A message from the Alabama Policy Institute
With the 2025 Alabama Regular Legislative Session now in the past, the focus shifts to what legislators should begin working on in preparation for the next session. While conservatives saw several victories this year, much work remains to be done, particularly around tax reform.
During the 2025 session, the Legislature provided Alabamians with an additional 1% in grocery tax relief. Beyond that, little was done to reduce the overall tax burden on Alabama residents. In fact, the Legislature’s failure to make the state’s overtime income tax exemption permanent reflects one of the largest tax increases in state history.
In terms of what reforms lawmakers should implement in 2026, some of that could depend on what action, if any, happens in Washington, D.C. in the coming days.
At the end of this year, many provisions of the federal Tax Cuts and Jobs Act (TCJA) of 2017 are set to expire. Currently, Congress is working on a budget reconciliation package which could make some of those expiring provisions permanent, as well as introduce new tax reductions for some American citizens and businesses. The bill was passed by the U.S. House of Representatives on May 22, 2025, by a one vote margin (215-214) and now heads to the U.S. Senate for debate and further changes, with only a slim margin for passage.
As it stands now, the bill would introduce new provisions such as a federal income tax exemption on overtime tax income and an exemption on up to $25,000 for tip wages. It would also raise the standard deduction for all income tax filers, which are set to be slashed if the provisions of the TCJA are not extended. If the TCJA provisions are allowed to expire, individual income tax rates would also increase for many filers.
On the corporate income tax side, as passed the House the bill would extend many provisions of the TCJA, such as bonus depreciation and research and development expensing. It would also increase the qualified business income deduction for pass-through entities from 20% to 23%, meaning lower taxes for small businesses and entrepreneurs. The overall federal corporate income tax rate (21%) will remain unchanged, as this reduction was one of the permanent provisions of the TCJA.
In terms of what Alabama lawmakers should do in 2026, first they should re-establish and make permanent the overtime income tax exemption. At the federal level, this was a priority for President Trump during the 2024 campaign and is close to becoming a reality. Alabama U.S. Senator Tommy Tuberville also recently introduced a bill that would provide a tax deduction of up to $10,000 for single filers and $20,000 for joint filers for overtime wages. Re-establishing the overtime income tax exemption in Alabama would save taxpayers an estimated $320 million per year and would provide an incentive to not only work, but work longer hours.
Because corporate income tax rates will remain unchanged at the federal level, it is past time that Alabama lawmakers take steps to reduce the state’s rate.
When the TCJA was enacted, it lowered federal corporate income tax rates from 35% to 21%. Since Alabama statute allows for federal income taxes paid to be deducted from state returns, this meant that Alabama companies faced a de facto tax increase because they had fewer federal taxes to deduct from state corporate income tax returns. Alabama’s 6.5% corporate income tax rate is tied with Tennessee as the highest in the Southeast.
While arguments can be made that Alabama’s effective rate is lower than other states, the bottom line is that having the highest statutory rate in the region puts Alabama at a competitive disadvantage in attracting and keeping business in the state. Lowering the rate to 5.5% or below would make Alabama much more competitive.
While state policy regarding overtime taxes and corporate income taxes could be influenced by federal changes, there are fewer interactions with individual income taxes. However, this area is desperately in need of reform. Since 2020, more than 30 states have implemented individual income tax rate cuts. In Alabama there has only been limited and targeted relief, no across the board rate changes.
The lack of progress on income tax rate reform has left Alabama with one of the highest rates in the Southeast, with most income being taxed at 5%. Without action, by 2027 Alabama will only have a lower rate than South Carolina (6.2%). Again, this puts the state at a competitive disadvantage in attracting new residents (and workers) to Alabama. The state should consider moving to a flat income tax rate of less than 4% to provide relief and better position Alabama for the future.
Beyond the overtime tax and corporate and individual income tax reforms, there are other areas that lawmakers can look to provide additional relief.
While decreasing the state’s sales tax on groceries by an additional 1% during the 2025 session was a victory for taxpayers, Alabama remains in the minority of states that tax groceries at all. Thirty-three states and the District of Columbia levy no sales tax on food items. It is past time for Alabama to abolish this tax.
Alabama’s business privilege tax has been another topic of discussion over the past few years. The business privilege tax is a state government fee levied for the privilege of being organized under the laws of Alabama or doing business in the state. During the 2022 regular session, Alabama lawmakers repealed the minimum privilege tax, with the change being fully implemented during the 2024 tax year, saving businesses an estimated $23 million each year.
No company should be required to pay the state a fee purely for the privilege of doing business within Alabama’s borders. Lawmakers should continue to pursue a full repeal of the tax, saving Alabama businesses more than $215 million each year.
Even though Alabama’s state government has taken in record amounts of revenue each year since 2017, that money has been used to expand government at record levels as well, not reduce the tax burden on citizens. Taking less taxes from Alabamians should be the top legislative priority in 2026.