The Texas Legislature made important changes to the state’s new Margin Tax before adjourning its 80th legislative session on May 28, 2007.
Beyond the Margin Tax corrections, the Legislature’s work this session on tax matters was marked more by what it rejected than what it passed. Lawmakers rejected a Senate-led attempt to convert the state’s new Margin Tax to a pure Gross Receipts Tax. It refused to allow local governments to exceed the 2 percent cap placed on local sales and use tax rates. And, it did not adopt any of the Paulken Commission’s recommendations for addressing escalating Property Tax appraisals. Indeed, of more than 200 bills filed to amend some part of the state Tax Code, only about a dozen will actually make it to the Governor’s desk.
Governor Rick Perry has until June 17, 2007 to sign or veto a bill.
The following is a summary of significant Tax Code changes approved by the Legislature. Unless otherwise indicated, the bills become effective September 1, 2007.
Franchise Tax (a.k.a. Margin Tax) Technical Corrections Bill (House Bill 3928)
- Amends the definition of “client company” to include a business that contracts with a temporary employment service as well as a staff leasing firm;
- Amends the definition of “controlling interest” to reduce the threshold from 80 percent or more to more than 50 percent. Controlling interest for a
- corporation is either more than 50 percent, owned directly or indirectly, of the total combined voting power of all classes of stock of the corporation, or more than 50 percent, owned directly or indirectly, of the beneficial ownership interest in the voting stock of the corporation;
- partnership, association, trust or other entity other than a limited liability company (LLC) is more than 50 percent, owned directly or indirectly, of the capital, profits, or beneficial interest in the partnership, association, trust, or other entity;
- LLC is either more than 50 percent of
- the total membership interest of the LLC, owned directly or indirectly; or
- the beneficial ownership interest in the membership interest of the LLC, owned directly or indirectly.
- Amends the definition of the Internal Revenue Code (IRC) to mean the IRC of 1986 that was in effect for the federal tax year beginning on January 1, 2007, not including any changes made in federal law after that date.
- Amends the definition of “lending institution” to mean an entity that makes loans and is either
- regulated by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Office of Thrift Supervision, the Texas Department of Banking, the Office of Consumer Credit Commissioner, the Credit Union Department, or any other comparable regulatory body;
- licensed by, registered with, or otherwise regulated by the Department of Savings and Mortgage Lending;
- a broker or dealer as defined by the Securities Exchange Act; or
- an entity that provides financing to unrelated parties solely for agricultural production.
- Adds a definition of “natural person” to mean a human being or the estate of a human being.
- Adds a definition of “security” for limited purposes of the tax. The definition of security is limited to specific subsections of statute related to the determination of total revenue and apportionment. For these limited purposes, security has the meaning assigned by Section 475 (c)(2), IRC, and includes instruments described by Sections 475 (e)(2)(B), (C), and (D) of the IRC.
- Amends the definition of “staff leasing services company” to mean a business entity that offers staff leasing services or temporary employment services. The addition of temporary employment services to the definition of staff leasing services company will allow the client company of a temporary employment service provider to deduct certain payments to the provider as compensation.
- Modifies the definition of “unitary business” to allow the Comptroller to consider any one of the following factors as relevant in the determination of the existence of a unitary business:
- activities of the group members are in the same general line of business;
- activities of the group members are vertically integrated; or
- the members of the group are functionally integrated due to strong centralized management.
- Amends the definition of a “taxable entity” to specifically include limited liability partnerships (LLPs) and clarifies that the exclusion for a general partnership owned by natural persons does not apply to LLPs.
- Deletes the references to a family limited partnership (FLP), passive investment partnership (PIP), and trust as entities that are not included as a taxable entity. If an FLP, PIP, or trust qualifies as a passive entity, the entities would be excluded from being a taxable entity.
- Amends the definition of a “taxable entity” to exclude a nonprofit self-insurance trust created under Chapter 2212, Insurance Code, a trust qualified under Section 401(a), IRC; or a trust or other entity that is exempt under Section 501(c)(9), IRC.
- Clarifies that capital gains from the sale of real property, gains from the sale of commodities traded on a commodities exchange, and gains from the sale of securities are types of passive income for purposes of determining whether an entity is a passive entity.
