Texas legislature passes revised "margin" franchise tax

Sweeping changes in the tax base and the tax rate of the Texas franchise tax passed by the state legislature in 2006 and modified in 2007 are scheduled to go into effect for reports originally due on or after January 1, 2008, extending coverage to an estimated 200,000 entities doing business in Texas, including partnerships.

Many managers of Texas businesses are not yet aware of the liability or the costs of compliance with the new tax, a tax on the "margin" of business revenue, according to members of the Fort Worth Chapter, Texas Society of Certified Public Accountants, who participated in a survey conducted between September 18, and 24, 2007.

Of 242 CPAs responding to the survey, 52 percent said that in their opinion, most affected business entities are not yet aware of the tax's impact. Although the tax is applicable to revenue for tax years ending in 2007 (current revenue), many will not compute the tax or file returns until Spring, 2008.

Other findings from the Fort Worth survey indicate that local CPAs expect the number of returns they prepare to increase, expect more entities to be filing, and anticipate that the cost of compliance will increase.

A brief overview of key features in the new law, published by the Texas Comptroller of Public Accounts follows:

Who must file

The franchise tax has been extended to general, limited, and limited liability partnerships which were exempt under the previous law.

Most entities will be required to file franchise tax reports, including corporations, limited liability companies, business trusts, professional associations, business associations, and joint ventures.

Taxable entities with revenues of $300,000 or less will owe no tax. Taxable entities with tax due of less than $1,000 will owe no tax. However, all taxable entities, including those that will owe no tax, must file a report.

Who is exempt

The tax does not apply to sole proprietorships, general partnerships directly owned by natural persons (except for limited liability partnerships), certain unincorporated passive entities, grantor trusts, estates of natural persons, escrows, real estate mortgage investment conduits (REMICs), and certain real estate investment trusts.

Combined reporting is required for members of an affiliated group engaged in a unitary business.

Rate

Businesses with revenue of $10 million or less may either

  • Pay 5.75 percent times total revenue times their apportionment factor OR

  • Pay tax on their margin

    The new tax rate based on the margin is calculated as shown below.

    Businesses with revenue greater than $10 million must pay tax on their margin. The tax rate is 1 percent for most entities, but .5 percent for entities engaged in wholesale or retail trade who meet specific criteria.

    Tax base, aka Margin

    The revised tax base is the taxable entity's margin, which equals the lesser of three calculations:

  • Total revenue minus cost of goods sold,

  • Total revenue minus compensation, or

  • Total revenue times 70 percent.

    Revenue

    There are a limited number of exclusions from revenue.

    Costs of goods sold

    Costs of goods sold generally includes costs related to the acquisition and production of tangible personal property and up to 4 percent of administrative and overhead costs. There are other cost of goods sold allowances for certain industries.

    Taxable entities only selling services will generally not have a cost of goods sold.

    Discounts

    Discounts allowed to entities with revenue of less than $900,000 are:


    Total Revenue Discount Percent
    $0 - 300,000 100
    300,000 - 400,000 80
    400,000 - 500,000 60
    500,000 - 700,000 40
    700,000 - 900,000 20
    900,000 and over 0

    Temporary credits

    A special report from the Comptroller issued in March notes, "Among the changes made by the Legislature is the repeal of provisions relating to franchise tax credits. For reports due beginning in 2008, taxpayers will not be able to earn credits, but taxpayers will be able to use credits earned on earlier reports that have not otherwise been exhausted."

    Corporations and limited liability companies that were doing business in Texas on May 1, 2006, are eligible to take a credit based on business loss carryforwards that were not exhausted on a report originally due before January 1, 2008.

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