Is a single-member LLC that is a 'disregarded entity' for federal income tax still subject to the Texas franchise tax?

Plain-English summary

A taxpayer asked whether a single-member LLC that is a "disregarded entity" for federal income tax (an LLC the IRS ignores, folding its income onto its owner's federal return) is subject to the Texas franchise tax. The Comptroller answered yes - the federal "disregarded" label does not carry over to Texas.

• Franchise tax follows Texas rules, not federal classification. Each LLC that is organized under Texas law or that is doing business in Texas is subject to the franchise tax regardless of its treatment for federal income tax (Texas Tax Code Sec. 171.001(a)(2)). So an LLC the IRS treats as disregarded is still a separate taxpayer for the Texas franchise tax.
• How the LLC figures the tax. The (pre-2008) franchise tax had two components - taxable capital and earned surplus. Sec. 171.101(b) and Franchise Tax Rules 3.562(c) and 3.551 govern net taxable capital for an LLC. Rule 3.562 describes how an LLC determines its reportable federal taxable income and its net taxable earned surplus.
• Who the single member is matters for the surplus calculation. Rule 3.562 subsection (f) covers an LLC whose single member is an individual, and subsection (g) covers one whose single member is a corporation.
• The Comptroller also pointed the taxpayer to its plain-language publication The Texas Franchise Tax on Corporations (96-114) for a summary of the tax bases, rates, reporting periods, and due dates.

Currency note: This applies the pre-2008 franchise tax (taxable capital and earned surplus). The 2007 legislation (House Bills 3 and 3928) replaced it with the current margin tax effective January 1, 2008. Under today's margin tax an LLC is still a taxable entity, but the specific taxable-capital/earned-surplus mechanics described here are historical.

What this means for you

Owners of single-member LLCs

Do not assume that "disregarded for federal tax" means "exempt in Texas." If your LLC was formed in Texas or does business here, it owes the franchise tax as a separate entity and must file, even though the IRS reports its income on your personal or corporate return.

Accountants and tax professionals

Texas entity taxation is decoupled from federal check-the-box classification. Determine franchise-tax status from Sec. 171.001, then compute the entity's own bases under the franchise tax rules - and note that the earned-surplus computation for a single-member LLC differs depending on whether the member is an individual (Rule 3.562(f)) or a corporation (Rule 3.562(g)).

Common questions

Q: My LLC is a disregarded entity for the IRS. Is it exempt from Texas franchise tax?
A: No. Federal disregarded-entity treatment does not exempt an LLC. If it is organized in Texas or doing business here, it is subject to the franchise tax (Sec. 171.001(a)(2)).

Q: Does it matter whether my LLC has one member or several?
A: For the surplus computation it can. Rule 3.562(f) and (g) address a single-member LLC owned by an individual and by a corporation, respectively.

Q: Is this still current law?
A: The specific taxable-capital/earned-surplus rules are pre-2008 history. The margin tax replaced them effective January 1, 2008, though an LLC remains a taxable entity under current law.

Citations and references

Statutes and rules:

• Texas Tax Code Sec. 171.001(a)(2) - every LLC organized in Texas or doing business in Texas is subject to the franchise tax regardless of federal income tax treatment
• Texas Tax Code Sec. 171.101(b) - determination of net taxable capital
• 34 Tex. Admin. Code Secs. 3.562(c), 3.551 - net taxable capital for an LLC
• 34 Tex. Admin. Code Sec. 3.562(f), (g) - single-member LLC owned by an individual (f) and by a corporation (g)

Agency publication:

• The Texas Franchise Tax on Corporations (Publication 96-114)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200301789L

Original ruling text

January 29, 2003

**:

You ask if a single limited liability company (LLC) that is a disregarded
entity for federal income tax is subject to the Texas franchise tax.

The state statutes, publication and rules mentioned below, as well as other
related information, are available online at
.

Each LLC that is organized under Texas law or that is doing business in the
state is subject to franchise tax regardless of its treatment for federal
income tax. Texas Tax Code (TTC) Section 171.001(a)(2).

This agency's publication The Texas Franchise Tax on Corporations (96-114)
provides a concise summary of the tax. The publication identifies the entities
subject to the tax, explains the determination of the two components of the
tax, taxable capital and earned surplus, lists the respective tax rates,
describes the reporting periods and provides the due dates of the reports.

TTC Section 171.101(b) and Franchise Tax Rules Section 3.562(c) and Section
3.551 address the determination of net taxable capital for an LLC. Rule
Section 3.562 describes the determination of an LLC's reportable federal
taxable income and its net taxable earned surplus. Subsections (f) and (g) of
Rule Section 3.562 address the circumstances of an LLC whose single member is
an individual and a corporation, respectively.

If you have other questions, please call me toll free at 1-800-531-5441,
extension 3-4931, or directly at 512/463-4931.

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William E. York
Tax Policy Division