- Clarifies that an entity is not subject to the Margin Tax or the Additional Tax (a.k.a. Exit Tax) if, during the period on which the report is based, the entity qualifies as a passive entity.
- Clarifies that the applicable Margin Tax rate is applied to taxable margin, rather than per year of privilege period. Additionally, a retail electric provider that does not provide and is not affiliated with an entity that provides transmission and distribution utility service is considered to be primarily engaged in retail or wholesale trade and as such qualifies for the half percent tax rate.
- Adds a new section that provides a scale of discounts for small businesses. The discount is applied after the entity’s tax liability has been calculated and any allowable credits have been calculated. The following discount scale applies:
- 80 percent discount for taxable entities with more than $300,000 but less than $400,000 in total revenue;
- 60 percent discount for taxable entities with $400,000 or more but less than $500,000 in total revenue;
- 40 percent discount for taxable entities with $500,000 or more but less than $700,000 in total revenue;
- 20 percent discount for taxable entities with $700,000 or more but less than $900,000 in total revenue.
- Repeals the ability of a taxable entity to change its election of cost of goods sold (COGS) or compensation on an amended return and requires that a taxable entity “notify the comptroller of its election not later than the due date of the annual report.”
- Clarifies that the determination of total revenue is the sum of the “amount reportable as income” on the line references to the Internal Revenue Service (IRS) federal income tax returns, and defines that the “amount reportable as income” means the amount entered on the line to the extent the amount entered complies with federal income tax law.
- Amends the line references for the determination of total revenue for a partnership to be the “amount reportable as income” on lines 1c, 4, 6, and 7 on IRS Form 1065 and lines 3a and 5 through 11 on IRS Form 1065, Schedule K; line 17 on IRS Form 8825; and line 11, plus line 2 or 45 on IRS Form 1040, Schedule F. These changes in line references ensure that guaranteed payments are not double counted in the determination of total revenue and that “gross rental income” rather than “net rental income” is captured for partnerships in the determination of total revenue.
- Clarifies that in the determination of total revenue, a taxable entity must include the total revenue that was reported by the lower-tier entity as being total revenue to be included in the taxable entity’s (as the upper-tier entity) total revenue.
- Clarifies that a taxable entity that provides legal services may deduct from total revenue $500 per pro bono case handled by the taxable entity.
- Clarifies that a taxable entity that is a pharmacy cooperative may deduct from its total revenue “flow-through funds” from rebates from pharmacy wholesalers that are distributed to the members of the pharmacy cooperative.
- Amends the definition of “tangible personal property” to include “live and prerecorded television and radio programs.”
- Amends COGS to
- limit depreciation, depletion, and amortization to the amounts “reported on the federal income tax return on which the franchise tax report is based”;
- provide that a taxpayer can choose to either expense or capitalize costs;
- prohibit used merchandise sellers, such as pawn shops, that make loans to the public from choosing interest as COGS;
- clarify that an entity engaged in lending to unrelated parties for agricultural production qualifies to take interest expense as COGS; and
- clarify that an entity engaged in film or television production or broadcasting or the distribution of live and prerecorded television and radio programs may deduct as COGS the depreciation, amortization, and other expenses directly related to the acquisition, production, or use of the property, including expenses for the right to broadcast or use the property.
- Amends the definition of “compensation” to
- include net distributive income from an LLC treated as a sole proprietorship but only if a natural person receives the distribution;
- clarify that benefits are included only to the extent deductible for federal income tax purposes;
- provide that a small employer, as defined under the Insurance Code, that has not provided health care benefits to its employees in the year prior to its reporting period may subtract during the first 12-month period on which its margin is based amount equal to 50 percent of the health care costs for its employees. This amount is in addition to its cost of health care benefits that is already included in the determination of compensation. The small employer, during the second 12-month period on which its margin is based, may subtract an additional amount equal to 25 percent of the health care costs for its employees; and
- clarify that the $300,000 limitation on amounts paid to one employee applies to all amounts paid to the employee by all members of a combined group.
- Clarifies that the limitation that a taxable entity’s taxable margin cannot exceed 70 percent of total revenue applies to the taxable margin of a combined group.
- Clarifies that a member of a combined group may claim as COGS, qualifying costs, if the goods for which the costs are incurred are owned by another member of the combined group.
