction.

Line 12: the federal income tax deduction

Alabama lets you deduct the federal income tax you owe for the year. Not the withholding on your W-2; Form 40 says so next to the line. The figure comes from a worksheet built from your federal return: the regular federal income tax after nonrefundable credits, reduced by refundable credits such as the earned income credit and the additional child tax credit (verify). Self-employment tax is not part of it, though it is deductible on Alabama Schedule A. If spouses file jointly federally but separately in Alabama, or you lived here part of the year, the federal tax is prorated by Alabama AGI over federal AGI.

This line changes the arithmetic of everything else. A household that owes $7,000 of federal tax deducts $7,000 and saves $350 of Alabama tax. If it finds a federal deduction worth $1,000 of federal tax, it loses $1,000 of line 12 and pays $50 more to Alabama. The child tax credit, the energy credits, the new tips, overtime and senior deductions: each cuts federal tax and nudges Alabama tax up by about 5% of the saving. And a family whose federal tax is wiped out by the earned income credit and the child tax credit deducts nothing on line 12, which is why lower-income families pay the full 5% while higher earners pay less.

Exemptions

Line 13 is the personal exemption: $1,500 single or married filing separately, $3,000 married filing jointly or head of family. Line 14 is the dependent exemption, the whole of what Alabama gives a family for its children, and it falls by income.

Head of family, for an unmarried person keeping up a home for a qualifying child or relative, takes the $3,000 personal exemption and the larger standard deduction but the single rate schedule. Details in Credits and breaks for Alabama families.

The rate

Alabama AGI minus the four deductions is taxable income on line 16. The tax on line 17 comes from the table: single, head of family and married filing separately pay 2% on the first $500, 4% on the next $2,500 and 5% above $3,000; a joint return pays 2% on the first $1,000, 4% on the next $5,000 and 5% above $6,000. The lower brackets save a joint filer $100 against a flat 5%, a single filer $50. Nothing is indexed for inflation. Capital gains, interest, rent and gambling winnings are taxed the same as wages.

Because federal tax is deductible, the real Alabama rate on an extra dollar is 5% of what is left after federal tax. In the 22% federal bracket a $1,000 raise costs $220 federally, so Alabama taxes $780 of it: $39, or 3.9%. In the 12% bracket the real rate is 4.4%; in the 32% bracket, 3.4%.

The credits

Alabama has few credits and none refundable to an ordinary household. Residents take a credit on Schedule CR for income tax paid to another state on income Alabama also taxes, limited to the Alabama tax on that income. Schedule OC carries business and employer credits, most of which pass through from a business to its owners. There is no state earned income credit, child credit, child care credit, renter credit or property tax credit. Senior property tax relief runs through the county revenue commissioner, not Form 40.

City occupational taxes

Alabama has no county or school district income tax, but about two dozen cities levy an occupational license tax on wages earned inside the city, withheld by the employer and shown on the W-2: Birmingham 1%, Bessemer 1%, Auburn 1%, Opelika 1.5%, Gadsden 2%, Tuskegee 2%, and a dozen smaller towns at 0.5% to 2% (verify current rates and list). It is final when withheld: it does not appear on Form 40, cannot be credited against Alabama income tax, and is deductible only on Alabama Schedule A.

Withholding and estimated payments

Alabama withholding on wages follows Form A-4, the state’s own certificate, not the federal W-4. IRA custodians will withhold Alabama tax on request, reported on Schedule RS. Anyone who expects to owe at least $500 after withholding and credits must make estimated payments on Form 40ES, due April 15, June 15 and September 15, 2026 and January 15, 2027. The safe harbor is the smaller of 90% of this year’s tax or 100% of last year’s, 110% if last year’s Alabama AGI was over $150,000 ($75,000 married filing separately). The penalty is figured on Form 2210AL. The usual people caught are retirees drawing on IRAs, the self-employed, and anyone with a large gain.

How to file

The return is due April 15, 2027. Alabama grants an automatic extension to October 15, 2027 with no form to file, but it extends the filing, not the payment: pay what you expect to owe by April 15 with Form 40V marked “Automatic Extension Payment” or through My Alabama Taxes, or interest and a 1%-a-month late-payment penalty run from April. The late-filing penalty is the greater of 10% of the tax or $50. My Alabama Taxes files Form 40 free and takes e-check payments free. Refund status is at “Where’s My Refund” or 1-855-894-7391; allow 90 days. Dates, forms and addresses are in Alabama calendar and forms.