When the new margin tax replaced
the old franchise tax in Texas,
practically every business was affected. The transition isn’t necessarily
seamless either, as the new tax brings
many changes. For instance, limited partnerships that were previously exempt from
the franchise tax now must pay the margin
tax. Corporations and limited-liability companies that previously paid the franchise
tax now must use new methods to calculate the margin tax. Businesses are facing
new reporting rules for combined groups
and tiered-partnership arrangements. All
business owners are being forced to look
at how they structure their businesses,
account for business operations, file tax
returns and how much tax they’ll have to
pay.
“This new law contains many exceptions,
and the devil will be in the details,” says
Johnny J. Veselka, shareholder, Briggs &
Veselka Co. “There’s combined reporting
based on the ‘unitary business’ concept.
The law requires that taxable entities that
are part of an affiliated group engaged in a
‘unitary business’ report as a ‘combined
group,’ instead of reporting as separate taxable entities.”
Smart Business spoke with Veselka
about the new tax, what’s different about it
and what business owners need to be
aware of.
Why is there a new business tax in Texas?
The Texas Supreme Court found that the
state’s method of financing public schools
violated the constitutional prohibition
against a statewide property tax. After several attempts by Governor Rick Perry and
the Legislature to reform the Texas tax system, the governor appointed the Texas Tax
Reform Commission to recommend
reforms to the Texas tax structure. The
commission, chaired by John Sharp, issued
a report on March 29, 2006, that proposed
substantial modifications to the Texas franchise tax. The actual law enacted closely
followed the recommendations in the
report. The margin tax was to close the tax shortfall created by reduced property taxes.
When does the new tax go into effect?
For calendar year filers, the new tax will
be based on its taxable margin generated in
2007. The first report would be due May 15,
2008. For fiscal year filers, the liability will
be determined based upon whether its fiscal year end falls before or after May 31,
2007. Fiscal year taxpayers, with a tax year
ending on or after Jan. 1, 2007, but before
June 1, 2007, will be subject to the margin
tax for the period beginning June 1, 2006.
All other fiscal year taxpayers will file
based on their reporting period ending
after June 1, 2007.
How is the tax calculated?
The tax is calculated on taxable margin
or for certain electing taxpayers on total
revenue. Taxpayers’ taxable margin is a
concept similar to taxable income.
Generally, an entity’s taxable margin is its
revenue less either cost of goods sold or
compensation expense, but not both. This
choice can be made annually. If 70 percent
of an entity’s revenue is less than either of these calculations, then 70 percent of revenue is the taxable margin. Taxable margin
must also be apportioned to business performed in Texas.
What is the tax rate?
Most entities pay at the rate of 1 percent.
Retailers and wholesalers pay at a .5 percent rate. Taxpayers determine whether
they qualify as wholesalers or retailers by
reference to their industry classification
under the Federal Standard Industrial
Classification codes. If the business activity has a SIC code number in the 5,000s, it is
a wholesaling or retailing activity.
Businesses with total revenue below
$900,000 also will receive a discount on
their tax based upon a discount table.
Businesses with less than $300,000 of revenue are not required to pay the tax.
How are revenue, employee compensation
and benefits defined?
An entity must look to its federal income
tax return to determine its revenue. The
income amounts generally include gross
receipts — less returns and allowances —
dividends, interest, rents and royalties,
capital gains and other income. The cost of
goods sold deduction calculation depends
entirely on Texas rules that are similar, but
not identical, to the federal rules. Wages
and cash compensation cover most typical
compensation expenses. The starting point
is the Medicare wages and tips box on the
Federal W-2. It also includes the net distributive income paid to natural persons of
pass-through entities like S corporations,
partnerships or limited liability companies.
Stock awards and options deducted for
federal income tax purposes are also
included. Wages are capped at $300,000 per
person. Benefits are also deductible and
not subject to the $300,000 per person limitation.
JOHNNY J. VESELKA is a shareholder of Briggs & Veselka Co.
Reach him at (713) 667-9147 or [email protected].