Texas Franchise Tax for Beginners
Although you don’t have to pay personal income tax, you will be taxed for the privilege of doing business in Texas in the form of franchise tax. Franchise tax is imposed on the Margins of Certain Entities that are formed, or do business, in Texas.
Step 1: Certain Entities?
Generally, corporations, LLCs, business trusts and professional associations are subject to franchise tax. Sole proprietorships, general partnerships directly and solely owned by natural persons and exempt entities are not subject to franchise tax.
This may seem simple enough but it really isn’t.
For example, a single member LLC can file as a sole proprietor for federal income tax purposes, but it will not be considered as a sole proprietor for Texas franchise tax purposes. Also, general partnerships can elect limited liability status for federal return purposes. However, if a general partnership elects limited liability status, it will no longer be exempt from filing a franchise tax return, even though it is composed entirely of natural persons.
Step 2: Doing business in Texas
A business formed outside Texas may be subject to franchise tax when it engages in certain activities. Examples of such activities include:
- Leasing tangible personal property which is used in Texas;
- Maintaining a place of business in Texas;
- Processing: assembling, processing, manufacturing, or storing goods in Texas;
- Holding, acquiring, leasing, or disposing of any property located in Texas; or
- Having a telephone number that is answered in Texas.
I’m serious about the last one.
Step 3: Margins
The tax is imposed on the entities margin. Margin is the lowest of following:
- Total revenue minus cost of goods sold (“COGS”)
- If you sell goods, you can deduct items such as raw materials and production labor.
- Total revenue minus compensation
- If you sell services, you can deduct the amount you pay in salaries (capped at $300,000 per employee) plus certain benefits.
- Total revenue times 70 percent
- If your COGS or compensation is less than 30% you can use this option instead.
If your business has less than $1,110,000 in revenue, you need to file a return but your business is exempt from paying franchise tax. We only go after the big boys in Texas.
If you don’t file a franchise tax return, you could incur penalties and interest. If you need help filing a return or abating a penalty for failing to file a franchise return, call our office at 972-444-8401.