Taxes can be annoying and boring. But if you are starting a new business in the state of Alabama, you’ll be prepared to deal with them after reading this article.
The tax codes for each Alabama business structure and entity type have their individual advantages and disadvantages. Being aware of your business’s potential tax liability may help you decide how to structure your business.
Alabama Business Privilege Tax and Annual Report
Before I explain each Alabama business structure and the coinciding tax liabilities, you should know about the Alabama business privilege tax. Alabama requires all business entities that conduct business in Alabama to pay a business privilege tax. In addition, Alabama requires limited liability companies (LLCs), S and C corporations, limited liability partnerships (LLPs), and limited partnerships (LPs) to file an annual report.
The Alabama business privilege tax is dependent on each business entity's net worth. Alabama business privilege tax rates vary by the business’s net worth and are between $0.25 and $1.75 per $1,000 of net worth. There is a minimum tax of $100. Net worth applies to business conducted in Alabama specifically, including sales, employees, and properties of the business. Net worth of any business conducted outside of Alabama is not included in the net worth calculation and does not apply to the business privilege tax.
If your business does $250,000 of total revenue, but if only $100,000 of that revenue is from within Alabama, that would lower your business privilege tax rate to $1.00 per $1,000 from $1.25 per $1,000 at the $250,000 revenue value.
The required documents for when you file a business privilege tax return are an annual report, Form 20C (C corps), Form 20S (S corps), Form 65 (limited liability entities), and a statement providing information on any deductions the business is claiming.
The due date of the Alabama business privilege tax returns initial return varies as well. For C corporations, the due date is three and a half months after the beginning of their fiscal year. For the other business entities—S corps, LPs, LLPs, and LLCs—the due date is two and a half months after the start of the tax year.
The Alabama Department of Revenue does charge a late fee if you file your business privilege tax returns after the deadline.
If your business has employees, the Alabama Department of Revenue requires the business to pay or withhold employer taxes. These include federal income tax withholdings and social security tax, as well as state tax withholdings. Some businesses may be required to withhold federal and state unemployment tax and workers’ compensation insurance.
A sole proprietorship is the most common and simplest business structure. For legal and tax purposes, the owner is the business. The owner is the one also conducting the work of the business. Examples of these could be providing a service, such as mowing lawns, or selling a product, such as cookies or custom artwork.
In these examples, the owner is the operator and the business. Legally and financially they are seen as one and the same. With a sole proprietorship, there is no protection for your assets should the business get sued. Your personal assets could be seen as liabilities of the business.
Due to the lack of legal separation between the business and your personal assets, you should consider becoming a limited liability corporation (LLC) instead. An LLC creates a separation between the business and your personal assets.
Sole Proprietorship Taxes
When filing business taxes, you’ll need to report your net income or taxable income. This total will include any money you made from another job, as well as the net income from the sole proprietorship side business.
Calculating the net income of your business is easy. Subtract the total money your business made by the total of the business’s costs or expenses. Even simpler: sales minus expenses equals profit, also known as the taxable income. Don’t be worried if this number comes out negative.
Using a lawn mowing service as an example, I can explain the process of calculating your business taxes.
Throughout the previous calendar year, you and your lawn mowing service had sales of $10,000. For you to run your business, there are inevitable costs and expenses. These deductions could be the lawn mower, the truck, the gas, safety equipment, and advertisements.
You will need to track these expenses for tax purposes throughout the year, so save receipts and track your business mileage.
In this example, let’s say your total expenses came out to be $6,000.
The net income of your business would be the sales ($10,000) minus the expenses ($6,000) for a total profit or net income of $4,000. You would be required to pay Alabama state tax and federal income tax on that total amount.
When filing your income tax return for the calendar year, you will also need to report any job income as well as the net income from your business. If you have a nine-to-five job, that income will be taxed at the federal tax rate alongside your business income.
