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Understanding the Texas Franchise Tax

Understanding the Texas Franchise Tax

June 06, 2024

The Texas franchise tax, also known as the margin tax, is a privilege tax imposed on businesses operating in the Lone Star State. Established over a century ago, this tax serves as a significant revenue source for the state government and has undergone numerous modifications to adapt to the evolving economic landscape. In this article, we will explore the intricacies of the Texas franchise tax, including subjections, exemptions, calculating methods, and filing requirements.

Who is subject to the tax?

The franchise tax applies to most business entities operating in Texas. These include corporations, limited liability companies, S corporations, partnerships (general, limited, and limited liability), state limited banking associations, savings and loan associations, professional associations, business associations, banks, joint ventures, trusts, and other legal entities.

Exemptions and Exclusions

While the Texas franchise tax applies to a wide range of business entities, some specific exemptions and exclusions relieve certain entities from this tax obligation. Here is a detailed look at the types of entities that are exempt from the Texas franchise tax:

  • Small businesses: Entities with a total annual revenue of $2,470,000 or less (as of 2024) are not required to pay the franchise tax. Notably, this no-tax-due threshold is increased to this value from $1,230,000 starting this year. Moreover, entities under the no tax due threshold are no longer required to file a No Tax Due Report. However, the entity is still required to file Form 05-102, Public Information Report, or Form 05-167, Ownership Information Report.
  • Sole proprietorships and general partnerships: Sole proprietorships (except for single-member LLCs) and general partnerships (except for limited liability partnerships) that are entirely owned by natural persons are exempt from the Texas franchise tax. This exemption recognizes the simpler structure and typically smaller scale of these businesses.
  • Passive entities: Partnerships (general, limited, and limited liability) and trusts (other than business trusts) may qualify as passive entities if at least 90% of the entity’s income is from passive sources such as dividends, interest, net capital gain, or other investment gains.
  • Real estate investment trusts (REITs): Real estate investment trusts that meet the qualifications specified in Texas Tax Code Section 171.0002(c)(4) are exempt from the franchise tax.
  • Nonprofit organizations: Qualifying nonprofit organizations, including those focused on religious, educational, or charitable purposes, are exempt from the franchise tax.

How is the franchise tax calculated?

Businesses with annualized revenue over the no-tax due threshold of $2,470,000 may qualify for different tax rates, depending on their industry and total revenue amount. There are two forms used to calculate the total tax due: the Long Form or the EZ Computation Form. Notably, businesses are only liable for the portion of income attributable to Texas.

The Long Form

The calculation of the Texas franchise tax using the long form is based on a business’ margin, which is determined using one of these four methods. Businesses must choose the method that results in the lowest tax liability.

  1. Total Revenue times 70%
  2. Total Revenue minus Cost of Goods Sold (COGS)
  3. Total Revenue minus Compensation
  4. Total Revenue minus $1 million

Once the margin is determined, the applicable tax rate is applied. For most businesses, the rate is 0.75%, while wholesalers and retailers benefit from a reduced rate of 0.375%.

The EZ Computation Form

Entities with $20 million or less annualized total revenue also may opt to use the EZ computation form to calculate the franchise tax bill. The franchise tax rate for entities choosing this method is 0.331%. Although the tax rate using this form is lower than using the long form, no margin deduction (70% of revenue, COGS, compensation, or $1 million) is allowed when choosing the EZ computation method.

Filing Requirements

Businesses subject to the franchise tax must file an annual report with the Texas Comptroller of Public Accounts. This report is due every year on May 15 and must include information about the business revenue, the chosen margin calculation method (or the EZ computation method if applicable), and the resulting tax due. Businesses that require more time to file their franchise tax reports can request an extension. The Texas Comptroller of Public Accounts offers an automatic extension process under specific conditions:

  • First extension: An automatic extension of time to file until August 15 can be granted if the entity files an extension request by May 15 and pays at least 90% of the tax due for the current year or 100% of the tax reported as due for the prior year. Meanwhile, any overpayment must be refunded and cannot carried over to the next period.
  • Second extension: If the first extension is granted, a second extension to November 15 is permitted. This requires the business to file an additional extension request by August 15 and pay the remaining tax due for the current year. 

Conclusion

The Texas franchise tax is a fundamental component of doing business in Texas. For accurate and up-to-date information, businesses are encouraged to consult the Texas Comptroller’s office or seek guidance from tax professionals, ensuring compliance with all tax obligations and leveraging any applicable exemptions to minimize tax liability.