A company’s tax burden is part of doing business, but a major overhaul in the Texas franchise tax rules means new requirements for many. What was previously a franchise tax is now a tax on taxable margin. Many businesses that were not required to pay the franchise tax will find themselves needing to understand and pay the new margin tax.
Enacted to offset a 33 percent decrease in property taxes, the new margin tax brings many businesses into the system that were previously not taxed. While the old system only affected corporations and limited liability companies (LLCs), the new system casts a much wider net, according to Toni Mayfield, a senior manager in the tax practice at Whitley Penn LLP.
“The new margin tax law affects a large population of businesses, including existing franchise taxpayers and many other categories of businesses that weren’t subject to the franchise tax,” she says. “All businesses need to take a close look at the tax law changes and understand the new requirements as a result of these changes.”
Smart Business spoke with Mayfield about the new margin tax law and how Texas businesses will be impacted.
How does the margin tax affect existing taxpayers?
The new margin tax will go into effect for tax returns originally due May 15, 2008. Existing franchise taxpayers start with the new system beginning with their tax reports that are due in May 2008. This first report will be is based on their taxable margin during any accounting period ending in 2007.
How does the gross margin tax affect new taxpayers?
For companies that were not subject to the old franchise tax but will be taxed under the new rules, the new system starts with tax years beginning June 1, 2007. Any new taxpayers whose tax year begins January through May will not be affected until the following year.
How is taxable margin calculated?
Instead of being taxed on capital or earned surplus, companies are now taxed on taxable margin, using the lowest of three calculations: 70 percent of total revenue; total revenue less cost of goods sold; or total revenue less compensation and benefits. While the tax rate is 1 percent for most entities, those in the wholesale or retail trade will pay a tax rate of 0.5 percent.
What entities are taxable under the new margin tax law?
In general, any partnership, corporation, LLC, business trust, professional association or joint venture will be liable under the new margin tax law. Professional associations in particular should pay attention to the new gross margin tax law as they enjoyed a special exemption under the old law.
What entities are exempt?
A number of entities are exempt from the new margin tax, including sole proprietorships; general partnerships owned entirely by natural persons; nonprofit organizations; family limited partnerships with at least 80 percent of the interest held by members of the same family and at least 90 percent passive income; Real Estate Investment Trusts (REITs); insurance companies; businesses with gross receipts of less than $300,000 or an annual tax liability of less than $1,000; and passive partnerships and trusts.
It’s important to note that the Texas definition of a passive business is different than the federal definition. For purposes of this law, a passive business is defined in Texas as a general or limited partnership or nonbusiness trust with at least 90 percent of its income from sources such as dividends, interest, foreign currency exchange gain, royalties, bonuses or delay rentals from nonoperating mineral interests or gains the sale of real property.
How does the new tax margin law affect unitary businesses?
Under the old law, all entities reported their income as a single taxable entity whether or not they were consolidated for federal purposes. Under the new law, certain affiliated groups will be required to file a combined report. Businesses must report income as a combined group if they are considered to have a unitary business. Businesses are considered to have a unitary business if there is at least 80 percent common ownership and the business is a single economic enterprise whose joint operations produce a synergy and mutual benefit to all entities in the group.
How can new filers prepare for their first gross tax margin filing?
The new margin tax repeals the existing business incentive credits. Businesses with existing business loss or credit carryovers can deduct any remaining amounts against the margin tax. However, taxpayers must file a written election with the state comptroller by March 1, 2007 to claim the credit in future years.
TONI MAYFIELD is a senior manager in the tax practice at Whitley Penn, LLP. Reach her at mailto:[email protected] or (972) 392-6670.