New Alabama Law Exempts 2024 Overtime Pay from State Taxation

This alert was originally published by Phelps on Dec. 5, 2023 and was expanded for additional publication by SHRM under the title 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% pay raise (the state income tax rate), but it also creates new administrative and reporting requirements for their employers. 

The State of Alabama passed Act No. 2023-421 in June of 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 state employers when hiring new workers.

This new law currently 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.

What new duties can employers expect under this law?

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; and
  • 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.

Which wages are affected by the law?

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 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. 

How can employers prepare for the new law?

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 Jan. 1, 2024.

Please contact Michael E. Turner or any member of Phelps’ Labor and Employment team if you have questions or need compliance advice or guidance.