The Texas Legislature has reformed its
tax structure to supplement property
taxes with business taxes to fund its education system. One component is a
new business tax called the taxable margin
tax. Consequently, businesses operating in
Texas may be liable for substantially different tax bills when they make payments in
May 2008.
Before the margin tax was introduced,
Texas business owners were liable for a
franchise tax, which was relatively easy to
avoid by using loopholes. Some Texas businesses did not pay any taxes at all under its
provisions. The legislature eliminated
some of these loopholes with the margin
tax.
Smart Business spoke with Patrick
O’Shea of Grant Thornton LLP to learn
about the Texas margin tax, how it will
affect business owners and how they can
comply with it.
What is the gist of the margin tax?
The margin tax essentially replaces the
franchise tax. It is a tax on taxable margin,
which is generally gross revenue less the
greater of cost of goods, compensation or
30 percent of gross revenue. Being a tax on
margin, even companies with net operating
losses will likely be liable for some amount
of margin tax.
How is the margin tax calculated?
The margin tax is based on a percentage
of ‘taxable margin.’ It is the lower of total
revenue minus cost of goods, total revenue
minus employee compensation and benefits, or 70 percent of total revenue. The taxable margin is then apportioned by the percentage of the entity’s business done in
Texas. This percentage is calculated by
dividing gross receipts from business done
in Texas by gross receipts from business
done everywhere. The margin tax rate of
0.5 percent for taxable entities engaged primarily in retail or wholesale trade, or 1 percent for all other taxable entities, is then
applied to the apportioned taxable margin.
Service businesses are not eligible to use
the cost of goods sold method. In fact, service providers that were generally exempt
under the franchise tax because of the way
they were organized are expected to be
impacted detrimentally by the new tax.
Does the margin tax apply to all Texas business entities?
Even if they are not taxed under federal
income tax laws, they may not be exempt
from paying the margin tax. In addition, the
tax is computed and reported on a combined group basis, which is a significant
change. Entities with gross receipts of
$300,000 or less (inflation adjusted every
two years), estates, escrows, nonprofits,
insurance companies and passive entities
are exempt. Sole proprietorships and general partnerships that only have human
beings or the estates of human beings as
their partners are not taxed under the margin tax law, either.
What does the combined reporting requirement mean to business owners?
First, this is an entirely new concept in
Texas. Related entities that are unitary
businesses with greater than 80 percent
direct or indirect ownership (legislation
passed to change to 50 percent, but not yet law) must compute and report the margin
tax as if it were one taxpayer. This will now
include unitary companies that did not file
Texas franchise tax returns due to a lack of
nexus in the state. Essentially, combined
reports are very similar to the consolidated
returns filed for federal income tax purposes. Even if affiliated companies do not
experience increases in their tax liabilities
to the state, they will certainly have greater
compliance complexity.
When should companies start taking steps to
deal with this new tax?
Hopefully they already have. Although
the tax is effective Jan. 1, 2008, it is based
on the activity of companies as early as
June 1, 2006. That means all taxpayers are
already in the years on which the tax will
be based, and there is not one specific solution to minimize their margin taxes. There
is a transition provision regarding the
effective date that was passed in the current legislative session (currently under
consideration by the governor) that may
allow entities not previously subject to the
old franchise tax to terminate prior to July
1, 2007 and, at least, avoid the margin tax
through that date.
Can financial services advisers help businesses deal with the margin tax?
They can help business owners understand the margin tax impact to them and
comply with its changes and clarifications,
such as the combined changes. They can
also assist with the proposed transition
rule currently being contemplated and the
wind up of structures that are no longer
necessary to minimize the old franchise
tax. And, they can start helping them prepare for and minimize the future ramifications, such as the audits on the tax, which
will start four years down the road and will
likely be messy.
PATRICK O’SHEA is tax partner — State and Local Tax Practice,
with Grant Thornton LLP. Reach him at (214) 561-2356 or
[email protected].