Issues

The tax relief package I mentioned in the previous article reduced school maintenance and operation tax rates in 2006 from $1.50 to $1.33, and by one-third in 2007 to a rate of $1.00. This historic property tax relief, which benefits both business and residential properties, would not be possible without the revised franchise tax.

This new franchise tax is effective beginning January 1, 2008. The first actual payment of the tax is not due until May of 2008, and will generally be based on a taxpayer’s 2007 business activity. The tax base is broadened to “taxable margin”, meaning the number of taxpayers is expanded by including all businesses that receive liability protection, and the tax rate is lowered from 4.5% to 1% for most taxpayers, but with wholesalers/retailers paying a 0.5% rate.

For the sake of clarity, let's look at who this tax applies to and who is exempt. The tax applies to entities with liability protection which includes limited liability partnerships, limited partnerships, business trusts, corporations, limited liability companies, professional corporations and professional associations. The tax does not apply to sole proprietorships and general partnerships owned by individuals, partnerships that qualify as passive entities, grantor, non-profit, and certain federal exempt trusts, entities currently exempt from the franchise tax, taxable entities that owe less than $1,000 in tax, taxable entities with $300,000 or less in total revenue, estates of natural persons, and escrows, real estate investment trusts (REITs) and real estate mortgage investment conduits (REMICs).

While a majority of the changes to the franchise tax in the 2007 session were "technical" in nature, substantive changes included significant tax relief for small businesses. The small business exemption was expanded in the form of "discounts," while all businesses with $10 million or less in receipts are allowed to elect the "E-Z" calculation—a 0.575% tax on Texas gross revenue. Here are some of the highlights business owners need to be aware of:

• A laddered "discount" phase-in of the tax for small businesses was added. Any business earning total revenue between $700,000 and $900,000 gets a 20 percent discount. For businesses making between $500,000 and $700,000, a 40 percent discount applied. Businesses with $400,000 to $500,000 in total revenue earn a 60 percent discount and any business earning between $300,000 and $400,000 will get an 80 percent discount. Any business earning under $300,000 is completely exempt from the business tax.
• The line number references to federal partnership forms were corrected to eliminate double taxation on a partner's guaranteed payments. Similarly, line references for rental income for partnerships in calculating total revenue are changed to reflect gross, rather than net rental income, as intended in the original legislation.  
• An entity leaving the state but which had done business in Texas during 2007 must pay an exit tax on that business activity. A previously exempt entity, such as a limited partnership, will owe tax on 2007 activity unless dissolved by June 30, 2007.
• The definition of “client company” was expanded to include temporary employment services. Accordingly, “staff leasing services company” was expanded to include temporary employment services.
• The definition of “controlling interest” was reduced from 80 percent to “more than 50 percent.”  This definition is important because it determines whether an entity is part of an "affiliated group" for purposes of combined reporting.
• “The estate of a human being” is now included within the definition of a natural person, so that estates are not taxed.
• A new health care deduction has been created for small employers that offer health   care benefits to their employees. The deduction is available for the first two years in which benefits are offered.
• A new Business Tax Advisory Committee has been created to conduct a biennial study on the impact of the revised franchise tax and publish a report before each regular legislative session. The committee consists of the state comptroller as chair, with legislative and public members.