Everything's Bigger in Texas -- But This New Franchise Tax Is No Joke

Many of you know that Texas has recently enacted sweeping changes to its corporate income tax. Oh I know, Texas has no income tax – that would be unconstitutional. I’ve been asking myself -- How did we get to this?

Not that long ago, Texas had no income tax on individuals or corporations. There used to be a tax on the amount of “capital” a business employed in the state, which was poorly formulated and a few court cases and subsequent policy changes basically gutted it. Next they introduced the income component of the tax back in about 1991 or so. Still it was only applicable to certain business entities, because the Texas Constitution prohibits an individual income tax.

Now they have revised the tax once again. Somewhat curiously, they’re making a big to do about this not being a new tax or even a “margin tax” as some people call it. They say it’s merely a revised “franchise” tax. I guess they’re strategy is to minimize complaints, I’m really not sure. Their chief argument for it being the same old franchise tax, just slightly modified, is that it is still found in Chapter 171 of the Texas Tax Code. This all seems sort of silly – like they want to make the argument out to be what the tax is called. Who care’s what it’s called? The truth is this is a Texas-sized change in corporate taxation. For right now we’re stuck with it and we have to be ready for it since it is effective for reports due on or after January 1, 2008.

We are tax advisors and that the old saying within the industry is that any change in the tax law is good for business. However, I have a hard time taking off my Joe Citizen and Joe Business Owner hat and speaking strictly as a Tax Advisor when something as bad as this new tax is offered up by our elected officials.

Problem is, in speaking with many other business owners over the last several months, I’ve realized that very few people are even aware of this new tax and what it means to them. So we decided to inform people of this new tax and how it operates. That’s the reason for this newsletter and we will also be offering seminars on the new tax. Stay tuned and we’ll let you know when to tune in.

Here’s the basics:

This new franchise tax is basically a tax on the total revenues of a business with only a few deductions. The total revenues of the business are determined by adding up all the receipts of the “unitary combined group” – which is a totally new concept in Texas taxation. You are allowed the choice of two deductions. You can choose to deduct cost of goods sold or compensation. Then you multiply the net “margin” by the Texas apportionment factor giving you the taxable “margin”. Then finally you apply the applicable tax rate (either 1% or .5%)

Sounds simple and straight forward right? It’s not.

For example, here are just a couple issues that immediately come to mind:

• What is a combined/unitary group? First of all, it starts with 50% ownership, and it appears that “unitary” will be very broadly defined. That’s not good.
• The election of using cost of goods sold or the compensation deduction applies to all members of the group. What if some members of the group are service entities and others are manufacturers?

This tax will be a menace to businesses in Texas. But for now, this is what we’re stuck with. We will continue to stay on top of changes as they occur in this tax over the next few years and beyond.