Does Alabama Tax Overtime in 2026?
Yes - Alabama fully taxes overtime pay in 2026. Alabama had its own state overtime pay exemption from January 1, 2024 through June 30, 2025, but the legislature failed to extend it during the 2025 session. Since July 1, 2025, overtime is fully taxable in Alabama. Additionally, the federal OBBBA overtime deduction (IRC §225) does not reduce Alabama taxes because Alabama uses its own independent tax base - not federal AGI.
How Alabama's Overtime Tax Treatment Works
Alabama's overtime tax situation involves two separate stories: the rise and fall of Alabama's own state exemption, and the structural impossibility of the federal OBBBA deduction applying at the state level.
The expired Alabama exemption: In 2024, Alabama enacted a state-level overtime pay exemption that allowed hourly employees to exclude overtime wages (pay above the standard 40-hour workweek) from Alabama taxable income. This exemption was effective from January 1, 2024 through June 30, 2025. Multiple bills were introduced in the 2025 regular legislative session to extend the exemption, but none passed. The exemption expired on schedule, and overtime pay has been fully taxable in Alabama since July 1, 2025.
The federal OBBBA deduction: The federal "no tax on overtime" provision (IRC §225, enacted in the OBBBA in 2025) allows workers to deduct up to $12,500 ($25,000 MFJ) in qualifying overtime premium pay from federal AGI. However, Alabama does not start its tax calculation from federal AGI - it uses Alabama gross income computed under Alabama Code Title 40. Federal deductions that reduce AGI have no effect on Alabama taxable income. Alabama has not enacted legislation conforming to the OBBBA overtime provision.
Federal Overtime Deduction Quick Reference
| Detail | Value |
|---|---|
| IRC Section | §225 (OBBBA) |
| Maximum deduction | $12,500 overtime ($25,000 MFJ) |
| Deduction type | Above-the-line (Schedule 1-A) |
| FICA still applies? | Yes (Social Security 6.2% + Medicare 1.45%) |
| MFS eligible? | No (MFJ or Single/HoH only) |
| Effective dates | Jan 1, 2025 – Dec 31, 2028 |
| Alabama treatment | Does not conform |
| What qualifies? | Overtime premium only (the 0.5x above regular rate), FLSA non-exempt employees |
Worked Examples Comparing Federal and Alabama Treatment
Example 1: Warehouse worker (single filer, $45,000 income, $5,000 overtime premium)
Qualifying overtime premium: $5,000
Overtime deduction claimed: $5,000 (capped at $12,500)
Estimated federal tax savings: $600.00
Alabama return:
Alabama does not recognize the federal overtime deduction, and Alabama's own overtime exemption expired June 30, 2025. The full $5,000 in overtime premium pay is subject to Alabama income tax at the top 5% rate. Estimated AL tax on overtime: $250. Note: Had the expired Alabama exemption still been in effect, this worker would have saved $250 in Alabama taxes.
Example 2: Nurse (single filer, $75,000 income, $12,500 overtime premium - federal cap reached)
Qualifying overtime premium: $12,500
Overtime deduction claimed: $12,500 (capped at $12,500)
Estimated federal tax savings: $2,750.00
Alabama return:
Alabama does not recognize the federal overtime deduction. The full $12,500 in overtime premium pay is subject to Alabama income tax at 5%. Estimated AL tax on overtime: $625. Under the expired Alabama exemption (which ended June 30, 2025), this nurse would have owed $0 in Alabama tax on the same overtime income.
Alabama's Expired Overtime Exemption and the Full Story
Alabama made headlines in 2024 when it became one of the first states to enact its own overtime pay exemption - before the federal OBBBA was even passed. The Alabama exemption, effective January 1, 2024, allowed hourly workers to exclude overtime wages from Alabama taxable income. This was a straightforward state-level exclusion that applied directly to the Alabama return.
The exemption was designed with a built-in sunset date of June 30, 2025. As the expiration approached, multiple bills were introduced in the 2025 regular legislative session to extend the provision. Despite support from labor groups and some legislators, the extension bills failed to pass. The exemption expired on schedule.
Timeline:
- January 1, 2024: Alabama overtime exemption takes effect - overtime wages excluded from AL taxable income
- May 2025: Federal OBBBA enacted, creating federal overtime deduction (IRC §225) - but this does not apply to Alabama's independent tax system
- June 30, 2025: Alabama overtime exemption expires - extension bills fail in the 2025 session
- July 1, 2025 onward: Overtime fully taxable in Alabama at graduated rates up to 5%
This timeline means Alabama workers briefly had both federal and state tax relief on overtime (January–June 2025), then lost the state piece entirely. The federal OBBBA deduction continues to apply on their federal return, but Alabama workers receive no state-level relief on overtime pay.
Federal Tax Deductibility as an Alabama Quirk
Alabama uniquely allows taxpayers to deduct federal income tax paid from their Alabama return. When a worker claims the federal OBBBA overtime deduction and pays less federal tax, the federal-tax-paid deduction on the Alabama return is smaller - marginally increasing Alabama taxable income. This is a small but counterintuitive effect unique to Alabama's system.
Related Tools
- No Tax on Overtime Calculator - calculate your federal overtime deduction
- Alabama Tax Guide - full state tax overview
- Alabama Paycheck Calculator
- Does Alabama Tax Tips?
- W-2 Code TP: Tips Reporting Guide
- W-2 Code TT: Overtime Reporting Guide
- All 51 States: Tips & Overtime Tax Map