With the goal of raising revenue, Texas reformed its franchise tax effective in 2008, from a tax based on net capital or net income (earned surplus) to one based on taxable margin, which is thelowest of three calculations:
“The enactment of the margin tax brought a lot of new companies into the class of taxpayers, and generally raised taxes on existing taxpayers,” said Kirk Lyda, a partner at Jones Day in Dallas, Texas.
During the recent 83rd Legislative Regular Session in 2013, the Texas Legislature approved a measure modifying the franchise tax. House Bill 500, effective Jan. 1, 2014, makes significant changes to the tax by providing temporary rate reductions, revising the calculation of margin, expanding the definition of retail trade, and amending the cost of goods sold deduction, among other changes.
As a result, there has been confusion over the manner in which the newly enacted code sections interact with the ones that had previously been in place, Lyda explained, “the legislature has passed a number of tax reductions designed to reduce the increased tax burden. Many of the tax reductions have come through changes in the tax rate. While reducing taxes is always a laudable goal, the by-product is a tax rate that is fairly complicated in some situations.” Below is a breakdown of the franchise tax rates.
Taxable entities have no franchise tax obligation if the amount of tax computed is less than $1,000 or the taxable entity’s total revenue from its entire business is $1 million or less. The no tax due threshold is indexed to changes in the Consumer Price Index. For reports due on or after Jan. 1, 2014 and before Jan. 1, 2016, the indexed no tax due threshold is $1,080,000, up $50,000 from last year.
Subject to a number of exceptions, the Texas franchise tax rate is 0.5 percent of taxable margin for taxable entities primarily engaged in retail or wholesale trade and 1 percent of taxable margin for other types of taxable entities.
For reports originally due on or after Jan. 1, 2014 and before Jan. 1, 2015, a taxable entity primarily engaged in retail or wholesale trade may elect to pay the tax at a rate of 0.4875 percent of taxable margin. Other types of taxable entities may elect to pay the tax imposed at a rate of 0.975 percent of taxable margin. In addition, a taxable entity is entitled to a deduction of at least $1 million from total revenue in the computation of taxable margin for reports originally due on or after Jan. 1, 2014.
However, if the total revenue from a taxable entity’s entire business is $10 million or less, the entity may elect to pay the tax at a rate of 0.575 percent, but the entity may not take a credit, deduction, or other adjustment that is not specifically authorized by Texas law. This is referred to as the EZ computation.
Subject to a budget certification by the Texas Comptroller, for reports originally due on or after Jan. 1, 2015 and before Jan. 1, 2016, the tax rate for a taxable entity primarily engaged in retail or wholesale trade will be 0.475 percent, while the rate for all other taxable entities will be 0.95 percent. Lower tax rates would continue for reports due in 2015 if the state experiences increased revenue “so that any revenue loss caused by the rate reduction would be offset,” according publication by PwC.
The Texas franchise tax was substantially revised in 2008, and still appears to be a work in progress. Because the lower tax rates are only temporarily for 2014 and 2015, should we expect the rates in 2016 to revert back to those in effect in 2013? This question will likely remain unanswered until the next Texas legislative session begins in 2015 when the lowered rates may be extended and the franchise tax is, hopefully, simplified.
By: Jessica Lechuga
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