We’re only a little over a week away from the May 15 filing deadline for the 2012 Texas franchise tax reports. With that in mind, I wanted to discuss a few areas you may wish to consider while you prepare those reports and extensions.
Guidance on the Texas Franchise Tax From Tax Policy
The Tax Policy Division of the Texas Comptroller has published an article titled “Hot Topics for the 2012 [franchise tax] Filing” in the April edition of “Tax Policy News”. Among other tidbits, Tax Policy reminds us that inflation has caused a couple of the tax thresholds to increase. Now the small business exemption is $1,030,000 of revenue instead of $1 million, and the per-individual limit on the compensation deduction is now $330,000. The article also includes several tips and reporting-requirement reminders for those entities eligible to take the “temporary credit”–that’s the credit available to corporations and LLCs that had a loss carryforward under the “old” (pre-margin) franchise tax. If your report includes the temporary credit, you should take a look.
Another “Tax Policy News” article that you may wish to review is one from March 2012. It reminds report preparers that the IRS changed several of its tax forms late in 2011, which means franchise-tax preparers must use a different set of line numbers in 2012 compared to 2011. The online version of the the 2012 instructions includes the correct IRS line numbers, but the Comptroller warns that incorrect “hard copy” versions of the instructions may exist; be careful that you are using the correct instructions. This FAQ lists the cumulative changes in IRS form line numbers.
The SIC Code: A Big Texas Franchise Tax Audit Flag
I’d also like to discuss a particular audit flag that the Comptroller has been using. For at least the past couple of years, the Comptroller’s auditors have focused a lot of attention on the SIC code (and the NAICS code) used on Texas franchise tax reports. The Audit Division uses these number for two reasons:
- First, if the entity uses the lower .5% rate, the Comptroller will likely flag the report for audit if the SIC number isn’t in the 5000s. This is because generally only wholesalers and retailers are allowed to take the .5% rate, and the codes in the 5000s describe wholesalers and retailers.
- Second, if the entity takes the cost of good sold deduction, the Audit Division often examines the SIC and NAICS codes to determine if the entity is in a type of business that would normally qualify for the cost of good sold deduction (generally, wholesale, retail, agricultural, and manufacturing entities).
If you’re preparing a report that has an SIC code that could cause a problem, you may want to consider whether another SIC code more accurately describes the business. However, it’s also important to remember that the SIC code included on the report should not control either eligibility for the .5% rate or the COGS deduction.
For example, lets take a group of veterinarians operating as an LLC. The LLC’s business is clearly described by Industry Group 074 (“Veterinary Services”); this is a service category, not a wholesale or retail category. However, let’s assume that the entity also sells a large amount of animal feed and medicine–so much, in fact, that over 50% of its revenue is from the sale of goods, and the cost of these goods exceeds the amount of compensation earned by the vets and their employees.
Even though this entity is best described by a service SIC code, the entity also should still qualify for both the .5% rate and the deduction of cost of goods sold. Nevertheless, the entity may wish to use SIC Code 5191 (“Farm Supplies”) to avoid the audit flag.
However, even if the entity includes the veterinary service code on the report, it still qualifies for the lower rate and cost of goods sold deduction. The entity should be prepared to demonstrate its special circumstances to the Comptroller when the auditors come knocking. I’ve heard rumors that Comptroller auditors have been telling taxpayers that the SIC code used on the report “controls,” and cannot be changed. I’m unaware of any rule or statute that supports this position, so a taxpayer faced with such an argument should strongly consider either an administrative or court challenge.
I hope these pointers assist you during the next week, and beyond. If you have further questions, please let us know.