New Texas Margin Tax -- Business or Income Tax

Candidates for governor in Texas last week reacted to the Financial Accounting Standards Board’s (FASB) conclusion that the new Texas margin tax was an income tax under Financial Accounting Standards (FAS) 109 “because the tax is based on some measure of income.” FASB declined to set up a project to give advice on the matter.

Kathy Walt, spokeswoman for Republican Governor Rick Perry, and former state Comptroller Democrat John Sharp, who headed the commission that recommended the tax, said that FASB was providing instructions for accounting purposes only, according to the Houston Chronicle. Walt said that FASB considered part of the old franchise tax an income tax.

Perry’s opponents in the November election, who include independent Carole Keeton Strayhorn, the state controller, independent Kinky Friedman and Democrat Chris Bell, have all accused Perry of passing a state income tax, an action that is barred by the Texas constitution without a statewide referendum, the Chronicle reports.

Bell spokesman Jason Sanford said Perry managed “to pass [...] the biggest tax increase in state history.” Friedman campaign director Dean Barley called for litigation, saying, “We urge the business people of Texas to take this issue to the courts and test its legality.”

The expanded business tax, called the Margin Tax, replaces “the ineffective and loophole-riddled franchise tax,” according to the Web site of the Texas Society of Certified Public Accountants (TSCPA) and “is meant to partially replace the tax revenue lost by the significant cut in state property taxes that the Texas Legislature passed at the same time.”

The one percent tax will apply to all of a company’s revenue, minus the cost of goods sold or the cost of employee compensation, the Waco Herald Tribune says. The law does not tax net income, which is illegal in Texas. Sharp said that his group worked directly with business people and listened to their recommendations.

Revenue from the old franchise tax law had fallen to approximately $2 billion. The new law, Sharp says, should bring in approximately $6 billion from 150,000 mostly larger businesses. He said that most larger businesses were willing to pay a fair price for the limited liability protection afforded by the state through a “better business tax system,” the Brenham Banner-Press reports.

Any legal entity that does business in Texas, and enjoys some form of limited liability protection, must pay the new tax, Mike Seay and Jimmy Martens write on the TSCPA Web site. That includes corporations, limited partnerships, limited liability companies and limited liability partnerships. Sole proprietorships and general partnerships are not taxed under the new law.

Smaller entities that owe less than $1,000 in tax or have less than $300,000 in total revenue, are exempt from the tax. Other entities that are exempt are insurance companies, nonprofits, some cooperatives, certain trusts, estates of natural persons and some family limited partnerships, real estate investment trusts, and real estate mortgage investment conduits. Some kinds of passive entities are also exempt.

“Many businesses that paid no franchise tax should now expect to pay when the first returns are due, in May of 2008,” Seay and Martens write on the TSCPA Web site.

“To some extent, our previous franchise tax had an element of an income tax, so I think that people may view this as just a nonevent,” said Jerry Love, chairman of the TSCPA, speaking of FASB’s conclusion, the Tribune-Herald says. “Now if it were assessed against individuals, I think you would have more people be concerned,” he said.

Love’s colleagues, Seay and Martens predict, however, that the new law will be tested in the Texas Supreme Court because it “taxes a person’s share of partnership and unincorporated association income.” The court will have to decide whether the bill taxes the partnership or the individual.

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