Multiple House and Senate Committees in the last month have met and discussed the underperformance of the franchise tax/margin tax. On February 21, 2011 House Ways and Means met and again reviewed the current status of the franchise tax.
The tax was originally estimated to raise $6.4 billion last year but raised $3.9 billion in actual revenue. Of the $2.5 billion difference, $1 billion is attributed to the recession and $1.5 billion to the underperformance of the franchise tax.
Although there are several factors that contribute to the underperformance of the franchise tax, Mike Reissig, Associate Deputy Comptroller, has stated during previous committee hearings that the largest item contributing to the underperformance of the tax was the cost of goods sold (COGS) deduction which results in a $1 billion difference per year.
During the Ways and Means hearing, Reissig’s handouts to members of the committee highlighted the number of entities taking up COGS deduction. It was estimated that 68 percent of filers would deduct COGS; however, the actual numbers were 82 and 84 percent of filers taking COGS in 2008 and 2009 respectively. The handouts from Reissig give reasons behind why COGS was “unexpectedly large.”
Discussion is expected to continue on possible limits or changes to the COGS deduction under the state franchise/margin tax.
Two Options the Legislature May Carry Forward to Limit COGS deduction
1) Limit the deduction to 65 or 70 percent of a company’s total revenue. This could be harmful when considered in tandem to an existing provision in law that limits the tax base itself to 30% of total revenue. Under this proposal, for example, a company’s COGS deduction might be limited to 70% of its total revenue, guaranteeing that every company would pay a gross receipts tax of at least 0.3%: i.e., 1% of the remaining 30% margin.
2) Limit the deduction to 65 or 70 percent of COGS itself. This may not be as harmful as the option above but could still mean a substantial tax increase for many companies. For example, the COGS deduction could be simply calculated as COGS x 70%.
Other options/changes to franchise tax Being Suggested – Spotlight on Bills filed
HB 98 (Paxton) – Relating to the E-Z computation and rate of the franchise tax. The computation would be:
- Determine the taxing entity’s apportioned total revenue and then subtract the amount of federal income taxes paid during reporting period.
- Next subtract $1 million and apply that amount to one of the following:
- If difference is $1 million or less, then tax rate is 0.25 percent of the difference or
- If difference is more than $1 million, the tax rate is $2,500 plus 0.5 percent of the amount of the difference that exceeds $1 million
- No tax is required is amount computed is zero or less – but entity may be required to file an abbreviated information report with the comptroller
HB 146 (Laubenberg) – Relating to the retention of the $1 million total revenue exemption for the franchise tax. This bill repeals section 171.0021 of the Tax Code and other codes or chapters relating to discounts from tax liability for small businesses (those with revenue of $1 million or less.)
Identical legislation and/or companions to HB 146:
- HB 476 (Identical to HB 146) – King, Phil – Relating to the retention of the $1 million total revenue exemption for the franchise tax.
- HB 579 (Identical to HB 146) – Callegari – Relating to the retention of the $1 million total revenue exemption for the franchise tax.
- HB 1187 (Identical to HB 146) – Howard, Charlie – Relating to the retention of the $1 million total revenue exemption for the franchise tax.
- HB 1411 (Identical to HB 146) – Bonnen – Relating to the retention of the $1 million total revenue exemption for the franchise tax.
- SB 125 (Identical to HB 146) – Patrick – Relating to the retention of the $1 million total revenue exemption for the franchise tax.
HB 380 (Callegari) – Relating to the constitutional limit on the rate of growth of appropriations and the use of surplus state revenues. Contingent upon passage and voter approval of HJR 42 or similar legislation.
- Growth rate of appropriations from all revenue sources other than federal government may not exceed the sum of the estimated rate of increase or decrease in state population and the estimated rate of inflation or deflation
- Requires the LBB to determine the maximum allowable rate of growth of appropriations expressed as a percentage, the amount of appropriations for current fiscal biennium from all sources of revenue except the federal government, and the amount of revenue that could be appropriated in accordance with maximum allowable rate of growth as determined before submitting the budget
- If estimated rate of increase is a negative number, appropriations may not exceed amount of appropriations from sources in current fiscal biennium reduced by the product of that amount and sum of rates
- Upon an unencumbered positive balance of general revenues from preceding biennium, franchise tax rebates are to be issued by the Comptroller for each payer of the franchise tax according to his/her fractional share
HB 429 (Fletcher) – Relating to the classification of automotive repair shops as primarily engaged in retail trade for purposes of the franchise tax. The legislation adds the following language to the definition of “retail trade”: the activities classified as Industry Group 753 of the 1987 Standard Industrial Classification Manual published by the federal Office of Management and Budget.
