Small business owners should be well aware of state requirements for annual reporting, which can include franchise taxes. A franchise tax is something all entrepreneurs have to pay as the "privilege" or "cost" of doing business in a given state. In return, small business owners enjoy liability protections under state law.
In this post, we'll dig deeper into the Texas state franchise taxes — particularly what changed after it went through a massive overhaul of its franchise tax in 2006. These changes took effect in 2008 and became known as the margin tax.
After 2008, the major differences with the Texas franchise tax were as follows:
Who Pays
- Corporations (C Corps and S Corps alike)
- Limited Liability Companies
- Partnerships (except general partnerships owned by natural persons)
- Business Trusts
- Professional Associations
Tax Base
- Total revenue less the greater of:
- Cost of Goods Sold
- Compensation
- 30% of Total Revenues
Apportionment
- Wholesalers/Retailers: 0.5 %
- All Others: 1.0 %
Key Tax Credit
- None
Method of Filing
- Combined group (a business combines the financial data for its unitary subsidiaries and affiliates into a single tax return)
Tax History: What Texas' New Franchise Tax Accomplished
The rewrite of the franchise or "margin" tax in Texas was intended to accomplish several things:
- Align the tax with a modern economy
- Create a simpler business tax
- Eliminate tax planning opportunities
- Raise roughly $3 billion in new state revenue annually
Align the Tax With a Modern Economy
There was a longstanding criticism that Texas’ tax system was misaligned with the structure of the economy. Whereas the state and local entities rely heavily on property and sales taxes — which fall on industries that produce and sell goods — Texas was moving toward a service-based economy.
To better reflect the fastest-growing sector of the state’s economy, its tax reform was to shift part of the tax burden from goods-producing industries to service-providing industries. This was accomplished primarily through reductions in property taxes.
Create a Simpler Business Tax
The idea of the margin tax was simple: Calculate your Texas tax by taking a few items from your businesses’ federal tax return. But because the IRS is flexible in what companies can include these items, it created some confusion. In turn, the state of Texas had to create definitions specific to these terms.
Eliminate Tax Planning Opportunities
Under the old franchise tax, there were three main tactics to minimize taxes:
- “Delaware Sub:” A business places its Texas operations into a partnership and creates an “out-of-state” corporate subsidiary as a limited partner. As a result, neither the partnership or out-of-state limited partner were subject to the Texas franchise state tax.
- “Geoffrey’s Sub:” A company creates an out-of-state subsidiary as owner of intangible property (i.e., trademarks and patents.) Income to the out-of-state subsidiary wasn’t subject to the franchise tax.
- Profit Shifting: Unlike large corporations, certain smaller corporations didn’t have to add the amount of compensation paid to their company officers and directors to their tax base. Instead, these businesses had the option to pay their earnings as compensation to owners who were officers or directors. In turn, they converted profit into a deductible business.
The former Texas controller warned that these tax-saving strategies were eroding the tax base. Under the margin tax, these methods no longer offered any tax benefit.
Small Business Exemption
If you're a small business owner in Texas, this section is key to help you understand your franchise tax requirements.
Originally, businesses with less than $434,782 in receipts were exempted; this level is now set at over $1 million. Companies owing less than $1,000 are also exempt. Businesses with less than $10,000 in total revenues may opt for a simplified “EZ calculation” based on gross receipts.
How to Pay Your Franchise Tax
If you're a small business owner operating in Texas, these franchise tax rates, thresholds and deduction limits vary by the year you're reporting. For 2018, the rates are as follows:
| Item | Amount |
| No Tax Due Threshold | $1,130,000 |
| Tax Rate (Retail or Wholesale) | 0.375% |
| Tax Rate (Other than Retail or Wholesale) | 0.75% |
| Compensation Deduction Limit | $370,000 |
| EZ Computation Total Revenue Threshold | $20 million |
Your annual franchise tax report is due on May 15. If that date falls on a weekend or holiday, the due date will be on the next business day.
If you plan to terminate, merge, or withdraw from the Texas Secretary of State's office, you'll need to file and pay your company's final franchise tax report in the same year you plan on doing so.
What if you file late? You'll be charged a penalty:
- A $50 penalty is assessed on each report filed after the due date.
- If tax is paid anywhere from 1-30 days after the due date, a 5 percent penalty is assessed.
- If tax is paid over 30 days after the due date, a 10 percent penalty is assessed.
- As for interest, past due taxes are charged interest at 61 days after the due date.
For help filing your annual tax report in Texas or any other state, Incfile's Annual Report service can answer any questions and guide you through the process.