- Clarifies that for purposes of determining margin and apportionment, each member of the combined group must include its activities for the same period used by the combined group.
- Clarifies that each member of the combined group “shall be jointly and severally liable for the tax of the combined group.”
- Clarifies the language related to determining the taxable margin of a tiered partnership arrangement.
- Adds a new subchapter to Chapter 171, Tax Code, to establish an “E-Z Computation and Rate.” The new subchapter provides that not withstanding any other provisions of the Margin Tax, a taxable entity with $10 million or less in total revenue may calculate its tax liability by determining its total revenue, apportioning its total revenue and multiplying this amount by .575 percent. A taxable entity that chooses to pay the “E-Z Tax” may not take any credit authorized by the Margin Tax. The tax discount scale also applies to the E-Z Tax.
- Adds a new provision that requires a combined group to report to the Comptroller on its annual report the Texas sales of the non-nexus members of the combined group. This provision was added in response to several Senators' failed attempts to change the apportionment method of a combined group from the “Joyce” method to the “Finnigan” method.
- Amends the language relating to the treatment of eliminated receipts between members of the combined unitary group for apportionment purposes. The bill clarifies that for apportionment purposes certain receipts ultimately derived from transactions between members of a combined group must be included in the numerator of the apportionment factor. Receipts that are “ultimately derived from the sale of tangible personal property between individual members of a combined group where one member party to the transaction does not have nexus in this state shall be included in the receipts of the taxable entity from its business done in this state … to the extent that the member of the combined group that does not have nexus in this state resells the tangible personal property without substantial modification to a purchaser in this state.” Further, “receipts ultimately derived from the sale” is defined to mean the amount paid by the third-party purchaser for the tangible personal property.
- Clarifies that an entity may, for apportionment purposes, consider the gross proceeds from the sale of loans or securities treated as inventory for federal income tax purposes as gross receipts.
- Amends the Temporary Credit provision for net operating losses to clarify
- the credit applies to reports due after January 1, 2008;
- the credit can be taken over twenty consecutive privilege periods;
- the credit is the amount of “business loss carryforwards” calculated under Section 171.110(e) as that section applied to returns due before January 1, 2008, and the appropriate tax rate used to determine the credit is the 4.5 percent earned surplus rate;
- the credit is equal to 2.25 percent of the amount determined under the previous provision for the first ten consecutive reports and 7.75 percent of the amount for the 11th through the 20th consecutive reports; and
- unused credits can be carried forward subject to the 20-year limitation.
- Clarifies that an LLC must continue to file the public information report.
- Clarifies that the Comptroller may require an entity to file any necessary information to verify that the entity is not subject to the Margin Tax.
- Adds a new provision that clarifies that a client company can rely on information provided by a staff leasing services company when the information is provided on a form promulgated by the Comptroller or an invoice.
- Adds a new provision that establishes a “Business Tax Advisory Committee.” The advisory committee is presided over by the Comptroller and consists of two House members appointed by the Speaker of the House, two Senators appointed by the Lieutenant Governor, at least five state residents engaged in private business appointed by the Comptroller, and at least two state residents with state business taxation expertise. The advisory group will be required to conduct a biennial study of the effects of the Margin Tax. The advisory group is abolished on January 31, 2013.
- Clarifies that the Secretary of State may use the same procedures to reinstate a certificate or registration of a taxable entity after forfeiture by the Secretary of State as used to revive a corporation’s charter or certificate.
- Removes the requirement that certain entities file an information report on February 15, 2008.
- Clarifies the transition provisions to require the entities described below to pay an “additional tax” for the privilege of doing business in the state any time after June 30, 2007 and before January 1, 2008. The additional tax would be the appropriate Margin Tax rate applied to the entity’s taxable margin, which would be based on the period
- beginning on the later of January 1, 2007 or the date the entity began doing business in the state; and
- ending on the date the entity became no longer subject to the tax.
- is not doing business in the state on January 1, 2008;
- would be subject to the new Margin Tax but was not subject to the old Franchise Tax; and was doing business in the state after June 30, 2007 and before January 1, 2008.
- Repeals the provision that allows for the inclusion of a passive entity in a combined group.
