Texas Comptroller Proposes Rule Amendment That Would Allow Taxpayers to Retroactively Elect to Take Cost of Goods Sold Deduction or Compensation Deduction on Texas Franchise Tax Returns

Texas Comptroller of Public Accounts Susan Combs recently announced that she will allow taxpayers to change their election to deduct from total revenue 30%, the cost of goods sold, or certain compensation paid to employees. The Texas franchise tax or “Margins Tax” allows taxpayers, depending on their business, to elect to pay tax based on the lesser of income—less cost of goods sold, income less compensation, or income less 30%. When the tax was originally adopted in 2006, the law allowed a taxpayer to change its election by filing an amended return (if the taxpayer qualified to take the deduction).

During the 2007 Legislative Session, the provision was changed as part of “technical corrections” legislation to prohibit the choice of deduction from being changed. For example, if a taxpayer elected to take the cost of goods sold deduction (which is limited to retailers, manufacturers, and contractors) but did not qualify, the taxpayer could not amend its franchise tax return to elect to deduct compensation. Instead, the taxpayer’s only option was to take a deduction equal to 30% of income. During a recent House Ways and Means Committee meeting, taxpayers expressed concerns about the impact of the irrevocable election to the committee.

Comptroller Combs’s draft regulation (Rule 3.584) would allow taxpayers to file amended reports to change or correct their Margins Tax deductions from cost of goods sold to compensation or vice versa.