The 2013 Changes to the Texas Franchise Tax
The 83rd Regular Legislative session is at an end, and the Legislature passed many changes to the Texas franchise tax in the session’s final hours. The bill that included most of these changes was HB 500. I previously covered the House version of this bill, as well as the very different Senate version. The Legislature worked out the differences in conference committee over the Memorial Day weekend. I cover what they finally agreed upon below. I also include a few other Texas franchise tax changes that are in bills other than HB 500. Governor Perry still has an opportunity to veto these bills, but it’s unlikely that he’ll do so. His deadline is June 16.
Unless otherwise noted, the changes below are in HB 500. I’ve organized the changes by topic:
Changes to the Texas Franchise Tax Rate
In 2014, new “elective” franchise tax rate reductions will apply. Taxpayers who would normally pay 1% may elect to pay .975%. Taxpayers who would normally pay .5% may elect to pay .4875%. This equals an elective 2.5% rate reduction. Eligible taxpayers electing the “EZ Rate” are stuck with the .575% rate, the same rate they paid in 2013 and in earlier years.
Why are these rates elective? Why would any business choose not to take a lower rate? That’s unclear. The Comptroller’s Office apparently recommended that the rate reduction be elective.
In 2015, an even lower elective rate will apply, but only if the state has enough money to support it. If the Comptroller certifies that the state will have “sufficient revenue” to support the lower rates, then in 2015 taxpayers may elect to reduce the 1% rate to .95% and the .5% rate to .475%. This would be a 5% rate reduction. Again, no reduction for taxpayers electing the EZ method.
$1 Million Standard Deduction
HB 500 also gives taxpayers a new $1 million standard deduction. Taxpayers will still elect to deduct the greater of 30% of revenue, cost of goods sold, or compensation to compute taxable margin. But if none of these deductions is at least $1 million, the taxpayer can deduct $1 million. While this sounds like a major tax cut, it will actually only benefit taxpayers with less than $3.3 million in revenue. This is because revenue over this amount will make the “70% of revenue” election the better option. Moreover, the $1 million deduction will only assist taxpayers that are not wholesalers and retailers when their revenue is less than $2.4 million. Taxpayers with revenue over this amount are likely better off with the .575% EZ-tax rate.
Franchise Tax Exemptions
- The small business exemption is now permanently set to $1 million in revenue (adjusted for inflation). It was set to drop to $600,000 next year.
- The Legislature has clarified that nonadmitted insurance companies (like surplus lines insurers) are exempt from the Texas franchise tax if they pay a tax to any state or foreign jurisdiction for the privilege of doing business in that jurisdiction.
- “Political subdivision corporations” are now exempt from the Texas franchise tax. These corporations are organizations formed under the local government code to act as agents for local governments to negotiate and purchase electricity for the local governments’ use.
The .5% Rate for Retailers and Wholesalers
- Auto repair shops (activities described by SIC Code 753) qualify for the retailer rate.
- Rent-to-own stores (rental-purchase agreement activities regulated by Chapter 92 of the Business & Commerce Code) now qualify for the retailer rate. The reason why the Legislature must define rent-to-own stores by reference to another statute instead of the SIC Manual is because the SIC Manual does not include rent-to-own stores. This suggests that this change is merely a clarification and these businesses should have always been considered retailers.
- Heavy equipment rental companies (activities described by SIC Code 7353) qualify for the retailer rate.
- Tool rental, party rental, and furniture rental companies qualify for the retailer rate. These activities are described by SIC Code 7359. There are other activities listed under SIC Code 7359, but the Comptroller may interpret the bill to limit relief to only the three activities listed above. If the Comptroller interprets this provision this way, other businesses included in Code 7259 should rightly question how their tax can be equal and uniform when other taxpayers that share their SIC Code only pay half as much tax.
- Many combined groups with utility wholesalers or retailers may now qualify for the retailer rate. Under current law, if a combined group includes a utility wholesaler or retailer, the entire group is ineligible for the retailer rate. This provision expels the utility wholesaler or retailer from the combined group if: (1) Removing the utility wholesaler or retailer from the group would allow the group to qualify for the retailer rate and (2) the utility wholesaler or retailer contributed less than 5% of the combined group’s total revenue before removal. This provision effectively preserves the lower rate for the combined group while still requiring the utility wholesaler or retailer to pay the higher rate, on its own.
