What’s new in Alabama for 2026: a $1,000 overtime deduction, and a federal law that mostly passed the state by

For most Alabama households the 2026 return will look like the 2025 return with one new line on it: a deduction of up to $1,000 for overtime pay, worth $50 of tax at the 5% rate. The rates, the standard deduction, the exemptions and the $6,000 retirement exclusion are all exactly what they were, because Alabama indexes nothing and the Legislature passed nothing that moved them. The larger story is what the federal tax law of July 2025 did not do here. Alabama does not follow the federal deductions for tips, overtime or seniors. It does follow the higher SALT cap, the car-loan interest deduction and 100% bonus depreciation. And because Alabama lets you deduct the federal income tax you owe, every one of those federal cuts raises Alabama tax a little.

The Alabama Department of Revenue worked through the federal law section by section in an analysis dated October 31, 2025 and updated November 10, 2025. That document, and the one bill the 2026 Legislature passed for individuals, are the sources for nearly everything below.

The one Alabama change: overtime, act three

Overtime has had three different treatments in Alabama in three years, and the 2026 return is the first full year under the third.

2024 through June 2025: fully exempt. Act 2023-421, extended by Act 2024-437, took all overtime pay earned by hourly workers under the Fair Labor Standards Act out of Alabama income. It cost far more than the Legislature expected, and the 2025 session let it expire on June 30, 2025; HB467, which would have extended it, did not pass. Overtime earned from July 1 to December 31, 2025 was fully taxed.

2026 through 2028: a $1,000 deduction. HB527, signed by the Governor on April 16, 2026, adds a deduction of up to $1,000 per taxpayer for “qualified overtime compensation,” using the federal definition in Internal Revenue Code section 225, for tax years 2026, 2027 and 2028. It is allowed whether or not you itemize. Because it borrows the federal definition, it covers the same thing the federal deduction covers: the premium half of time-and-a-half, as the employer reports it, not the whole overtime paycheck. It is Act 2026-604. The Department says total overtime wages appear in box 16 of the W-2 and the premium portion in box 12 with code TT. Where the deduction will sit on the 2026 Form 40 is to come; the Department had not released the 2026 forms when this was written.

The arithmetic is modest. A worker with $1,000 or more of qualified overtime saves $50. A worker with $400 of qualified overtime saves $20. The deduction is per taxpayer, so a married couple who both work overtime can deduct up to $2,000 on a joint return. This is not “no tax on overtime”; it is a $1,000 deduction with a three-year life. The same bill suspended the state’s 2% sales tax on groceries from May 1 through June 30, 2026, which is the part of HB527 most people noticed.

The federal law of 2025, item by item

Alabama does not adopt the Internal Revenue Code wholesale. Its income tax statute names specific federal sections, and a federal change reaches Alabama only when the Alabama Code points at the section that changed. The Department calls this “piecemeal” conformity. The practical result is that the new federal deductions, which Congress wrote as brand-new code sections, do not reach Alabama, while changes to old sections the Alabama Code already cites, such as the mortgage-interest and SALT rules, flow through automatically.

Source: the Department’s One Big Beautiful Bill Act analysis, October 31, 2025, updated November 10, 2025. “Yes” means the Department says the federal change is tied to Alabama law through a cited section of the Alabama Code.

The quiet effect: a smaller federal tax bill means a bigger Alabama one

Alabama is one of a handful of states that let you deduct the federal income tax you owe for the year, on Form 40 line 12. That deduction is uncapped, and it makes the 5% rate softer than it looks. It also means that every federal tax cut raises Alabama tax, by about 5% of the federal saving. The federal tips, overtime and senior deductions, the larger child tax credit, the car-loan deduction for non-itemizers: each one lowers the federal tax, which lowers line 12, which raises Alabama taxable income. The effect is small, and it is real, and it is the right way to think about every federal change on this list.

What did not change, and the bills that died

The standard deduction. Still $8,500 joint falling to $5,000 as Alabama AGI passes $35,500; $3,000 single falling to $2,500 past $17,750; $5,200 head of family and $4,250 married filing separately, each falling to $2,500. These are the 2025 chart figures; the 2026 chart is to come, but the law behind it is unchanged. HB389 (2025), which would have raised the maximums to $9,500 joint and $3,500 single and widened the $1,000 dependent-exemption tier to $60,000 of AGI, passed the House and died in the Senate. Nothing like it was filed in 2026.

The exemptions. Personal exemption $1,500 single or separate, $3,000 joint or head of family. Dependent exemption $1,000 per dependent at Alabama AGI of $50,000 or less, $500 to $100,000, $300 above. Unchanged.

The $6,000 retirement exclusion. Still $6,000 per person 65 or older, against taxable defined-contribution retirement income (IRAs, 401(k)s, 403(b)s, 457 plans) on Schedule RS. HB388 (2025), which would have doubled it to $12,000, passed the House 103 to 0 and died in the Senate. It was not revived. Anyone who has read that the Alabama exclusion is $12,000 for 2026 has read a bill, not a law.

The rates. 2% on the first $500 of taxable income, 4% on the next $2,500, 5% above $3,000 (doubled for a joint return). They have not changed since the tax was enacted in 1933 and nothing in Alabama’s income tax is indexed for inflation.

Sales tax. The state rate on groceries fell from 3% to 2% on September 1, 2025 under HB386 (2025), the second step after the 2023 cut from 4%. HB527 suspended the 2% entirely from May 1 to June 30, 2026, then let it resume. Bills to repeal the grocery tax outright (HB336 and HB647 in the 2026 session) did not pass.

Car-loan interest, year two. The Schedule A deduction for interest on a qualifying new vehicle bought in 2025 through 2028 appeared on the 2025 Alabama return and continues for 2026. It is the one item from the federal law that Alabama itemizers may have missed last year, because the federal version did not require itemizing.

The ballot

There was no statewide tax question on the November 3, 2026 ballot. The four statewide amendments concerned lieutenant-governor vacancies, consolidation of school districts, the Pledge of Allegiance and student-led prayer, and the national anthem in schools. Several county-only amendments, including ones in Covington and Lamar counties, asked voters to create or expand property tax exemptions for homeowners 65 and older in that county alone; the county revenue commissioner can say whether yours passed. None of them touches the income tax return.

What to expect on the 2026 return

• Wage earners: the same return as 2025, plus a line for up to $1,000 of overtime if you had any. Tips are taxed in full.
• Hourly workers who remember the 2024 overtime exemption: it is gone. The 2025 return was the last with any exempt overtime, and only for January through June of that year.
• Retirees: nothing changed. Social Security and defined-benefit pensions are exempt; IRA and 401(k) withdrawals are taxed above $6,000 per person at 65. The federal $6,000 senior deduction lowers your federal tax and therefore trims the Form 40 federal tax deduction, so Alabama tax rises a few dollars.
• Families: nothing changed. The dependent exemption is $1,000, $500 or $300 by income tier; Alabama has no child credit or earned income credit. The bigger federal child tax credit raises Alabama tax by about 5% of the increase.
• Itemizers: the $40,000 SALT cap, the 0.5% charitable floor, mortgage insurance premiums and car-loan interest all apply on Alabama Schedule A. The non-itemizer charitable deduction does not exist here.
• Business owners, landlords and farmers: 100% bonus depreciation flows through to Alabama. No add-back.
• Everyone: the Legislature meets from January to May 2027, before the return is due, and it has made retroactive changes before. Check the Department’s What’s New before filing.