Once you’ve determined that your business is subject to the Texas Franchise Tax, the next step will be to compute the amount of that tax. Easy, right?
Unfortunately, as is often the case, it’s much more complex than it may appear. The Texas Franchise Tax is computed using a series of interrelated steps: (1) determining your business’ “taxable margin,” (2) apportioning that taxable margin to the State of Texas, and (3) determining and applying the appropriate tax rate. There are also certain exceptions, pursuant to which only some, or even none, of the above steps will apply.
The computation of the Texas Franchise Tax will be covered in four separate posts, starting with this one – determining the “taxable margin.”
Taxable Margin
As the first of several steps in computing the Texas Franchise Tax, determining the “taxable margin” is, by itself, a multi-step process.
The first step involves computing the entity’s “total revenue from its entire business.” [1] As a general matter, starting place in determining total revenue is with the amounts reported as income on the applicable federal income tax return. [2] However, the deductions reported on the federal income tax return are not included – the Texas Franchise Tax applies its own exclusions and deductions. [3] This can, as you may imagine, create some frustrating issues for taxpayers, especially in light of the already complex nature of computing total revenue.
Once total revenue has been determined, the Tax Code instructs taxpayers to compute the lesser of (i) 70% of total revenue and (ii) total revenue less than $1 million. [4] Set that number aside as “Figure A.”
Separately, compute the amount equal to total revenue, less the greatest of the following [5]:
- $1 million;
- The “cost of goods sold” deduction, as computed under Tex. Tax Code § 171.1012; or
- The “compensation” deduction, as computed under Tex. Tax Code § 171.1013.
Believe it or not, this is where things get complicated. Each cost of goods sold deduction (referred to as “COGS”) and the compensation deduction is incredibly sophisticated on its face, and often open to interpretation by both taxpayers and the Comptroller. To make matters worse, current and pending case law on specific portions of Texas Tax Code §§ 171.1012 and 171.1013 make these interpretations even more difficult at time. We’ll call the result of this complex analysis “Figure B.”
Once you’ve determined this figure, you’ll take the lesser of (i) Figure A and (ii) Figure B. Congratulations! You’ve (painstakingly) figured out your taxable margin.
[1] Tex. Tax. Code §§ 171.101(a)(1)(A)(i), (ii).
[2] Tex. Tax Code § 171.1011(c).
[3] See, e.g., Tex. Tax Code § 171.101(a)(1)(B), (a)(3); see also Tex. Tax Code §§ 171.1011(e)-(x).
[4] Tex. Tax Code § 171.101(a)(1)(A).
[5] Tex. Tax Code § 171.101(a)(1)(B).
