Forfeiture and Reinstatement under the Texas Franchise Tax

The failure of a taxable entity to file Texas franchise tax reports or pay franchise tax when due can have serious consequences, including loss of the ability of the entity to sue or defend itself in court and liability of directors and officers for the entity’s debts. But there are ways to mitigate the damage.

What’s a Taxable Entity?

Under the Texas franchise tax, a taxable entity generally includes:

partnership,
limited liability partnership,
corporation, banking corporation,
savings and loan association,
limited liability company, business trust,
professional association,
business association, joint venture,
joint stock company,
holding company, or
other legal entity.[1]

Excluded from this definition are sole proprietorships and certain general partnerships, passive entities, and entities that are exempt from franchise tax.[2] Note, however, that an entity that can file as a sole proprietorship for purposes of federal income tax (i.e., is a disregarded entity) is not a sole proprietorship for under the Texas franchise tax if it is formed in a manner that limits the entity’s liability.[3]

What are the Texas Franchise Tax Responsibilities of a Taxable Entity?

Taxable entities that do business in Texas or that are chartered or organized in Texas generally are required to pay franchise tax.[4] However, if a taxable entity owes franchise tax of less than $1,000 or its total revenue is not more than $1 million (as adjusted by every two to account for changes in the consumer price index) during a given year, then the taxable entity isn’t considered to owe any franchise tax for that year.[5] Thus, many taxable entities don’t actually have to pay franchise tax.

This may create a trap for the unwary, because the Comptroller takes the position that all taxable entities must file franchise tax reports and public information reports regardless of whether they actually owe any franchise tax.[6]

What Happens if a Taxable Entity Doesn’t Pay Franchise Tax or File Franchise Tax Reports?

Step One: The Comptroller will Forfeit the Taxable Entities Corporate Privileges/Right to Transact Business

The Comptroller will forfeit the corporate privileges or the right to transact businesses of a taxable entity if the taxable entity doesn’t file a franchise tax report or pay franchise tax within 45 days after the date the Comptroller mails the entity a notice of forfeiture.[7]

The consequences of forfeiture of corporate privileges are twofold.

First, the taxable entity is denied the right to sue and or defend itself in a court in this state, unless the suit is to forfeit its charter or certificate of authority in the state.[8] The taxable entity also may not seek affirmative relief in a case brought before its corporate privileges were forfeited unless its privileges are revived.[9]

Second, officers and directors of the taxable entity may be on the hook for any debts that the entity incurs while its corporate privileges are forfeited in the same manner as a partner would be liable for the debts of a partnership.[10] This includes any taxes and penalties imposed on the corporation that becomes due and payable after forfeiture.[11] An exception applies to an officer or director who shows that a debt was incurred over their objection or without their knowledge and the exercise of reasonable diligence to become acquainted with the affairs of the corporation wouldn’t have revealed the intention to create the debt.[12]

Step Two: The Secretary of State will Forfeit the Taxable Entity’s Charter or Certificate of Authority

If the corporate privileges or right to transact business of a taxable entity are forfeited and the taxable entity doesn’t pay the amounts necessary to revive its corporate privileges within 120 days, then the Comptroller is required to certify the name of the corporation to the Texas Attorney General and Secretary of State.[13] At that point, one of two things is required to happen: 1) the Attorney General shall sue to forfeit the charter or certificate of authority of the taxable entity, or 2) the Secretary of State may forfeit the taxable entity’s charter, certificate, or registration without a judicial proceeding.[14] Although, it’s the secretary of state that takes the lead.

Once a taxable entity’s charter, certificate, or authority is forfeited, the entity becomes what’s known as a “terminated entity.”[15] The designation means that the taxable entity is prohibited from continuing its existence for the purpose of continuing its business or affairs unless the entity is reinstated.[16] Instead, the taxable entity can continue its existence only for the limited purposes of:

prosecuting or defending in the terminated filing entity’s name an action or proceeding brought by or against the terminated entity;
permitting the survival of a claim by or against the terminated filing entity that exists before the entity’s termination or within a three-year period after termination and that is not barred by limitations;
holding title to and liquidating property that remained with the terminated filing entity at the time of termination or property that is collected by the terminated filing entity after termination;
applying or distributing property, or its proceeds, as part of the entity’s winding up of its affairs; and
settling affairs not completed before termination.[17]

How Can a Taxable Entity Get Reinstated?

If the taxable entity catches the problem early (i.e., before its charter or certificate of authority is forfeited), the Comptroller will revive the entity’s privileges if it pays any franchise tax, penalty, and interest that is due.[18]

The process for reinstating a taxable entity’s charter or certificate of authority after tax forfeiture is governed by the Texas Tax Code as opposed to the Texas Business Organizations Code, which governs most other forfeitures of an entity’s charter of certificate of authority.[19] The Secretary of State will set aside the tax forfeiture of a charter or certificate of authority upon request for reinstatement by a stockholder, director, or officer of the taxable entity if the entity files each franchise tax report and pays all tax, penalty, and interest due.[20]

When a forfeiture is set aside through this mechanism, the Comptroller revives the taxable entity’s corporate privileges or right to do business and the taxable entity is considered to have continued in existence without interruption from the date of forfeiture.[21]

However, reinstatement doesn’t affect the liability of officers and directors during the periods between forfeiture and reinstatement.[22]

State and Local Tax Attorneys

Do you need assistance with the topics discussed in this Insights post? Freeman Law can help you navigate these complex issues. We offer value-driven services and provide practical solutions to complex issues. Schedule a consultation or call (214) 983-3410 to discuss your concerns!

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[1] Tex. Tax Code § 171.0002(a) (Definition of a Taxable Entity).

[2] Id. § 171.0002(b).

[3] Id. § 171.0002(d).

[4] Id. § 171.001(a) (Tax Imposed).

[5] Id. §§ 171.002(d) (Rates; Computation of Tax), 171.006 (Adjustment of Eligibility for No Tax Due, Discounts, and Compensation Deduction).

[6] See Tex. Tax Code §§ 171.201 (Initial Report), 171.202 (Annual Report), 171.2022 (Exemption from Reporting Requirement), 171.203 (Public Information Report), 171.204 (Information Report); 34 Tex. Admin. Code § 3.584 (Margin: Reports and Payments).

[7] See Tex. Tax Code §§ 171.251 (Forfeiture of Corporate Privileges), 171.2515 (Forfeiture of Right to Transact Business in this State), 171.256 (Notice of Forfeiture).

[8] See id. §§ 171.252(1) (Effects of Forfeiture), 171.254 (Exception to Forfeiture).

[9] Id. § 171.253 (Suit on Cause of Action Arising Before Forfeiture).

[10] Id. § 171.252, 171.255(a), (b) (Liability of Director and Officers).

[11] Id. § 171.255(a).