2008 Developments in Texas Franchise (Margin) Tax

2008 Developments in Texas Franchise (Margin) Tax

Kal Malik, Esq.

During calendar year 2008, Texas Comptroller announced several clarifications and amendments and proposed amendments to its rules regarding several franchise tax matters. The following is a summary of some of these matters.

Tiered Partnerships

The Comptroller has clarified that the "tiered partnership" provision (Tex. Tax Code Section 171.1015) is not available if the lower-tier entity is included in a combined group. Further, a lower-tier entity that is not part of a combined group may choose to report total revenue to any or all of its upper tier entities. The lower-tier entity must submit a franchise tax report for the total revenue that remains with the lower-tier entity. The lower-tier entity does not reduce its cost of goods sold or compensation deduction based on the amount of total revenue reported to the upper tier entities.

Revenue Exclusions

The Comptroller announced changes in its policy excluding certain items from total revenue for franchise tax purposes. The co-payments and deductibles received under Medicaid, Medicare and other programs (Tex. Tax Code Section 171.1011(n)) may be excluded from total revenue. The Comptroller announced that it will amend Rule 3.587(e)(10)(A) to reflect this policy change. Similarly, the interpretation of Tax Code Section 171.1011(j) which was originally interpreted to apply to all exclusions from total revenue, will apply only to expenses that have been excluded from total revenue. Hence, under the revised interpretation, when excluding revenue, such as revenue received from the Medicaid, Medicare and other programs specified in Section 171.1011(n), no corresponding adjustment needs to be made to the compensation or cost of goods sold deduction for costs related to the revenue. The Comptroller has further clarified the scope of the exclusion stating that health care providers and health care institutions may exclude from total revenue copayments and deductibles received from supplemental insurance for patients insured under the Medicaid, Medicare and other specified programs.

Nontaxable Entities

In response to several inquiries from taxpayers, the Comptroller announced that all nontaxable entities, including passive entities, will be subject to the following reporting requirements:

(1) If an entity has notified the Comptroller or the Secretary of State that it is doing business in Texas, the entity must notify the Comptroller that it qualifies as a passive entity by filing the "No Tax Due" report, Form 05-163, and blackening the circle in Item 1, by the due date of the report for which the entity qualifies as a nontaxable entity. Passive entities do not have to file a "Public Information Report" or "Ownership Information Report".

(2) If a nontaxable entity has not notified the Comptroller or the Secretary of State that it is doing business in Texas, the nontaxable entity must notify the Comptroller in writing only when the entity no longer qualifies as a nontaxable entity.

(3) If an entity receives notification in writing from the Comptroller asking if the entity is taxable, the entity must reply to the Comptroller within 30 days of the notice.

The Comptroller announced that its rules requiring annual reporting of qualification as passive entities will be amended accordingly.

Annual Period Calculation

The Comptroller has announced that when the accounting period upon which the report is based is more or less than 12 months, a taxable entity must annualize its total revenue calculation to determine its eligibility for the "no-tax-due" or "simplified calculation" provisions of the Texas Tax Code. Therefore, to annualize total revenue, a taxable entity is required to divide total revenue by the number of days in the period upon which the report is based, and then multiply the result by 365.

Reimbursement of Landlord Expenses

Relying on the Federal Tax Regulations Section 1.61-8(c), the Comptroller has determined that since the reimbursement of landlord expenses are reported for federal tax purposes in gross rental income and not offset expenses, for franchise tax reporting purposes these expense reimbursements must be included in total revenue. Thus, landlord entities that are subject to the Texas franchise tax, are required to include in revenue any reimbursements of taxes and insurance.

Definition of "Internal Revenue Code"

To highlight the non-availability of certain increased tax write-offs passed by Congress under federal tax law, the Comptroller has emphasized that for Texas franchise tax purposes, the term "Internal Revenue Code"means the Internal Revenue Code of 1986 in effect for the federal tax year beginning on January 1, 2007. Therefore, any changes made to the Internal Revenue Code after January 1, 2007, are not applicable for Texas franchise tax. As a result, increased write-offs such as Section 179 expense deduction or "bonus depreciation" under the Small Business and Work Opportunity Act of 2007 (passed May 25, 2007) are not applicable capping the Section 179 expense deduction at $112,000 for Texas franchise tax.

Please contact Kal Malik at 713-993-9699 if you have any questions.