- Repeals the provision that requires a taxable entity with more than 100,000 employees to file a report with the Comptroller indicating the number of the entity’s employees in Texas that receive state assistance for the employee or the employee’s family.
- Adds a non-severable clause to the Margin Tax that states that if the Margin Tax is found invalid the E-Z Tax is also invalid.
The fiscal analysis of House Bill 3928 indicates that the changes and clarifications proposed by the bill will have a negligible fiscal impact, even though several of the bill’s provisions will generate additional revenue. These include the change to the line references for determining total revenue for partnerships to incorporate gross rental income rather than net rental income, and the change that lowers the ownership threshold for including an affiliate in the unitary combined group.
Four specific provisions in the bill would reduce the new revenue generated by the changes to the Margin Tax. Two of the provisions are considered technical in nature: a clarification in the apportionment treatment of the sales of securities and loans and a clarification that the 4.5 percent earned surplus tax rate would apply in the calculation of the business loss carryforward tax credit. One provision provides for changes in the small business exemption by implementing a scaled discount schedule for taxable entities with more than $300,000 but less than $900,000 in total revenue. The last provision with a revenue impact was the addition of the E-Z Tax.
As indicated above, Senate Finance Committee Chairman Steve Ogden made several attempts to change the apportionment method for a combined group from the Joyce method that was included in the tax bill when it passed last year to the Finnigan method. The Joyce method requires that only Texas sales by members of the combined group having nexus with the state must be included in the numerator of the apportionment factor. The Finnigan method requires that the Texas sales of all members of the combined group be included in the numerator when any member of the combined group has nexus. In the failed attempts to change the apportionment method, the Joyce method was consistently characterized as a “loophole” even though the method is used by 12 other states, while the Finnigan method is used by fewer than five states. With the requirement that taxpayers submit the Finnigan report to the Comptroller, it is expected that this issue will be debated again when the Texas Legislature meets in 2009.
Sales Tax (House Bill 3319)
- Clarifies that a retailer is entitled to a sale for resale exemption on purchases of cell phones that are provided to customers as part of the customer’s purchase of cell phone service.
- Narrows the exemption applicable to purchases of over-the-counter drugs to only those products bearing an FDA Drug Fact Panel.
- Moves the date for the annual sales tax holiday from the first weekend in August to the third weekend in August so that it will occur closer to the state’s new uniform school start date. Adds school backpacks to the list of items exempted during the holiday. These changes become effective immediately on the signature of the Governor.
- Repeals destination-based sourcing rule for sales of services.
- Exempts materials used in constructing pharmaceutical biotech cleanrooms as part of a new facility built after July 1, 2003; the provision removed the requirement that the facility have a value of at least $150 million dollars and that construction begun before August 31, 2004. This change is effective on July 1, 2007.
- Exempts hydrogen-powered cars from the state’s Motor Vehicles Sales Tax.
- Clarifies that sales tax applies to ready-mix concrete produced by a ready-mix concrete contractor and incorporated into real property improvements; requires contractors to separately state and individually invoice a customer for each yard of ready-mix concrete produced and consumed in the improvement of real property, and to collect and remit the tax based on price of the materials determined by the greater of the invoice price or fair market value of the ready-mix concrete incorporated into the project.
Sales Tax Holiday on Energy Efficient Products (House Bill 3693)
- Creates a two-day annual sales tax holiday on certain household appliances and products that have been given the Energy Star efficiency rating by the U.S. Environmental Protection Agency and the U.S. Department of Energy. The annual holiday will occur Memorial Day weekend, beginning at 12:01 a.m. on the Saturday prior to the last Monday of the month and ending at 11:59 p.m. on Monday. During that period, no sales tax will be due on sales of Energy Star washers, ceiling fans, dehumidifiers, dishwashers, incandescent and fluorescent light bulbs, programmable thermostats, air conditioners priced at $6,000 or less and refrigerators priced at $2,000 or less.
Motor Fuels Tax (House Bill 1332)
- Exempts diesel fuel used as feedstock in the manufacturing of tangible personal property or as a medium to remove drill cuttings from a wellbore in the production of oil and gas.
- The Legislature failed to adopt an omnibus motor fuels tax bill, which had been amended by the House to include a three-month holiday this summer from paying the state’s motor fuels taxes.
