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| June 12, 2006 |
Volume 11, Issue 4 |
SPECIAL TAXATION SESSION:
WHAT REALLY HAPPENED
After six efforts in regular and called sessions, the Texas Legislature passed significant amendments to the Texas Franchise Tax in order to meet certain requirements recommended by the Texas Supreme Court with regard to funding education. It apparently worked, because the district court that had imposed a restraining order on the State of Texas with regard to education funding has lifted that order. That does not mean that there may not be future attacks. However, for the present the school districts will receive funding and will be able to engage in business this fall. (Parents may now breathe a sigh of relief.)
In order to provide property tax relief as required by the Texas courts, the Texas Legislature mandated certain changes to the property tax and significantly expanded the scope of business taxes in the state. In addition, those who indulge in tobacco will find their habit a bit more expensive. As a final piece of the package, the so-called “Liar’s Affidavit” was attacked by a change to the motor vehicle sales tax that requires an imposition of at least 80% of a “standard presumptive value” based on blue book values.
Property Tax Reduction
In the 2006-07 school year, all school districts must reduce their rates to 88.67% of their 2005 M & O rates. Districts may then add up to $0.04 one time to that rate without voter approval. In future years, the property tax rate will depend on the rate previously adopted and a “state compression percentage” based on the amount of revenue in the Property Tax Relief Fund for rate reduction.
Franchise Tax Changes
This is where the major efforts were concentrated. In a nutshell, any business that has limited liability is potentially subject to the franchise tax in Texas. More significantly, the tax is now based on gross receipts with certain limited deductions. That tax is now a “margin tax” rather than a tax on capital. However, theoretically it is still a “franchise tax” rather than income tax because it is imposed on entities that have limited liability as a result of the laws of Texas or federal law. Loopholes were closed in rather dramatic ways. The ability to shift activities to so-called Delaware corporations was eliminated through the imposition of taxes on a consolidated basis. So let’s look at some commonly asked questions.
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What businesses are subject to the tax? |
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A taxable entity includes not just a corporation, limited liability company, banking corporation, and savings and loan association but also a partnership, business trust, professional association, business association, joint venture, joint stock company, holding company, or other legal entity. Excluded are sole proprietorships, general partnerships in which all partners are natural persons, passive entities, grantor trusts, estate of a natural person, escrow, a real estate investment trust unless it directly owns real estate, and a real estate mortgage investment conduit. A “passive entity” is a partnership with over 90% of its income from investments such as dividends, interest, gains from investments, distributive income from a partnership, royalties, bonuses, delay rental income, and other income from other non-operating mineral interests.
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What is total revenue for purpose of the margin calculation? |
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Total revenue corresponds with certain items on the federal corporate tax return including line 1 c and lines 4 – 10. You may exclude bad debt, foreign royalties and foreign dividends and income from a related entity to the extent it is included in the other items.
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What about income from federal government securities? |
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It is excluded. Interest income from state, county and municipal securities is not included in total revenue either, as it is not reported on the applicable lines for federal income tax purposes.
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What is deducted in order to get to the “margin”? |
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The business will deduct the greater of the following:
• Costs of goods sold, which for lenders is interest expense
• Compensation, which includes wages and cash compensation paid to all officers, directors, owners, partners, employees provided that no more than $300,000 can be included for any given person (no limit on benefits, though)
• A margin of 30%
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What can be included in the compensation deduction? |
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All benefits including workers comp, health care, and retirement (to the extent deductible for federal income tax purposes). Compensation excludes social security, Medicare contributions and other payroll taxes. However, it does include the wages and benefits portion of payments for staff leasing services.
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What is a combined return? |
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Taxable entities that are part of an affiliated group must file a combined group report in lieu of individual reports. An affiliated group is one engaged in a unitary business. In other words, it is a single economic enterprise made up of commonly controlled entities sufficiently interdependent, integrated and inter-related through their activities so as to provide a synergy and mutual benefit that provides a flow of value to the separate parts. (Whew) For banking, that means that the bank’s holding company, Delaware holding company if any, bank, and any subsidiaries should be combined. However, dividends between the groups are excluded.
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Do we still need a Delaware holding company? |
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Not for Texas tax planning purposes.
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If we have a consolidated return how do we handle the allocation? |
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You still use an apportionment formula that is based on Texas gross receipts divided by gross receipts everywhere. Any revenue that is excluded from gross revenue is excluded from both sides of this allocation formula.
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What is the tax rate? |
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For all businesses except wholesale and retail trade, the rate is one percent. For wholesale or retail trade it is one-half of one percent.
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Will this raise enough taxes? |
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The estimators believe it will. But to be sure, in 2007 the Comptroller of Public Accounts must identify and require the state’s top 1000 franchise tax payers, the state’s top 1000 private employers, the top 1000 business in terms of gross receipts, and the state’s 1000 top school tax payers to file an information return by February 15, 2007 reporting the amount of margin tax they would have paid based on 2006 business activity. This will be used to further refine revenue estimates. Because it is due February 15, 2007, the Legislature will have time in the 2007 regular session to fine tune the law.
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What is the effective date? |
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The bill is effective January 1, 2008, but is based on the 2007 financial numbers, and applies to reports originally due after that date. |
Sample Form
To assist you in guesstimating the impact of this bill on your institution, you may use the tax worksheet on our web site. This is in a members only area, so you will need to:
 log in on the web site click on Advocacy click on Legislative Issues under State Tax Issues, click on Perry Tax Worksheet
The Comptroller of Public Accounts will begin working on regulations soon. IBAT will be following the rule-making process closely.
There will probably be a number of clean-up amendments to House Bill 3 in the next session. Some are clean-up of unintended consequences. For example, there is a double counting of guaranteed payments in the partnership area. Also, the law inadvertently referred to a line in the federal tax return that relates to net rather than gross income from real estate rental activity. Other amendments are likely. We will be working with various experts along with our Board of Directors to assess what, if any, changes should be sought regarding the impact of this new tax on our members.
IBAT would like to express its thanks to a number of outside experts who helped us monitor this bill and provided technical assistance on various issues. These include, but are not limited to, the following:
 Chet Fenimore and Jeff Blair – Jenkens & Gilchrist, P.C. Cox Smith & Matthews Incorporated BKD, LLP (also prepared the tax worksheet on our website) Davis, Kinard & Co., P.C. Fisher, Herbst & Kemble, P.C. Padgett, Stratemann & Co. Payne, Falkner, Smith and Jones, P.C. Carl Andersen – World Savings Numerous IBAT members who provided “numbers” and raised important issues
We will continue to communicate additional information as it becomes available.
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