For the first time, House Bill 3 will subject many non-corporate business entities, such as limited partnerships, limited liability partnerships, grantor trusts, and general partnerships owned by corporations, to the new Franchise Tax (a.k.a. Margin Tax) effective for reports due on or after January 1, 2008. If one of these entities becomes subject to the Margin Tax on January 1, 2008, its accounting year for computing the new tax can begin as early as June 1, 2006, if it is a fiscal-year taxpayer, or January 1, 2007, if it is a calendar-year taxpayer. In any case, gross receipts prior to June 1, 2006 cannot be considered for computing the tax due on May 15, 2008 for these non-corporate business entities.
In the event a corporation or limited liability company (LLC) leaves the state after December 31, 2006, but prior to January 1, 2008, House Bill 3 imposes a final privilege tax on the entity for the period from January 1, 2007 (or the date the entity was organized or started to do business in Texas) and ending on the date the entity was no longer subject to franchise tax. However, the language of the bill does not impose a final privilege tax on non-corporate business entities that leave the state prior to January 1, 2008.
The remainder of Section 22 of House Bill 3 treats a partnership that failed to exit the state prior to January 1, 2008 as still falling under the provisions existing as of January 1, 2008, thereby subjecting it to the Margin Tax as far back as June 1, 2006. The Legislature included language to impose a requirement that the partnership terminate in order to be treated as exiting the state for purposes of avoiding the imposition of the Margin Tax. Mergers, consolidations, and divisions of partnerships must result in a loss of 50% or more of the ownership interests of the members to qualify as terminated.
In order to expand the ability of the Comptroller to impose a final privilege tax on non-taxable business entities that merge into a corporation or LLC prior to January 1, 2008, the Legislature passed two pieces of legislation: House Bill 3928 and House Bill 1207, both of which clearly impose a final privilege tax on non-taxable business entities that exit the state from June 30, 2007 to December 31, 2007, regardless of the mechanism used to do so. But for periods prior to June 30, 2007, the partnership termination language in Section 22 of House Bill 3 is simply ineffective in addressing the merger, liquidation, or consolidation of a non-taxable corporate entity into a taxable entity.
Last week, the Comptroller issued its Frequently Asked Questions (FAQ) – Transition Provision, which gives non-taxable business entities, especially limited partnerships, the opportunity to avoid the Margin Tax prior to June 30, 2007. In other words, if the limited partnership merges into a new or existing corporation or LLC before July 1, 2007, only the margin of the limited partnership operations post-merger date will be subject to the Margin Tax. See http://www.window.state.tx.us/taxinfo/franchise/tranfaq.html.
Specifically, for purposes of the Margin Tax, the Comptroller will look to the legal formation of an entity, regardless of its treatment for federal income tax purposes. Furthermore, a conversion of a limited partnership will be treated as an invalid termination and will be treated as in existence on January 1, 2008 for purposes of imposing the Margin Tax.
The Governor signed both House Bill 3928 and House Bill 1207 into law late last week. Accordingly, any non-taxable business entity should strongly consider merging out of existence before July 1, 2007 to eliminate taxable margin through June 30, 2007. For fiscal-year entities, these savings could stretch back to June 1, 2006. These savings may be impacted by a new provision that requires a non-taxable business entity part of a combined group to determine margin and apportionment using the same period used by the combined group.
- Topics
- Transaction Tax
- Texas