Texas Business Taxes
Business Tax Overview
There are multiple types of taxes that apply to businesses operating in Texas. Many of these taxes are industry specific and/or product specific. However, there is a common tax that applies to most businesses in Texas, the franchise tax.
Franchise Tax Overview
The Texas franchise tax is a privilege tax imposed on every taxable entity formed or organized in Texas. It is also imposed on every taxable entity doing business in Texas. Franchise tax is calculated by multiplying a given tax rate by an entities taxable income. Taxable entities include certain partnerships, corporations, LLCs, business trusts, professional associations, business associations, joint ventures, and other legal entities. Entities that are exempt from franchise tax include sole proprietorships, general partnerships directly and solely owned by natural persons (except the tax actually does apply to all limited liability partnerships), certain passive entities, and certain other specific entities exempted by law.
Calculating Franchise Tax Due in Texas
In order to calculate franchise tax due, a business entity must determine its (1) applicable franchise tax rate; (2) amount of taxable income; and (3) available credits.
Determining your franchise tax rate:
The typical franchise tax rate for most businesses in Texas is 1%. However, qualifying wholesalers and retailers have a reduced tax rate of .5%. To qualify as a wholesaler or retailer, certain criteria must be met. These criteria can be accessed from the Comptroller’s website. In addition to the reduced rate for wholesalers and retailers, entities with $10 million or less in total annualized revenue electing to use the E-Z computation, the franchise tax rate is .575%.
Calculating your taxable income:
Unless an entity qualifies and elects to file using the E-Z computation or has less than $1 Million in revenue, to determine taxable income, you first need to determine an initial taxable base, also known as a revised taxable base. As such, every business should perform the following three calculations:
1) Total revenue x 70% = revised taxable base
2) Total revenue – Cost of Goods Sold (COGS) = revised taxable base
3) Total revenue – compensation = revised taxable base
After performing these three calculations, the lowest revised taxable base should be selected and utilized for the remainder of the calculation. Next, this number should be reduced for any sales outside of Texas. This can be done by determining the percentage of revenue derived from sales outside the state, and then reducing the revised taxable base by that percentage. At this point, certain deductions can be taken if your business uses clean coal or solar energy devices; however, these deductions will not be applicable to most businesses. This will leave you with a final taxable income base.
Calculating franchise tax due:
Once the final tax base has been calculated, the tax base should be multiplied by the applicable tax rate, probably 1% (see discussion above to determine the exact applicable rate). Finally, this number should be reduced by any available tax credits or discounts. Credits include, but are not limited to, temporary credits for business loss carryforwards and capital investment credits. Discounts apply when total revenue is less than $900,000, and can reduce the tax due by as much as 80%. After these reductions, you are left with the total tax due.
This process is illustrated with the following formula:
(Franchise Tax Rate x Taxable Income) – Available Credits and Discounts = Franchise Tax Due
Reporting Franchise Tax in Texas
Franchise tax reports are required for all businesses in Texas that have an annual revenue threshold that exceeds a certain statutory minimum. For companies that do not have 12 months of revenue to report, revenue must be annualized to determine if threshold is met. Currently, taxable entities having over $1,000,000 in revenue are required to submit franchise tax reports; however, unless the law is changed during the current legislative session (the 82nd Legislative Session), this revenue requirement will decrease to $600,000 on January 1, 2012. It should be noted that even when companies are exempt from filing standard franchise tax reports due to their total revenue, they are still required to file a “No Tax Due Report” with the comptroller.
The initial franchise tax report is due one year and 89 days after the beginning date of the company’s activities in Texas. Additionally, annual reports are due on May 15. The accounting period should begin with the day after the previous franchise tax report ended and should end with the last accounting period ending date for federal income tax purposes in the year before the year the report is originally due.
A Final Thought
Officially, Texas does not have a state income tax though some might argue franchise tax and income tax are one in the same. However, Texas’ franchise tax is far lower than the income tax in many states. As such, even though this tax does operate like a state income tax, franchise tax is still more business friendly than many of the income taxes in other states, contributing to a belief held by many people – Texas is one of the best places in the United States to operate a business.