Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states corporations are subject to a corporate income tax, while income from pass-through entities such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which most often are flat regardless of the amount of income, generally range from roughly 4% to 10%. Personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
Currently, six states – Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming – do not have a corporate income tax. However, four of those states – Nevada, Ohio, Texas, and Washington – do have some form of gross receipts tax on corporations. Moreover, five of those states – Nevada, South Dakota, Texas, Washington, and Wyoming – as well as Alaska and Florida currently have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a franchise tax or privilege tax. This is frequently justified as a tax simply for the “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Alabama has both a business privilege tax and a corporate income tax. Your business may be subject to one, both, or neither of these taxes depending on its legal form. Additionally, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.
The business privilege tax is a tax on the net worth of your business. The rate for the tax depends on how much taxable income your business has, and ranges from $.25 per $1,000 in net worth to $1.75 per $1,000 of net worth. The specific breakdown is as follows:
The business privilege tax applies to businesses formed to limit individual liability, including traditional corporations, S corporations, LLCs, and limited liability partnerships. Affected businesses must pay a minimum privilege tax of $100 regardless of net worth. For most types of businesses, the business privilege tax is due two-and-a-half months after the end of the business’s tax year. Thus, if your business’s tax year is the same as the calendar year, the business privilege tax is due on March 15th. However, for corporations with a tax year that ends on a date other than June 30, the tax is due three-and-a-half months after the end of the tax year. In general, business privilege tax returns are due at the same time that a business’s corresponding federal tax return would be due.
For most traditional corporations, Alabama’s corporate income tax is charged at a flat rate of 6.5% of taxable net income.
Here’s a brief look at additional details for five of the most common forms of Alabama business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Alabama corporations are subject to Alabama’s corporate income tax at a flat rate of 6.5% of net income. This tax must be paid in addition to the business privilege tax.
Example: For the latest tax year, your Alabama corporation had a net income of $100,000 and the corporation’s net worth was also $100,000. Other things being equal, your corporation will owe Alabama corporate income tax in the amount of $6,500 (6.5% of $100,000). The corporation will also owe Alabama business privilege tax in the amount of $100 ($100,000 total net worth taxed at $1.00 per $1,000 of net worth).
An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect S status. Unlike a traditional corporation, an S corporation is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each individual shareholder is subject to federal tax on his or her share of the corporation’s income. In other words, S corporations are pass-through entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.) Alabama recognizes the federal S election, and Alabama S corporations are not required to pay income tax to the state. However, individual S corporation shareholders will owe state tax on their share of the company’s income. Moreover, as limited liability entities, S corporations are required to the pay the state’s business privilege tax.
Example: For the latest tax year, your S corporation had net income of $100,000 and the company’s net worth was also $100,000. The $100,000 in net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your individual state tax returns. The business will also owe Alabama privilege tax in the amount of $100 ($100,000 total net worth taxed at $1.00 per $1,000 of net worth).
Like S corporations, standard LLCs are pass-through entities and are not required to pay income tax to either the federal government or the State of Alabama. Instead, income from the business is distributed to individual LLC members, who then pay federal and state taxes on the amount distributed to them. While typically not required to pay corporate income tax, LLCs, as limited liability entities, are required to pay the state’s business privilege tax.
Note, however, that while by default LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, disregarded entities), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject to Alabama’s 6.5% tax on taxable net income.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $100,000 and the company’s net worth was also $100,000. The $100,000 in net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your respective portions on your respective individual tax returns. The LLC will also owe Alabama privilege tax in the amount of $100 ($100,000 total net worth taxed at $1.00 per $1,000 of net worth).
Partnerships are not corporations; moreover, standard partnerships do not limit the liability of the individual partners. Therefore, Alabama partnerships are subject neither to Alabama’s corporate income tax nor to the state’s business privilege tax. Instead, income from the business is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns.
Note, however, that limited liability partnerships (LLPs) and limited partnerships (LPs) do limit the liability of individuals; therefore, LLPs and LPs are subject to the business privilege tax.
Example: For the latest tax year, your partnership, which is not an LLP or LP, had net income of $100,000 and the business’s net worth was also $100,000. The $100,000 in net income will be divvied up between you and your fellow partners, and you will each pay tax on your respective portions on your respective individual tax returns. The partnership does not owe any business privilege tax.
Like standard partnerships, sole proprietorships are not corporations and provide no limitation on liability for the sole proprietor. Therefore, an Alabama sole proprietorship is subject neither to Alabama’s corporate income tax nor the state’s business privilege tax. Instead, income from your business will be distributed to you as the sole proprietor, and you will pay tax on that income on your individual federal and state tax returns.
Example: For the latest tax year, your sole proprietorship had net income of $100,000 and the business’s net worth was also $100,000. The $100,000 in net income is distributed to you personally, and you pay tax on that income on your individual federal and state tax returns. The business does not owe any business privilege tax.
Our primary focus here is on businesses operating solely in Alabama. However, if you’re doing business in several states, you should be aware that your business may be considered to have nexus with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Alabama, it may be subject to Alabama taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Alabama’s corporate income tax and business privilege tax, check the Department of Revenue website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Frederick Daily (Nolo).