Texas Businesses to be Taxed on “Margin”

By Frank Conroy

In 2006 the Texas Legislature made significant changes to the Texas Franchise Tax. Most businesses will notice these changes in their first state tax filing due on or after January 1, 2008. The new tax law is commonly referred to as the Margin Tax.

Who Pays?

The Texas Franchise Tax continues to apply to corporations and limited liability companies (LLCs) organized or doing business in the state of Texas. Beginning with the 2007 tax year (returns due in 2008), it also applies to other businesses such as  partnerships (with some exceptions), business trusts, professional associations (PAs), business associations, joint ventures and other legal entities organized or doing business in Texas.

Because the tax applies to margin, as defined by the law, and not the net profit of the business, some businesses will pay tax even when they have no profits. As a group, service businesses are expected to pay significantly more under the new law.

Who Doesn’t Pay?

The new law does not apply to businesses organized as sole proprietorships, general partnerships where all partners are natural persons, certain unincorporated passive entities, grantor trusts and a few other specified forms of business.

Taxable entities with gross receipts less than $300,000 will not be subject to the tax, and discounts on the tax rate apply to businesses with gross receipts up to $900,000. No tax will be due if the calculated tax is less than $1,000.

How Much Will Your Business Pay?

The new tax is either 1% or ½% of taxable margin, depending on the type of business. Retailers and wholesalers will pay the ½% rate and all others will pay the 1% rate.

Margin, very simply stated, is total gross receipts reduced by one of three annually elected deductions. These deductions are: (1) cost of goods sold, (2) eligible compensation and benefits, or (3) 30% of gross receipts. Gross receipts, cost of goods sold and eligible compensation and benefits are all terms that are specifically defined in the law, and there are considerable wrinkles in the statute that must be considered in calculating margin. For example, eligible compensation is limited to no more than $300,000 per employee, but benefits can be added above that limit.

Once margin is calculated, an apportionment factor is applied to determine the amount attributable to Texas. Then the appropriate rate is applied to determine the tax.

Taxable entities with total revenue less than $10,000,000 may use an “EZ Computation” and pay tax on gross receipts times the apportionment factor times 0.575% (.00575).

Other Changes and Impacts

Under the old law, separate franchise tax returns were filed for each entity, regardless of ownership. Under the new law, combined reporting will be required for businesses with common ownership, as defined.

In Conclusion

The state of Texas has dramatically changed the way it taxes businesses within its jurisdiction. Businesses are advised to consult their tax advisor as soon as possible to begin planning for this tax. In particular, businesses with losses carried forward from the previous law must file a special form on or before the due date of the 2008 return to reserve their right to these losses. For some, the new tax will represent a significant increase in state taxes, and some changes in accounting procedures may be necessary in order to maximize the allowable deductions.

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