On September 15, TTARA’s Dale Craymer hosted James LeBas and Karey Barton to discuss the current margin tax debate and reviewed how the margin tax was formulated into Chapter 171 of the Tax Code. The webinar can be found here.
The HillCo report below is a summary of remarks intended to give you an overview and highlight of the discussions on the various topics discussed. This report is not a verbatim transcript; it is based upon what was audible or understandable to the observer and the desire to get details out as quickly as possible with few errors or omissions.
Dale Craymer, Moderator
Presentation: The Ballad of the Margin Tax
- The ‘margin tax’ is a way of calculating a business’s franchise tax; broadest tax imposed by the State
- A franchise tax is a “privilege tax” – a tax privilege to do business in a formed afforded
- Since 2008, the franchise tax has been based on taxable “margin”
- Provides an overview of the calls for Franchise tax reform in the 2000s
- Additionally, lawmakers were looking for new sources of revenue to pay for school finance reforms
- Both house and senate wanted broader reform package
- Governor Perry wanted to leave franchise tax as is, but tax corporate-owned partnerships, i.e. close “loopholes;” coupled with school finance reform and homeowner property tax relief
- Formula includes: cost of goods sold and compensation and accounts for 3.30% total revenue
- Provides an overview of the formula for the franchise tax on margin
Q: What was the genesis of the actual structure of the margin tax?
- LeBas – Had been through every conceivable tax structure, had to come up with something unforeseen, something unusual to be able to get it passed
- LeBas – Turn a tax from a net worth tax to a gross receipts tax
- LeBas – Saw the advantages of gross receipts tax, there would have to be a deduction for employment, a fixed deduction per employee – would work for certain industries but not others
- LeBas – Idea has to be made workable
- LeBas – A basket tax proposal – gave tax- payers a choice, idea of an alternative was born
- LeBas – A (alternative) T (tax) M (Margin)
Q: What were challenges of putting this onto paper and into a workable tax?
- Barton – The idea of the combines reporting was the more challenging point of it
- Barton – Drafting up the language to create the structure for the two-rate structure and being able to get the language built around that
- Barton – Going with a combined reporting – used a more than 50% ownership structure which was the best way to do the combined reporting
Q: What was the hiccup with cost of goods sold; why do TX and Federal government have different terms for this?
- LeBas – Identified the ideas as wanted to use cost of goods sold as a deduction
- Barton – IRS does not audit cost of goods sold
- Barton – It could up the deduction that could under-mine the revenue investments that they had been working on
- LeBas – COGS is important because it’s the most commonly claimed deduction throughout tax-payers
- Barton – You had to be producing or selling goods that you owned, and a retailer couldn’t be selling more than 50% of goods that they produced themselves and still qualify to deduct those COGS
- LeBas – The idea of the flowthrough deduction caused some issues
Q: Conversations whether the state could even tax partnership; has that issue been settled and how?
- Barton – Settled by Texas supreme court
- Barton – Not taxing individual partners taking legal entity – we can tax the partnership directly
Q: What issues are surrounding revenue aspect of the tax?
- LeBas – So much about the margin tax concept was new, toughest issue was the data itself
- LeBas – Could not construct a revenue estimate – they looked at federal data to help with concept and bill draft
- Barton – Comptroller office discounted the revenue about a billion dollars
- LeBas – Revenue estimate turned out to not be conservative enough
- LeBas – Was using best data they could find, but could not find data that matched up with the bill
Q: Asks panelists for expectations of far higher revenue
- LeBas – Property tax relief fund- which was supposed to help with this – $6 billion hit at $4 ½ billion
- Barton – A lot of businesses had not included depreciation on manufacture equipment and COGS – which messed up the data, was not included in federal number
Q: Was revenue was lower than expected?
- LeBas – Could not objectively, figure out what tax-payers would choose, made it harder to determine outcome, when deciding what to deduct, end up with less revenue, did not know how much, that was not modeled with staff or agency
Q: What Implementation of this new tax and challenges; what does it mean to produce a good?
- Barton – A lot of retailers out there that have store brands, are they producing those or contract manufacturing those? therefor they are being produced by someone else
- Barton – Texas did not recognize the federal income tax concept of check the box
- Barton – What qualifies for COGS, what does it mean to produce a good?
- Barton – In public policy every question has to be looked at a context “compared to what?”
- Barton – Supreme court order was part of reality “everything cost somebody something”
- LeBas – Before margin tax there were many businesses paying far less franchise and property tax but made it unequal
- LeBas – All business and education group endorsed plan but when bill came through a year later, they disliked it
- LeBas – Overall package of bills within margin tax was included, probably a shift of $1 billion within the overall system
- LeBas – The way the old franchise tax had become was very voluntary- you could almost pick and choose what you wanted to pay
- Barton – Businesses that were closely held or smaller businesses had the ability to deduct officer and director compensation from your earned surplus
- Barton – Businesses that were closely held took all their profit and dulled it out at the end of year, to the officers and directors of their corporation and didn’t have to pay the 4 ½ % earned surplus tax on it because it was not added back into the tax base