Telecommunications Infrastructure Fund (House Bill 735)
- Abolishes the telecommunications infrastructure fund and the assessments on telecommunications utilities and mobile service providers used to fund it. Consumers actually paid the tax in the form of a Telecommunications Infrastructure Fund reimbursement fee added to their monthly bills. House Bill 735 becomes effective on September 1, 2008.
- House Bill 1196 requires a business that receives a public subsidy, including “tax refunds, tax rebates, or tax abatements” to state in its application for the subsidy that it does not and will not knowingly employ an undocumented worker. Violators would be required to repay the subsidy with interest.
- House Bill 2010 grants local district courts original jurisdiction to decide whether a Texas-based business has sufficient nexus with another state to be required to collect and remit sales and use taxes for that state.
- House Bill 3314 creates personal liability for officers, managers, and directors of businesses that participate in tax fraud.
- House Bill 3315 authorizes the Comptroller to enter into cooperative agreements with other states to enforce state premium tax laws. The bill provides that home warranty insurance premiums are subject to tax. In finally adopting the bill, the Senate accepted restrictions on the Comptroller’s rulemaking authority that had been included in the bill by the House.
- Senate Bill 190 requires the Comptroller to provide information detailing the sales and use tax collected or paid by businesses that paid or remitted at least $25,000 the preceding year if the information is requested by the municipality. Cities that do not impose a property tax are entitled to receive detailed sales and use tax information for business that paid more than $500 in local sales tax the preceding year. Prior law required the comptroller to provide this information only to cities having populations of less than 275,000 and only for businesses remitting more than $25,000 in local sales tax. This bill becomes effective immediately upon being signed by the Governor.
- Senate Bill 377 lowers the threshold for requiring a business to pay taxes by electronic funds transfer. Current law permits the Comptroller to require electronic tax payments only if a business remitted $100,000 or more in the previous year. Senate Bill 377 lowers the threshold to $10,000, but requires that the Comptroller grant waivers for businesses showing hardship or impracticality. This change is effective immediately upon the Governor’s signature. The bill also permits the Comptroller to require any business that paid $50,000 or more the previous year in sales tax or oil and gas production taxes to file future reports electronically, effective September 1, 2008.
- Senate Bill 242 codifies the transfer of administrative law judges that decide tax cases from the Comptroller’s office to the State Office of Administrative Hearings. This bill becomes effective immediately upon being signed by the Governor.
Senate Bill 1615 authorizes state agencies to use private debt collectors to collect delinquent obligations, subject to compliance with referral guidelines and approval by the Attorney General. The bill further authorizes the Comptroller to use private collectors on certain delinquent taxes, and permits the imposition of a fee of up to 30% of the obligation.
Economic Development (House Bill 3694)
- Changes and clarifies provisions of the Enterprise Zone Program:
- clarifies that counties with a population of 750,000 or more may nominate a project that is located in the jurisdiction of a municipality located in the county (this provision has immediate effect);
- increases the number of designations from 85 to 105 projects that can be approved during any biennium;
- modifies the criteria for job retention projects, removing the specific output criteria and replacing these criteria with the requirement that the project be able to employ at the appropriate levels economically disadvantaged individuals;
- moves the monitoring of the projects for compliance from the Governor’s Economic Development office to the Comptroller’s office; and
- clarifies that the sales tax refund claim from an enterprise project can be for sales tax paid on purchases of all taxable items rather than a limited list of taxable purchases.
- Adds new franchise tax investment credit that is limited to an enterprise project that was nominated before January 1, 2005 for qualified capital investments made in an enterprise zone on or after January 1, 2005 and before January 1, 2007.
- The enterprise project must have been subject to the Franchise Tax (i.e., a corporation or LLC) before the changes made to the Franchise Tax by the Legislature last year in House Bill 3.
- The tax credit earned by the enterprise project for a capital investment made in an enterprise zone must be taken on a tax return due on or after January 1, 2008 and before January 1, 2009. For most taxpayers, if not all, that means that the franchise tax credit must be taken on the tax return due May 15, 2008. The tax credit is limited to 50 percent of the business's total tax liability. If the tax credit exceeds 50 percent of the business’s tax liability, the overage can be carryforward and claimed by the business on the next five consecutive tax returns.
- This provision has a January 1, 2008 effective date.
- Transaction Tax