A law passed during the 1997 regular session of the Alabama Legislature allows for an exemption from Alabama income taxes for certain employees who lose their jobs as a result of administrative downsizing.

Act number 97-705, now codified as section 40-18-19.1, Code of Alabama 1975, exempts the first $25,000 of severance pay (including unemployment compensation, termination pay, or income from a supplemental income plan) received by an employee who loses their job as a result of “administrative downsizing.”

Act Number 2021-240 amends code section 40-18-19.1 to increase the severance pay exemption from $25,000 to $50,000 annually beginning with the 2020 tax filing year. Taxpayers who filed their 2020 tax return may file an amended return if their severance exemption exceeded the original $25,000 allowed, but in no case should exceed $50,000. Others should file and use their actual severance pay not to exceed the $50,000 limit. Please note that if your severance pay was less than $50,000, only the amount up to your severance pay is exempt. For example: your  wages are $40,000, you received a $30,000 severance package, box 16 of your W-2 should only be reduced by $30,000 for the severance pay exemption, and box 14 of the W-2 should reflect the $30,000 severance pay.

Employers may request approval for the exemption by submitting their written request to:

Individual and Corporate Tax Division
Alabama Department of Revenue
P.O. Box 327410
Montgomery, AL 36132-7410

The request must accompany the company’s downsizing plan and must provide the following information:

• Alabama withholding account number,
• Federal employer ID number,
• The reason for administrative downsizing,
• The number and description of employees affected,
• The total amount of benefits to be paid to the affected employees which will be exempted,
• The method used to compute the severance pay,
• The calendar year of payment of exempt severance pay,
• Return name, phone number and email address to contact in case we have any questions, and
• List of the employees including their first and last name, last four digits of their social security number, position held, date of separation, full amount of severance pay, and exempt amount of severance pay up to $50,000 annually for tax years 2020 forward. For lists with multiple employees, please total the columns with the full amount of severance pay and exempt amount of severance pay for all employees.

The employer should also provide a copy of any severance/termination information that is distributed to the affected employees. Please allow 30 days for the processing of your application. Employers must obtain approval to exempt the payments for each calendar year the payments are made.

Alabama income tax must not be withheld when exempt severance payments are made. Also, the amount of the exempt severance payments should not be included in Alabama taxable wages (box 16) of the employee W-2 form, but should be disclosed in box 14 (Other) of the W-2 as exempt severance payments.

Employers should fax the approval request letter to 334-242-0112 or email it to laura.walden@revenue.alabama.gov.

If you have questions, contact Laura Walden at 334-242-1301 or laura.walden@revenue.alabama.gov.