The franchise tax is Texas’ main tax on business. It is a major revenue source for the state government. There is a level of controversy involved due to the legislature's devotion to supporting a business-friendly reputation. 

Who Does the Texas Franchise Tax Apply To?

Any business, company or association (described as a “taxable entity”) doing business in Texas must file and pay franchise tax. The list includes:

• corporations;
• limited liability companies (LLCs), including series LLCs;
• banks;
• state limited banking associations;
• savings and loan associations;
• S corporations;
• professional corporations;
• partnerships (general, limited and limited liability);
• trusts;
• professional associations;
• business associations;
• joint ventures; and
• other legal entities.

There are also exceptions to this tax; entities that are not subject to this tax.

Why Is There a Franchise Tax?

As described by Texas law, the franchise tax is defined as “a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas.” Part of this privilege includes protection from liabilities under state law. 

How Do I Calculate The Franchise Tax?

A business’ tax liability is based upon a taxable entity margin; which is defined by the state as the total revenue minus one of four potential deductions.  These deductions consist of total revenue, combined reporting, margins and cost of goods sold. 

While the franchise tax seems fairly straightforward, conceptually it can be complex in application. To break it down; taxpayers begin the calculations of their tax bill with their total revenue. From there, they can subtract the highest of four deductions. These four deductions, according to the Texas Taxpayers and Research Association, are:

• Cost of goods sold (COGS)
  • “The COGS deduction is the most used method to calculate franchise tax owed. Texas’ definition of “cost of goods sold” draws from, but is not identical to, the definition in federal tax law; consequently, it can be an area of confusion.”
• Compensation 
  • “The compensation deduction is the amount entered in the Medicare wages and tips box of an employee’s Form W-2 or its equivalent, along with any distributed income and stock awards. The compensation deduction is primarily used by professional services companies, such as law firms and healthcare providers.” 
• 30% of their total revenue
  • “A business may choose to subtract 30% of its total revenue to determine its margin.”
• $1 million; which is indexed to inflation. 
  • “A 2013 amendment allows businesses the simple option to deduct $1 million.”

From there, the total is divided and allocated to Texas based upon the company’s percentage of sales in the state. The correct tax rate is then applied to determine the total bill. The only exception to this is if a taxable entity qualifies and chooses to file using E-Z computation. A business that chooses to use the E-Z Computation is not eligible for the cost of goods sold (COGS), compensation or other margin deductions and may not claim any credits. 

How Do They Determine the Tax Rate?

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 is the Franchise Tax Due?

Franchise taxes are due on May 15th every year.

Conclusion

The franchise tax is complicated, has a disparate impact on businesses and can be confusing. But at the end of the day, the tax is less oppressive than many other state and local taxes and business taxes.

How Peisner Johnson Can Help

If you are doing business in Texas, the franchise tax is something you’ve had to figure out and navigate. We can help you through it. Similarly, you are most likely dealing with the complexities of sales tax. We are here to help you determine your nexus and sales tax responsibilities. We can help you make certain your sales tax is in order and your business is compliant. To ensure your compliance, give us a call. We can do a refund review to rule out any further sales tax responsibilities in other states or local jurisdictions. If your business is needing sales tax help or have any questions, we are a phone call away!