|
Texas Enacts Sweeping Franchise Tax Changes
SALT Tax Alert, June 22, 2006 |
On May 18, Texas Governor Rick Perry signed House Bill 3 that enacts a major overhaul of the franchise tax effective for returns due on or after January 1, 2008. The new law effectively replaces the current franchise tax primarily applicable to corporations and limited liability companies with a modified gross receipts tax applicable to nearly all types of business entities.
Taxpayer Definition Expanded
Under the new law, the definition of a taxable entity is expanded from the current imposition on corporations and limited liability companies to also include partnerships and business trusts. Specifically excluded are sole proprietorships, grantor trusts, general partnerships directly owned in total by natural persons, "passive entities" and certain REITs and REMICs. Passive entities are generally partnerships and nonbusiness trusts that have at least 90% passive income, such as dividends, interest, and gains from the sale of real property and securities.
New Tax Base - "Taxable Margin"
The taxable capital (net worth) and earned surplus (net income) tax bases are replaced with a tax on apportioned taxable margin. Taxable margin is defined as the lesser of:
- Total revenue less the greater of cost of goods sold or compensation, or
- 70% of total revenue.
Total revenue is generally gross revenue reported on a taxpayer's federal return, including gross sales less returns, interest, dividends and net capital gains, reduced by bad debts, foreign dividends and royalties, and certain federal dividend received deductions. Currently, corporations also include gross rental income and partnerships include net rental income. Technical correction legislation is expected to modify the tax base of partnerships to include gross rental income. Special rules apply to certain taxpayers including contractors, real estate brokers, financial institutions, law firms, health care providers, and staff leasing companies.
Cost of goods sold includes direct costs of acquiring or producing real or tangible personal property and specified related costs. Although a taxpayer's federal method of accounting is generally followed in computing cost of goods sold, the new law provides a detailed list of specifically included and excluded expenses which does not fully conform to the federal definition of cost of goods sold.
Compensation is defined to include wages and cash compensation plus all employer provided benefits, including health and welfare benefits, retirement plan contributions, and workers compensation insurance. Wages are generally Medicare wages and tips reported on IRS Form W-2. For entities taxed as partnerships or federal S corporations, compensation includes net distributable income to partners and shareholders that are natural persons. Wages and cash compensation are limited to $300,000 per person.
Tax Rate
The taxable margin tax rate is .5% for entities primarily engaged in retail or wholesale trade, as defined by Texas, and 1% for all other taxpayers.
Combined Unitary Reporting Required
An "affiliated group" of entities engaged in a unitary business are required to file a combined group return. An affiliated group is a group of taxable entities with an 80 percent or more controlling interest owned by a common owner or one or more member entities. The determination of whether commonly controlled entities are engaged in a unitary business is factually intensive. Please consult with your Plante & Moran tax team. An affiliated group filing a combined return is treated as one taxable entity.
Apportionment
The apportionment rules generally remain the same except for the elimination of the throwback rule and the requirement to source receipts from the servicing of loans to the location of the real property securing the loan. Currently, Texas receipts of an affiliated group member are included in the receipts factor numerator only if the member has nexus. However, affiliated group member receipts are included in the receipts factor denominator without regard to nexus.
Small Taxpayer Exceptions
A taxable entity is exempt from the new franchise tax if its tax liability would be less than $1,000 or its total revenue is less than or equal to $300,000. The Texas Comptroller is expected to require taxable entities meeting a small taxpayer exception to file an information return.
Nexus Standard & Financial Accounting Matters
Texas law states that the tax based on taxable margin is not an income tax subject to Public Law 86-272. At this time, it is not clear whether Public Law 86-272 will apply to the revised Texas franchise tax.
Separate from the issue concerning Public Law 86-272 is the application of FAS 109 for financial statement reporting purposes. Many commentators have preliminarily stated that the revised franchise tax on taxable margin should be accounted for as an income tax for financial statement reporting. Please consult with your Plante & Moran assurance team for further guidance.
Temporary Credit - Filing Deadline March 1, 2007
Texas has enacted a temporary credit that is essentially based on a taxable entity's apportioned net deferred tax asset. To establish the credit, a taxable entity must provide the Texas Comptroller written notification by March 1, 2007 of its intention to claim the credit. The nonrefundable credit may be claimed against the franchise tax on taxable margin for up to 20 consecutive privilege periods. Further guidance is expected regarding the form of the written notification. The Plante & Moran State and Local Tax Group is available to assist you with establishing your credit.
The information provided in this alert is only a general summary and is being distributed with the understanding that Plante & Moran, PLLC is not rendering legal, tax, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assumes no liability whatsoever in connection with its use.
