Consider revisiting the Texas franchise tax during inflation
ARTICLE | May 27, 2022
Authored by RSM US LLP
Too often businesses take the same position on state tax returns year after year – lovingly termed SALY (same as last year) by many of us in the accounting industry. This is particularly true when there have not been significant legislative or legal changes in a particular state. Businesses, especially those in the middle market, often fail to take economic conditions into account when preparing returns. This occurs with respect to many types of taxes. Through the last few months, the United States is experiencing the highest inflation rates in over 40 years. High inflation affects many aspects of business operations, profitability, and ultimately tax liabilities. But taxpayers should be aware that rising inflation can have a significant impact on Texas franchise or margin tax liabilities.
As most know, the margin tax applies to corporations, limited liability companies, partnerships, business trusts, professional associations, business associations, joint ventures, and other legal entities organized in Texas or that do business in Texas. Entities with revenues of $1,230,000 or less do not owe the tax. All entities, however, must file franchise tax returns.
Rising inflation can, and likely will, affect the tax base. The base is the entity’s margin which is equal to the lesser of the entity’s: total revenue minus cost of goods sold, total revenue minus compensation, total revenue minus $1 million, or 70% of the entity’s total revenue. The taxable margin is the lowest of the four calculations. The taxable margin is then apportioned if appropriate.
A business’s cost of goods generally is the costs related to the acquisition and production of tangible personal property and real property. Compensation and benefits include wages and cash paid to officers, owners, partners, and employees as well as workers’ compensation, health care, and retirement benefits. In most industries and sectors, the costs of goods sold and compensation have risen significantly due to inflationary pressures and ongoing pandemic response around the globe.
A business subject to franchise tax may have traditionally had higher compensation costs relative to costs of goods sold. The opposite may have been true as well. A business may have long used the 70% of total revenue as the basis for the tax because it had modest cost of goods sold or compensation. Inflationary pressures in both labor and costs of goods may change those outcomes. Higher inflation is projected to last for the foreseeable future. Therefore, understanding and modeling this effect on franchise tax calculations is important not only for the current filing periods but for planning purposes.
Finally, there have also been many legal developments with respect to the Texas franchise tax. Several Texas Supreme Court decisions have been issued concerning the definition of costs of goods sold and sourcing of receipts. See, for example, Hegar v. Gulf Copper & Manufacturing Corp. and Sirius XM Radio Inc. v. Hegar, There have also been statutory developments granting tax reductions to the aerospace industry and revised sourcing rules in the past year or so. While many businesses and tax professionals may be aware of those changes, they should also consider that rising prices may affect the overall franchise tax calculation and ultimate liability in Texas. Taxpayers with questions should speak to their Texas state and local tax adviser for more information.
Call us at (325) 677-6251 or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Chris Gorman, David Brunori, Shakeb Syed and originally appeared on 2022-05-27.
2022 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Condley and Company, LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Condley and Company can assist you, please call (325) 677-6251.