Identical legislation to HB 429:
- SB 476 (Patrick) – Relating to the classification of automotive repair shops as primarily engaged in retail trade for purposes of the franchise tax.
HB 658 (Villarreal) – Relating to the repeal of state sales tax and franchise tax refunds for certain ad valorem tax payers. Repeals the authority for a taxpayer who has a Chapter 312 (city or county) tax abatement, but not a school tax abatement, to receive a refund of sales and franchise tax. Current law provides for a maximum of $10 million in refunds per year for all taxpayers combined.
HB 701 (Murphy) – Relating to the total revenue exemption for the franchise tax.
- Extends $1 million total revenue exemption for the franchise tax to December 31, 2013
- Makes effective the total revenue exemption for the franchise tax $600,000 on January 1, 2014, providing a 40% discount for taxable entities with total revenue between $600,000 and $700,000 and a 20% discount for taxable entities with total revenue $700,000 to $900,000
HB 795 (Zerwas) – Relating to the franchise tax and alternative revenue sources and spending priorities for this state.
- Requires Comptroller to conduct a study concerning alternative methods to the franchise tax and revisit the Texas Constitution for funding priorities and requirements in prioritizing the revenue needs of the state
- Comptroller must submit a report to the Legislature by November 1, 2012 containing the results of the study, which must identify most effective revenue-generating methods, legislation necessary to implement the methods, and reductions in state expenditures necessary to implement the reductions
HB 817 (Hughes) – Relating to the computation of taxable margin for purposes of the franchise tax by certain taxable entities.
- Allows taxable entities that elect to subtract compensation for the purpose of computing taxable margin for the franchise tax to include as wages and cash compensation any nonemployee compensation paid to independent contractors
HB 869 (Creighton) – Relating to the franchise tax and alternative revenue sources and spending priorities for this state.
- Requires Comptroller to conduct a study concerning alternative methods to the franchise tax and revisit the Texas Constitution for funding priorities and requirements in prioritizing the revenue needs of the state
- Comptroller must submit a report to the Legislature by November 1, 2012 containing the results of the study, which must identify most effective revenue-generating methods, legislation necessary to implement the methods, and reductions in state expenditures necessary to implement the reductions
- Repeals Section 171.0021 of the Tax Code and Sections 1(c), 2 and 3, Chapter 286 (HB 4765) Acts of the 81st Legislature (81R) related to the computation of the franchise tax
- Repeals Chapter 171, Franchise Tax, Tax Code; effective January 1, 2016
HB 877 (Howard, Charlie) – Relating to the definition of controlling interest for purposes of the franchise tax.
- Adjusts definition of “controlling interest” for an association, trust, limited liability company and any other entity
HB 891 (Howard, Charlie) – Relating to the computation of cost of goods sold for purposes of the franchise tax by certain affiliated taxable entities.
- Related-party transactions not made at arm’s length may be:
- Subtracted by the purchasing member as a COGS at an amount not exceeding the market value of the transaction and
- Included by a selling member in the selling member’s gross receipts for purposes of Sections 171.103, 171.105, 171.1055, and 171.106 an amount not exceeding the market value of the transaction
HB 932 (Paxton) – Relating to the franchise tax liability of certain taxable entities.
- Amends Section 171.002(d), Tax Code, to provide that a taxable entity is not required to pay any tax and is not considered to owe any tax also if its taxable income from its entire business during the period on which the margin is based is zero or less
- Provides the Comptroller may not require an entity that does not owe any tax due to 171.002(d) to file a report verifying the entity does not owe any tax
HB 1115 (Paxton) – Relating to a franchise or insurance premium tax credit for contributions made to certain nonprofit educational assistance organizations.
- Provides a taxable entity that contributes to a nonprofit educational assistance organization may claim credit for a contribution of at least $500 against the franchise tax or state premium tax
- Outlines credit specifications relevant to the franchise and premium taxes and limits the total amount of credits that can be claimed for FY 2012 against the franchise tax to $100 million and against the state premium tax to $25 million
- Outlines qualification requirements for organizations to be certified by the Comptroller as a certified nonprofit educational assistance organization
- Requires certified nonprofit educational assistance organizations to report to TEA biannually and outlines reporting requirements
- Requires the Comptroller to publish total amount of tax credits available for each state fiscal year and allows the Comptroller to develop procedures for allocating the credits
HB 1170 (Madden) – Relating to the computation of the franchise tax by certain taxable entities that rent or lease equipment.