- A provision of HB 500 clarifies the revenue exclusion for flow-through funds paid to subcontractors on real property construction, repair, and remodeling jobs. The statute previously stated that payments must be “mandated by contract” to be passed to subcontractors. The Comptroller interpreted this to mean that the contract between the taxpayer and the taxpayer’s customer must specify the funds to be passed to the subcontractors. The new provision states that the payments to subcontractors must be “mandated by contact or subcontract.” This clarifies that the revenue exemption is still valid if the taxpayer’s contract with the subcontractor mandates payment. This appears to be a clarification instead of a change in law. The provisions also adds “remediation” to the list of activities eligible for the revenue exclusion.
- Aggregate haulers may exclude from revenue payments to “subcontractors” performing transportation services for the entity, and barite haulers may exclude from revenue payments to “nonemployee agents” doing the same. It’s unclear if the drafters meant for these two exclusions to have different requirements or if this is a drafting error.
- Motor carriers (entities registered under Chapter 643 of the Transportation Code) may exclude from revenue “flow-through revenue derived from taxes and fees.”
- Waterway transportation companies are allowed a revenue exclusion if they don’t take a cost of goods sold deduction. The revenue exclusion is equal to the costs an entity selling goods would be allowed to deduct, without regard to whether the costs are distribution costs.
- All entities may exclude the cost of vaccines from revenue. The definition of vaccine is broad, and the exclusion is not limited to a particular line of business, so medical practitioners, veterinarians, and pharmacies should all be entitled to this exclusion.
- Pharmacy networks may exclude from revenue “reimbursements, pursuant to contractual agreements, for payments to pharmacies in the pharmacy network.”
- Landman service companies may exclude from revenue payments to subcontractor landmen.
- Crop dusters (entities primarily engaged in agricultural aircraft operation as defined by 14 C.F.R. Section 137.3) may exclude virtually all of their direct expenses of providing their services from revenue. This provision is in HB 2451, not in HB 500.
- The Legislature revised the definition of a “qualified destination management company.” For the past few years, the tax code has allowed qualified destination management companies to exclude from revenue payments made to others to provide “destination management services.” The definition of “qualified destination management company” is now arguably more restrictive, but the Legislature has broadened the definition of “destination management services” to include shuttle services and airport “meet-and greet” services. These changes are in HB 3169, not HB 500.
Cost of Goods Sold
- Pipeline companies are entitled to a cost of goods sold deduction for their depreciation, operations, and maintenance costs allowed by the rest of the COGS section even if they do not own the product flowing through the pipe. Previously, pipeline companies that did not own the product they transported did not qualify for the COGS deduction because they sold a service and not a good. Pipeline companies qualifying for this provision can ignore the exclusion banning distribution costs from the cost of goods sold deduction.
- Movie theaters may include costs to acquire, produce, exhibit, or use a film in their cost of goods sold deduction. This provision is effective September 2013. The term “movie theaters” is undefined.
- Receipts from Internet hosting (as defined by Tax Code Section 151.108(a)) are now sourced based on the location of the customer instead of the location of the server. Clearly the intent is to attract Internet hosting companies (and other businesses with larger sever requirements) to Texas.
- Entities rehabilitating “certified historic structures” qualify for a franchise tax credit equal to 25% of the eligible costs and expenses per structure. This credit can be sold and transferred to others. This provision is not effective until 2015.
- There is a new complicated credit for entities engaged in “qualified research,” as defined by section 41 of the Internal Revenue Code. The credit is only available to entities that do not use the sales tax exemption for qualified research described by Amanda in her post discussing changes to the Texas sales and use tax. This provision is in HB 800, not HB 500.
- The Legislature has expanded the credit for clean energy projects to include power plants fueled by natural gas. The Legislature also pushed the start date for entities to apply for the credit back to 2018. This provision is in HB 2446, not HB 500.
Incentives to Move to Texas
- Businesses with no filing responsibility in Texas (including membership in combined groups) that relocate to Texas can deduct their relocation costs. (Costs to move equipment, inventory, and other costs). The deduction is from apportioned margin. In other words, it is in addition to the usual cost of goods sold or compensation deductions. The deduction can only be taken on the entity’s initial franchise tax report.
Members of combined groups without franchise tax nexus with Texas will no longer have to report their Texas receipts to the Comptroller.
Written by: Michael Seay
Tags: construction business, cost of goods sold deduction, half-percent rate, health care, movie theaters, nexus, rent to own, SIC Code, small business exemption, standard deduction, Texas franchise tax, Texas tax law, transportation companies