Alabama is among the more tax-friendly states for retirees. According to the Alabama Department of Revenue, the state ranks 48th among the states in per-capita taxation and its real estate tax is among the lowest in the nation. It provides tax breaks to people over age 65 that reduce their tax bills.
Alabama does not apply its graduated income tax of 2 percent to 5 percent to Social Security retirement benefits. It also exempts from income tax the pension benefits from corporate, military or other government sources. However, it does apply its income tax to retirement distributions from an employer-sponsored defined-contribution retirement plan such as a 401(k), and it taxes retirement distributions from individual retirement accounts that are federally taxed. The income tax also applies to all income a person over 65 earns from work. There is a $1,500 exemption for each taxpayer, another $1,500 for a spouse and $1,000 per dependent. Taxpayers can choose a standard deduction or take itemized deductions.
Real Estate Taxes
Alabama exempts all residents age 65 and older from the state's 0.65 percent real estate property tax, which is levied on a taxable value of just 10 percent of a home's market value. Alabama cities and counties also levy real estate taxes on a home's state taxable value, but residents over 65 with annual federal adjusted gross incomes below $7,500 or who are totally disabled regardless of income are exempt from these local real estate taxes. Those over 65 with annual federal adjusted gross incomes between $7,500 and $12,000 get a $5,000 deduction from the taxable value of their principal residence.
Retirees must pay the state's 4 percent sales tax levied on most retail sales of goods including groceries. But prescription drugs are tax exempt, as are all services. Alabama's sales tax rate is among the lowest in the country. As of 2012, only seven other states have a state tax rate equal to or less than Alabama's. But its cities and counties can levy a local sales tax of up to 8 percent on top of the state sales tax.
Alabama levies a personal property tax of 0.65 percent on automobiles, motorcycles and motor homes but does not apply the tax to other valuable personal property such as home furnishings or computers. A motor vehicles' taxable value is 15 percent of market value. Alabama does not have a state inheritance or estate tax, but it is a collection agent for the federal estate tax.