As a sole proprietorship, you will owe 6.5% of your business income as Alabama's corporate tax. You will also pay the federal government taxes on your business income, as well as any other sources of income. The federal tax rate is a marginal tax rate so your tax rate will depend on which tax bracket you are in.
Sole Proprietorship Tax Documents
As a small business owner, you will need to familiarize yourself with a few IRS forms when filing your taxes in Alabama. These forms include the standard Form 1040 for personal federal income tax returns and a Schedule C Form. The IRS recommends filing these federal forms quarterly throughout the year for your business.
The Schedule C Form is the Profit or Loss from Business form from the IRS. This is where those receipts will come in handy for calculating your business’s total income and expenses. The IRS divides expenses into multiple categories, including vehicles, insurance, office expenses, travel, meals and entertainment, and utilities.
Partnerships are viewed as pass-through entities by the state of Alabama. This means the business profits and losses are split among the partners. These earnings are reported through the federal income tax returns of each partner. Since the partners are responsible for the taxes on the income of the business, the business does not pay a corporate tax.
Unlike a sole proprietorship, as a partnership you will need an EIN, or federal tax ID number, from the IRS.
Some partnerships require licenses and permits. Using this official site on business licensing from the Alabama Department of Revenue will identify the necessary forms.
General partnership arrangements do not provide any liability protection. The personal assets of the partners are not protected if the business is sued. In general partnerships, each of the partners has the power to make decisions for the partnership.
Under this structure, the profits and losses of the business are also shared equally between the partners. Each partner will pay tax on their share of the company profits. This structure requires solid partners, since negligent partners can expose your personal assets as a liability on top of the business’s debts.
Under a limited partnership (LP), there is at least one of each type of partner—a general and a limited partner. Limited partners put money into the business and receive profits equal to their share of the business.
General partners earn their share of the business profits as well, but they are the only ones responsible for the debt of the business. The general partner(s) is also the sole active business manager.
Limited Liability Partnership
Limited liability partnerships (LLPs) serve to protect each of the partners from actions taken by their partners. The partners are still taxed as a partnership. Under an LLP, the individual partners are protected should an individual partner be sued. This liability protection does not protect the assets of the business itself.
This is one of the more complex partnerships and demands a lot of documentation. However, the benefit of the partners not being taxed at the corporate rate and not being at risk for the business's debts may be worth it.
Limited Liability Limited Partnership
Limited liability limited partnerships (LLLP) are relatively new, but they are recognized by most states. In an LLLP, the assets of the partnership and the partners themselves are separated. These are built off the limited partnership and are examples of limited liability entities. It even covers the general partners with liability protection.
Under each of the partnership business structures, the business income is taxed the same way.
The business’s income is split between the partners and reported on their personal income tax return along with their ordinary income. This income will be reported on their tax return to both the state of Alabama and the federal government.
Much like a sole proprietorship, the profits, expenses, and deductions from the tax year will need to be calculated and reported.
Partners are not employees and should not be given W-2 forms.
Partnership Tax Documents
The partnership will need to file and submit a Form 1065, Return of Partnership Income. This is a partnership version of the Schedule K form. Additional documents will be required for the taxes collected throughout the year. These forms can be found on the IRS partnership website.
As an individual partner of a partnership, you would need to file Form 965, for tax liabilities, and Schedule E, for supplemental income, alongside the standard Form 1040 for the federal income return. A variety of tax preparation software can make this process easy.
Limited liability entities will need to file Form 65 as part of the Alabama business privilege tax reporting process.
Limited Liability Corporations
After getting your company name through the Certificate of Name Reservation, a Certificate of Formation, and sending $200 to the Secretary of State, you will be on your way to starting your LLC in Alabama.
An LLC serves as a pass-through entity. The profits and losses are handed to each of the LLC members. Individually, they will be taxed for their portion of the LLC's profits. The major advantage of an LLC is the liability protection it gives the members. By separating the personal and business assets, only the business is exposed to any possible lawsuits.
For more information, read my comprehensive guide to starting your own LLC.
