Over the last two years, the number of business affected by the Texas franchise tax has increased rapidly. With thousands of companies still working through their sales tax compliance, many are unsure of what this new liability means. In this post, we break down everything you need to know.
What is the Texas Franchise Tax?
The Texas Comptroller defines the Texas franchise tax as:
“a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas.”
Legally, it’s defined as a fee for the right to conduct a substantial amount of business in Texas. In practice, the franchise tax functions like an additional fee on top of your sales tax.
It also shares a number of similarities with income tax.
The tax rate varies depending on the annual revenue of your business:
- Businesses with receipts less than $1.18 million pay no franchise tax.
- Businesses with $1.18 million to $10 million in annual receipts are taxed at a rate of 0.575%.
- Businesses with more than $10 million in revenue pay a franchise tax of 1%.
- A foreign taxable entity with no physical presence in Texas now has nexus if, during any federal accounting period ending in 2019 or later, it has gross receipts from business done in Texas of $500,000 or more.
When you compare it to Texas’ 6.25% sales tax rate, tax rates of 0.575-1% seem pretty low. But in context, the total costs are pretty significant. 1% of $10 million is still $100k.
The important question surrounds who is responsible for paying for this. Unlike sales tax – where the consumer is responsible for the expense, franchise tax comes out of your pocket. This means the franchise tax could actually cost your business more money than sales tax. (Assuming you’re compliant.)
How Do I Know If the Franchise Tax Applies to Me?
If your revenues in Texas in a single year are above $1.18, you have franchise tax nexus. However, the number of businesses that meet this threshold has drastically increased over the last few years – primarily due to the creation of economic nexus.
Originally the tax only applied to businesses with a sufficient physical presence in the state. But when Texas implemented economic nexus in October 2019, they updated their franchise tax to affect businesses with a sufficient economic presence. They also presumed that anyone with a sales tax permit has franchise tax.
This new definition went into effect for the 2020 franchise tax year. Because of this, the number of businesses that have franchise tax liability is much higher than in years past.
When Is Payment Due?
Franchise taxes are due on May 15th every year.
Factors like COVID-19 and extreme weather resulted in extensions in both the 2020 and 2021 filing seasons. The 2021 filing date is June 15.
What Happens if I Don't Pay It?
The penalty for non-compliance starts with 10% late fee based on an estimate of what you owe. And sometimes there’s an additional 10% late fee, called a jeopardy determination, added on top. If you’re registered with the secretary of state, they’ll also revoke your right to do business in the state until you’re compliant.
The effects of these penalties are significant.
Say, for example, your revenue hits the minimum threshold of $1.18 million in Texas. You’d owe $67,850, or 0.575% of your revenue. A 20% penalty is an extra $13,570 out of your pocket. Plus, losing your license to do business in Texas could cause you to lose your entire $1.18 million in annual revenues in Texas going forward.
If that wasn’t enough, failure to comply with the franchise tax can also impact your other taxes. For example, Texas can take your sales tax refund to cover your debt on the franchise tax.
How Do I Get Compliant?
Despite the confusion surrounding the franchise tax, getting compliant is a straightforward process. Here’s what you’ll need to do:
- Compare your total revenues in Texas to the thresholds defined above.
- If your revenues are more than $1.18 million you likely have franchise tax liability.
- You might also be liable if you’re registered to collect sales tax in Texas.
- Identify which tax rate applies to your business.
- Calculate how much you owe.
- File a return every year by May 15th and pay the proper amount to the department of revenue.
Getting compliant with the Texas franchise tax isn’t as bad as it seems. Every business can do it with the right approach and guidance. The real problem is that it’s one more way taxpayers can fall out of compliance. The tax codes are filled with laws that are easy to comply with but just as easy to miss. For most businesses, the best way to ensure you’re on the right track is to conduct a holistic review of your situation and seek outside guidance.
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