Volume 26: New Margin Tax Replaces Texas Franchise Tax

With everyone looking ahead to next year’s 2008 presidential election and the potential tax changes a new administration could pose, it is easy to overlook real tax changes that are imminent in Texas. The new state margin tax that is scheduled to replace the existing state franchise tax, however, offers immediate and sweeping changes for Texas businesses.

Texas’ new margin tax will be effective for returns due May 15, 2008, which for most taxpayers will be based on operating results for the 2007 calendar year and will be levied on taxpayer’s “taxable margin” rather than taxable income.

“Margins, the profit earned on a product or service, provide an alternative means by which the state can tax a business,” said Tony Grijalva, chairman and CEO of G&A Partners and its affiliate, Grijalva & Allen, P.C. Together, both companies assist growing businesses in managing their HR, administration, and accounting functions.

Generally speaking, the new margin tax is more comprehensive than the present franchise tax. In other words, it applies to more business entities, thus increasing the number of taxpayers subject to the tax. It is estimated that as many as 50,000 more Texas businesses will be subject to the new margin tax.

“Service providers, like law firms, advertising or marketing agencies and medical practices, make up a significant portion of the Texas businesses that will incur the new tax,” said Grijalva. “Many of these businesses have been exempt from paying any kind of state income tax under the existing franchise tax.”

The new tax will be levied on all entities that currently enjoy liability protection under Texas statutes and that have more than $300,000 in gross receipts. This includes corporations, limited liability companies, limited partnerships, business trusts, some general partnerships, joint ventures and professional associations. Among entities not subject to the new tax are sole proprietorships, tax exempt entities, such as not-for-profit organizations, estates and certain family limited partnerships.

The margin tax calls for taxpayers to pay 1 percent (or .5 percent for retailers, distributors and wholesalers) of the business’ taxable margin, which is defined as 1.) total revenue less cost of goods sold; 2.) total revenue less compensation and benefits or 3.) 70 percent of total revenue.

For purposes of defining total revenue, the new tax law refers to the Jan. 1, 2006 federal tax law. As is often the case, there are some allowed exclusions including Medicaid, Medicare and workers' compensation receipts for physician and health care facilities, payments billed as flow-through from subcontractors for general contractors and pro bono service costs up to $500 per case for attorneys.

Not surprisingly, this overview merely scratches the surface of Texas’ new tax law, and there are significant elements and intricacies not addressed here.

“Whenever there are tax changes, there are necessarily technicalities, conditions and definitions that require a knowledge and understanding of tax law that the average layperson could not possibly possess,” said Grijalva. “That’s why it is always advisable that businesses consult a tax professional to assist them in planning for and filing their company’s taxes.”

For assistance in interpreting or planning for the new margin tax, companies are invited to contact G&A Partners/Grijalva & Allen, P.C. at 713-784-1181.