If you own a business in Texas, you’ve likely encountered (for better or worse) the Texas franchise tax. The franchise tax is a tax imposed on any “taxable entity” that does business in Texas or that is chartered or organized in Texas. [1] The Texas franchise tax is imposed “to the limits of the United States Constitution and the federal law adopted under the United States Constitution.” [2]
The determination of whether this tax applies to a specific business, and the proper computation of the tax, are each fraught with questions and complications. In this post I’ll address one of the more common inquiries faced by taxpayers – nexus.
Nexus
The term “nexus” refers to a State’s authority to impose tax on an entity or individual. The Comptroller’s regulations provide that “a taxable entity is subject to Texas franchise tax when it has sufficient contact with this state to be taxed without violating the United States Constitution. [3]
Currently, under the United States Constitution, there are two mechanisms by which the State of Texas can assert that a taxpayer has nexus: (i) physical presence nexus, or (ii) economic nexus.
Physical Presence Nexus
The Comptroller’s regulations have, since their inception, included a list of activities that constitute physical presence nexus. [4] As the name would suggest, these include activities that can be used to establish that an entity or individual has some physical presence in the state. The listed activities include, among others:
- Advertising in Texas;
- Performing a contract in Texas;
- Delivering into Texas items the business has sold;
- Having employees or representatives in Texas;
- Having inventory in Texas;
- Leasing tangible personal property in Texas;
- Acting as a general partner in a general or limited partnership that does business in Texas;
- Holding real estate in Texas; and
- Providing any service in Texas.
Economic Nexus
Contrary to physical presence nexus, economic nexus is a relatively new concept that was introduced in 2018 via the Supreme Court’s decision in South Dakota v. Wayfair. [5] In a landscape that previously only allowed nexus to be established with sufficient physical presence, this case represented a paradigm shift, allowing states to establish nexus for out-of-state taxpayers who do sufficient business with a taxing state. [6]
Effective December 29, 2019, the Comptroller revised its regulations to incorporate economic nexus requirements. These were further updated effective February 10, 2021. As of today, the economic nexus framework for Texas franchise tax is as follows:
- For each federal income tax accounting period ending in 2019 or later, a foreign taxable entity has nexus in Texas, and is subject to Texas franchise tax, if during that accounting period it had “gross receipts from business done in Texas” of $500,000 or more.
- For purposes of this test, “gross receipts” means “all revenue reported by a taxable entity on its federal return, without deduction for the cost of property sold, materials used, labor performed, or other costs incurred.” [7]
It is important to note that a business can have nexus with the State of Texas if it has either physical presence nexus or economic nexus. [8]
[1] Tex. Tax Code § 171.001(a).
[2] Tex. Tax Code § 171.001(b).
[3] 34 Tex. Admin. Code § 3.586(c).
[4] 34 Tex. Admin. Code § 3.586(d).
[5] South Dakota v. Wayfair, 585 U.S. 162 (2018).
[6] Id.
[7] 34 Tex. Admin. Code § 3.586(f).
[8] Id.