- Section 171.002 Subsection (c) (2) [less than 50 percent of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs] does not apply to total revenue activities in a trade that rents or leases tangible property as described by Industry Group 735 of the US Dept. of Labor Standard Industrial Classification Manual
HB 1358 (Howard, Charlie) – Relating to the exclusion of certain flow-through funds by qualified courier and logistics companies in determining total revenue for purposes of the franchise tax.
- Defines
a “qualified courier and logistics company” - Allows a qualified courier and logistics company to exclude from its total revenue subcontracting payments made to nonemployee agents for the performance of delivery services on behalf of the taxable entity
HB 1373 (Bohac) – Relating to the computation of the franchise tax by certain taxable entities.
- Allows a taxable entity that receives at least 50% of the entity’s total revenue from transporting freight, merchandise or other property by motor vehicle to elect to pay the E-Z computation and rate of the franchise tax
HB 1439 (Berman) – Relating to the franchise tax liability of certain taxable entities.
- Does not require a taxable entity, except members of a combined group, to pay any tax or owe any tax for a period on which margin is based if the taxable entity’s taxable income is zero or less
- Allows the Comptroller to require a taxable entity that does not owe any tax to file an abbreviated information report stating the amount of the taxable entity’s taxable income
HJR 18 (Branch) – Proposing a constitutional amendment requiring any increase in a franchise tax rate to be approved by two-thirds of all the members elected to each house of the legislature. The language requires a record vote of 2/3 of the members in regards to any legislation increasing any franchise tax rate above the rate in effect on the date the bill was filed. The 2/3 vote does not apply to a bill that amends the manner in which the franchise tax is computed or the manner in which it is administered or enforced.
Identical legislation to HJR 18:
- HJR 25 (Identical to HJR 18) – Paxton – Proposing a constitutional amendment requiring any increase in a franchise tax rate to be approved by two-thirds of all the members elected to each house of the legislature.
HJR 42 – (Callegari) – Proposing a constitutional amendment concerning the limitation on the rate of growth of state appropriations and the use of unencumbered surplus state revenues to provide for a rebate of state franchise taxes, to reduce public school district property taxes, and to fund the state’s rainy day fund. (Enabled by HB 380, Callegari)
- Rates of change of appropriations from all sources of revenue other than the federal government may not exceed a rate equal to the sum of the estimated rates of increase/decrease during the preceding biennium, and
- Changes voting for adoption of resolution for appropriations in excess of amount authorized during a state of emergency from majority to two-thirds votes of the members of each house
- Provides the Comptroller must certify a bill containing an appropriation, showing the amount appropriated does not exceed the limitation set on the rate of growth of appropriations, before it can be passed or sent to the Governor
- Requires the Comptroller, if a bill containing an appropriation that exceeds the limitation set on the rate of growth of appropriations, to endorse his/her finding on the bill, return the bill to its originating house and notify the Senate and House immediately
- Changes the percentage of unencumbered general revenues transferred to the economic stabilization fund to 25%
- Requires the Comptroller ascertain the amount of the unencumbered positive balance of general revenues on the last day of the preceding state fiscal biennium that remains after the transfer of revenues to the economic stabilization fund
- Provides the Comptroller shall issue franchise tax rebates of franchise taxes paid during the preceding biennium equaling 1/3 of the remaining unencumbered positive balance of GR ascertained and proportional to each franchise tax payer’s franchise taxes paid to the total amount of franchise taxes collected
- Requires Comptroller to transfer 2/3 the amount of unencumbered GR ascertained to the property tax relief fund to be used for reducing school district property taxes
HJR 49 – (Anderson, Charles) – Proposing a constitutional amendment requiring any increase in a rate of the franchise tax be approved by two-thirds of all the members elected to each house of the legislature. The bill would:
- Require 2/3 vote of all members if a proposed bill increases a rate of the franchise tax per year of privilege period of taxable margin above the corresponding rate provided in HB 3 of the 79th Legislature
- The language applies to any taxable entity
- Language does not apply to any decreases, only subsequent increases.
- The 2/3 vote does not apply to a bill that amends the manner in which the franchise tax is computed or the manner in which it is administered or enforced.
SB 392 – (Patrick) – Relating to the classification of certain entities as primarily engaged in retail trade for purposes of the franchise tax.
- Amends the definition of “Retail trade” in Section 171.0001(12) of the Tax Code to include apparel rental activities classified as Industry 5999 or 7299 of the 1987 Standard Industrial Classification Manual published by the federal Office of Management and Budget.
- Allows for the rate of the franchise tax to be .5 percent of taxable margin.
