Does Alabama Tax Overtime in 2026? The Expired Exemption

Alabama workers who count on overtime pay got caught between two expiration dates. The state's own overtime exemption, which had been in effect since 2024-01-01, expired on 2025-06-30 after the legislature failed to extend it. And the federal OBBBA overtime deduction, while still active, does not reduce Alabama state tax because Alabama uses its own independent tax code.

The result: overtime is fully taxable in Alabama at graduated rates up to5%, with no state-level relief. Workers still get the federal deduction on their federal return, but nothing on their Alabama return.

The expired Alabama overtime exemption

Alabama enacted its own overtime pay exemption effective 2024-01-01. The law allowed hourly employees to exclude overtime wages from Alabama taxable income. It was a straightforward benefit: overtime pay above the regular 40-hour workweek was simply not counted when calculating Alabama income tax.

That exemption was always temporary. It had a sunset date of 2025-06-30. During the 2025 regular session, multiple bills were introduced to extend it, but none passed. When the session ended without action, the exemption lapsed. From July 1, 2025 forward, overtime pay is treated the same as regular wages for Alabama income tax purposes.

The timing was especially unfortunate. Congress had already enacted the OBBBA, which included a federal overtime deduction. But that federal provision does not help at theAlabama level, for reasons tied to how Alabama structures its tax code.

Why the federal OBBBA deduction doesn't help

Most states start their income tax calculation from federal AGI. When a federal above-the-line deduction (like the OBBBA overtime deduction) reduces AGI, it automatically reduces the starting point for state tax in those states. Alabama does not work this way.

Alabama uses its own concept of "Alabama gross income," computed independently from federal figures. The state has its own set of deductions, its own standard deduction of $2,500 (single), its own personal exemption of $1,500 (single), and its own graduated rate structure. Federal above-the-line deductions that reduce federal AGI have no effect on Alabama taxable income.

Alabama does offer one unusual feature: it allows taxpayers to deduct the federal income tax they paid from their Alabama taxable income. This creates an indirect link. If the OBBBA deduction lowers your federal tax bill, you have a smaller federal tax deduction on your Alabama return, which slightly increases your Alabamatax. The relationship actually works against you in this specific case, though the effect is small.

Worked example: construction worker with $8K OT

Consider James, a single filer who works in construction in Birmingham. He earns $40,000 in regular wages. During 2026, he works significant overtime and earns an additional $16,000 in overtime wages, of which $8,000 is the overtime premium (the 0.5x portion above his regular rate). His total income is $56,000.

If Alabama still had its state overtime exemption, the $8,000 in overtime premium would have been excluded from Alabama taxable income, saving James approximately $400 at the 5% top rate. That exemption is gone, and the federal OBBBA deduction does not fill the gap.

The double hit for Alabama workers

Alabama workers are dealing with two separate problems. The state's own overtime exemption expired, restoring state-level taxation on overtime pay. And the federal OBBBA overtime deduction, while available on the federal return, provides no state-level relief because Alabama does not use federal AGI.

The practical impact depends on how much overtime a worker earns. At Alabama's5% top rate (which kicks in above just $3,000 in taxable income), every $1,000 of overtime premium costs $50 in Alabama tax that would have been exempt under the prior law.

For a worker claiming the full federal overtime deduction of $12,500, theAlabama tax on that amount is $625. In a conforming state like Ohio or North Carolina, that state tax would be eliminated by the federal deduction flowing through.

Tips face the same problem

The non-conformity issue is not limited to overtime. Alabama also does not conform to the OBBBA tips deduction. Tip income is fully taxable at Alabama's graduated rates, and the federal tips deduction (up to $25,000) has no effect on Alabamatax. For a server or bartender in Alabama, the state tax picture is the same as it was before the OBBBA passed.

Alabama's position is shared by a handful of other states that maintain their own independent tax codes, including Pennsylvania (which uses eight classes of income). For a full comparison of every state's conformity status, see the state-by-state tips and overtime tax map. To estimate your Alabama take-home pay, try the Alabama paycheck calculator.