The U.S. Supreme Court’s recent decision in U.S. v. Windsor raises many questions for the world of tax. The decision invalidated the portion of the Defense of Marriage Act that defines “marriage” only as a union between a man and a woman for federal purposes. However, the decision did not invalidate the portion of the Defense of Marriage Act that allows states to refuse to recognize same-sex marriages performed in other states. This means that federal law now recognizes same-sex marriage in those states where it is legal. However, it remains unclear what the decision means for married same-sex couples residing in states like Texas that don’t recognize same-sex marriage – for example, if a couple married in New York and then moved to Texas.
This uncertainty has implications for both federal and state tax law alike. Other bloggers have already discussed the federal tax implications of this uncertainly (for example “DOMA, Taxes, and Where You Live” from Don’t Mess with Taxes). But the U.S. Supreme Court’s decision may also create an interesting issue under the Texas franchise tax. In short, the decision makes it unclear when businesses owned by a married same-sex couple must file as a combined group.
The Texas Tax Code requires “taxable entities that are part of an affiliated group engaged in a unitary business” to file one Texas franchise tax report as a combined group, rather than individual reports for each entity. The Texas Tax Code defines an “affiliated group” as “a group of one or more entities in which a controlling interest is owned by a common owner or owners. . .” By rule, the Texas Comptroller effectively removed the “or owners” language from the statute and narrowed the definition of an “affiliated group” to “entities in which a controlling interest is owned by a common owner . . .”
However, the Texas Comptroller’s Rule 3.590(b)(4)(E) states that an individual constructively owns an interest “owned by his or her spouse.” This is the only family attribution rule that the Comptroller has recognized. The following examples illustrate these rules.
Example 1: Phil and Seth are brothers. They live in Texas. Phil owns 100 percent of the stock of Phil Corp., a Texas corporation, and Seth owns 100 percent of the stock of Seth Corp., a Texas corporation. Neither Phil nor Seth own an interest in any other entity taxable under the Texas franchise tax. Phil Corp. and Seth Corp. will file separate Texas franchise tax reports because no common owner owns a controlling interest in both corporations. Neither Texas tax law nor Texas Comptroller policy treat the stock Phil owns as belonging to Seth for combined reporting purposes, or vice versa.
Example 2: Phil and Amy are married. They live in Texas. Phil owns 100 percent of the stock of Phil Corp., a Texas corporation, and Amy owns 100 percent of the stock of Amy Corp., a Texas corporation. Neither Phil nor Amy own an interest in any other entity taxable under the Texas franchise tax. If we assume Phil Corp. and Amy Corp. are in the same unitary business, the two corporations must file together as a combined group because a common owner (either Phil or Amy) owns a controlling interest in both corporations. This is because Texas law treats Phil as the owner of Amy’s stock and vice versa.
But now, after the U.S. Supreme Court’s decision, we have the following issue:
Example 3: Seth and Dean are married. They live in Texas, but were married in New York, where same-sex marriage is legal. Seth owns 100 percent of the stock of Seth Corp., a Texas corporation, and Dean owns 100 percent of Dean Corp., a Texas corporation. Neither Seth nor Dean own an interest in any other entity taxable under the Texas franchise tax. If the two corporations are in the same unitary business, must Seth Corp. and Dean Corp. file one Texas franchise tax report as a combined group, or must they file separately?
Right now, the answer is unclear because the Texas Constitution expressly prohibits same-sex marriage. Therefore, as the law currently stands, Texas law would not treat Seth and Dean as married, but New York law and federal law would. The Texas Comptroller’s rules do not state which definition of “spouse” the Comptroller will use for Texas franchise tax purposes.
On the one hand, it makes sense for the Comptroller to defer to Texas law. This is particularly true here where the possible justification for treating both spouses as the owner of stock owned by one spouse stems from Texas’s community property laws. On the other hand, much of the Texas franchise tax law follows federal income tax law, so it may make sense for the Comptroller to follow the federal definition of marriage.
What if Seth and Dean did not live Texas, but still lived in New York, where they were married? In this case the Texas community property law would irrelevant. Will the Comptroller pay any attention to how a same-sex couple’s home state treats their relationship?
Until the Texas Comptroller (or a court) provides further guidance, these questions remain unanswered. If a same-sex couple owns more than one taxable entity, they should compute their franchise tax with and without combination and determine which method results in less tax. If there is a significant tax difference, the couple may wish to consult with a Texas tax attorney.