The government allows single-member LLCs created by an individual, but the risk is the legal interpretation of where the individual ends and business begins, similar to a sole proprietorship. This may allow the personal assets of the single member to be exposed as a liability. As disregarded entities, single-member LLCs are not required to file a Form 65.
As a pass-through entity, the LLC pays federal income tax on the business income at individual federal income tax rates. The LLC owners will be taxed federally for their profits after accounting for their expenses and deductions. The businesses are still required to pay Alabama’s business privilege tax due to being classified as a limited liability entity.
LLC Tax Documents
Like other Alabama business entities, an LLC is subject to the Alabama Department of Revenue’s business privilege tax. As a limited liability entity, a Form 65 will need to be filed. As a pass-through entity, a Form PPT will also be required.
The required federal tax documents for an LLC are similar to the other business structures.
The taxes of a single-member LLC will be similar to that of a sole proprietor. You would report the business’s profits, deductions, and expenses from the tax year on the Schedule C form along with your typical Form 1040 document. Don’t forget, as a single-member LLC, you’re not required to file a Form 65 for Alabama.
Under a multimember LLC, each of the members will report their share of the profits and expenses, much like in a partnership. They will be required to file a Form 1065 and a Schedule K-1 form that reports their share of the income, losses, and deductions. Each member will also need to file the Form 1040 document.
If your LLC has employees, there are additional forms required to pay the payroll taxes. You will need to familiarize yourself with Forms 940, filed annually, and 941, filed quarterly.
C corporations are big-brand types of domestic corporations that pay federal income tax and state income tax when they file a corporate income tax return. The shareholders and employees of the corporation would owe taxes at the individual level for their income and dividends. This is known as “double taxation.”
C Corporation Taxes
A C corporation pays corporate income taxes on its profits. These are calculated like other businesses but will likely be more complex due to their scale and the associated employee taxes and insurances involved.
The profits of a C corporation may be taxed a second time. This can occur when corporations pay out a dividend to their shareholders. The shareholders are then responsible for paying the taxes on those dividends for that tax year.
C Corporation Tax Documents
Since C corporations can be complex, I highly recommend using an accountant. In addition to filing a federal corporate tax return using Form 1120, Alabama corporations will also need to file the Alabama annual report form Schedule AL-CAR as part of the business privilege tax. This will include Form 20C.
An S corporation can be thought of as being owned and operated by the employees. As such, there are strict operational processes in place to protect the shareholders who work for the company. The law protects the employees so that their benefits and corporation stocks are not included as part of their income and compensation.
S Corporation Taxes
While S corporations file federal corporate tax returns, their shareholders will report their share of the corporation's income, losses, and expenses on their individual income tax returns and pay the corporation's taxes. S corporations avoid paying any corporate taxes by passing them through to the shareholders.
As an Alabama corporation, an S corporation will pay a flat state tax rate of 6.5% on their net taxable income. The Alabama business privilege tax will also be required for S corporations.
S Corporation Tax Documents
S corporations file Form 1120-S for the federal income taxes. Similar to multimember LLCs and partnerships, a Schedule K-1 form is required for the shareholders of an S corporation along with their Form 1040.
Alabama corporations will need to file documents for the Alabama business privilege tax. An Alabama annual report form, Schedule AL-CAR, and Form 20S will also be required for S corporations.
Understanding the various tax requirements will give you confidence in choosing the best business structure for your endeavor as you invest in your future as an Alabama business owner.
By keeping accurate records, contacting a business attorney when necessary, using the correct tax forms, and following the government’s recommended yearly or quarterly reporting deadlines, stressing over state taxes in Alabama will become a thing of the past.
The Alabama Department of Revenue site provides online accounts for LLCs and corporations in Alabama to receive reminders and state tax information throughout the year.
In case I missed anything related to the Alabama business privilege tax and annual report filing, here is a link to the Alabama Department of Revenue’s FAQ page.