When the new margin tax replaced the old franchise tax in Texas, practically every business was affected. The transition isn’t necessarily seamless either, as the new tax brings many changes. For instance, limited partnerships that were previously exempt from the franchise tax now must pay the margin tax. Corporations and limited-liability companies that previously paid the franchise tax now must use new methods to calculate the margin tax. Businesses are facing new reporting rules for combined groups and tiered-partnership arrangements. All business owners are being forced to look at how they structure their businesses, account for business operations, file tax returns and how much tax they’ll have to pay.
“This new law contains many exceptions, and the devil will be in the details,” says Johnny J. Veselka, shareholder, Briggs & Veselka Co. “There’s combined reporting based on the ‘unitary business’ concept. The law requires that taxable entities that are part of an affiliated group engaged in a ‘unitary business’ report as a ‘combined group,’ instead of reporting as separate taxable entities.”
Smart Business spoke with Veselka about the new tax, what’s different about it and what business owners need to be aware of.
Why is there a new business tax in Texas?
The Texas Supreme Court found that the state’s method of financing public schools violated the constitutional prohibition against a statewide property tax. After several attempts by Governor Rick Perry and the Legislature to reform the Texas tax system, the governor appointed the Texas Tax Reform Commission to recommend reforms to the Texas tax structure. The commission, chaired by John Sharp, issued a report on March 29, 2006, that proposed substantial modifications to the Texas franchise tax. The actual law enacted closely followed the recommendations in the report. The margin tax was to close the tax shortfall created by reduced property taxes.
When does the new tax go into effect?
For calendar year filers, the new tax will be based on its taxable margin generated in 2007. The first report would be due May 15, 2008. For fiscal year filers, the liability will be determined based upon whether its fiscal year end falls before or after May 31, 2007. Fiscal year taxpayers, with a tax year ending on or after Jan. 1, 2007, but before June 1, 2007, will be subject to the margin tax for the period beginning June 1, 2006. All other fiscal year taxpayers will file based on their reporting period ending after June 1, 2007.
How is the tax calculated?
The tax is calculated on taxable margin or for certain electing taxpayers on total revenue. Taxpayers’ taxable margin is a concept similar to taxable income. Generally, an entity’s taxable margin is its revenue less either cost of goods sold or compensation expense, but not both. This choice can be made annually. If 70 percent of an entity’s revenue is less than either of these calculations, then 70 percent of revenue is the taxable margin. Taxable margin must also be apportioned to business performed in Texas.
What is the tax rate?
Most entities pay at the rate of 1 percent. Retailers and wholesalers pay at a .5 percent rate. Taxpayers determine whether they qualify as wholesalers or retailers by reference to their industry classification under the Federal Standard Industrial Classification codes. If the business activity has a SIC code number in the 5,000s, it is a wholesaling or retailing activity. Businesses with total revenue below $900,000 also will receive a discount on their tax based upon a discount table. Businesses with less than $300,000 of revenue are not required to pay the tax.
How are revenue, employee compensation and benefits defined?
An entity must look to its federal income tax return to determine its revenue. The income amounts generally include gross receipts less returns and allowances dividends, interest, rents and royalties, capital gains and other income. The cost of goods sold deduction calculation depends entirely on Texas rules that are similar, but not identical, to the federal rules. Wages and cash compensation cover most typical compensation expenses. The starting point is the Medicare wages and tips box on the Federal W-2. It also includes the net distributive income paid to natural persons of pass-through entities like S corporations, partnerships or limited liability companies. Stock awards and options deducted for federal income tax purposes are also included. Wages are capped at $300,000 per person. Benefits are also deductible and not subject to the $300,000 per person limitation.
JOHNNY J. VESELKA is a shareholder of Briggs & Veselka Co. Reach him at (713) 667-9147 or firstname.lastname@example.org.