Income Taxes on Business Income in Alabama

April 13, 2006

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In Alabama, you're generally free to choose to operate your business as a C corporation, S corporation, partnership, limited liability company (LLC), or sole proprietorship. However, the entity type you select for your business may, in some cases, decide whether you or your business pays income taxes on the business income.

Corporations. Domestic (corporations organized in Alabama) and foreign corporations (corporations organized in a state other than Alabama), are subject to an Alabama income tax. Your corporation is subject to tax if it's:

domiciled in Alabama or licensed or qualified to transact business in Alabama
doing business in Alabama or deriving income from sources in Alabama, including income from property in Alabama
acting in a fiduciary capacity

If your corporation is an Alabama domestic corporation, the corporation pays tax at the rate of 6.5 percent of net income. Foreign corporations in Alabama pay tax at the rate of 6.5 percent of the net income derived from property situated and business transacted in the state.

If you are a multistate business whose only activities in Alabama consist of sales and do not include owning or renting realty or personal property and whose gross sales volume for the tax year does not exceed $100,000, you may elect to pay an income tax at the rate of 0.25 percent of such sales volume.

S corporations. If you meet the federal tax law requirements to operate as an S corporation, the IRS allows your business to "pass through" its income to the shareholders. This means that your business will not pay any IRS corporate level income tax. However, you'll have to claim your entire share of the business income on your personal federal income tax return even if you did not take any money out of the business.

In Alabama, the law extends this favorable tax treatment to state corporate income tax liability and S corporations will not be subject to the corporate income tax.

Partnerships. If you operate your business as a partnership, your partnership will not be taxed on its net income. Instead, partners must include in their Alabama taxable adjusted gross income their distributive share of partnership income.

Limited liability companies (LLCs). Alabama law recognizes businesses operating as limited liability companies (LLCs). Domestic and foreign LLCs in Alabama are classified as partnerships for Alabama tax purposes. Accordingly, your LLC will not be taxed on its net income. Instead, members must include in their Alabama taxable adjusted gross income their distributive share of LLC income.

If a business is classified as an association taxable as a corporation for federal income tax purposes, it will also be taxable as a corporation for Alabama tax purposes.