Texas Comptroller Plans Desk Audits of the Revised Franchise Tax

Reports from the Texas Comptroller of Public Accounts (“Comptroller”) have revealed that actual receipts from the revised Texas Franchise Tax were well below revenue projections for the tax. During a hearing before the Texas House Committee on Ways & Means, the Comptroller’s office announced plans to provide oversight of the new tax through the use of desk audits.

Texas audits typically cover an audit period of four years, and it is rare for the Comptroller to perform an audit on a single year. However, the Comptroller’s office plans to perform as many as 25,000 desk audits of 2008 Texas Franchise Tax reports. “We don’t usually do a one year audit, but because this is a new tax and there is such a difference between what we expected and what we estimated, we are going in and doing some desk audits,” said Mike Reissig, Associate Deputy Comptroller.

According to Mr. Reissig, the desk audits will focus heavily on the cost of goods sold deduction. “The cost of goods sold has been the biggest area of discrepancy we have seen,” said Mr. Reissig. “It explains the largest amount of difference between what we expect and what we receive.” The auditors will first determine whether taxpayers were eligible to take the cost of goods sold deduction. Generally, only taxpayers who acquire or produce goods are eligible to deduct cost of goods sold. The law defines the term “goods” as real or tangible personal property sold in the ordinary course of the taxpayer’s business.

If it is determined that the taxpayer was not eligible to deduct cost of goods sold, the tax will be recomputed using a deduction of 30% of total revenue to determine the taxpayer’s margin. Under the revised tax, no taxpayer’s margin may exceed 70% of total revenue. If the taxpayer was eligible to use the cost of goods sold deduction, the auditors will review the expenses included in the deduction for potential overstatements.

Mr. Reissig stated that the cost of goods sold deductions were larger than expected. “What we don’t know is what specific factors within cost of goods sold may have been larger or interpreted differently than what we expected,” he said. “That’s the kind of thing we can only learn when we go in and audit.”

The desk audits will also focus on whether taxpayers used the correct tax rate and whether no-tax-due returns were appropriate. A taxpayer subjected to a desk audit may also be subjected to a full audit in the future, during which a more comprehensive review of the taxpayer’s books and records would be conducted. Ryan will closely monitor any future developments associated with the Comptroller’s audit plans.