For a new fiscal-year corporation, which accounting-period ending dates apply to the taxable-capital and earned-surplus components on its initial and first annual Texas franchise tax reports?

Plain-English summary

A tax preparer asked the Comptroller to confirm the correct reporting periods and accounting-period ending dates for a new client's (pre-2008) franchise tax reports. The client received a certificate of authority on September 28, 2001, began doing business then, and is a fiscal-year taxpayer with a September 30 year-end. The key lesson: the taxable-capital component (Schedule A) and the earned-surplus component (Schedule B) are keyed to different accounting-period dates, and getting them wrong (or filing an extension without payment) can create delinquencies.

Initial report

• Due date. The initial report was due December 26, 2002; with a properly filed extension, February 10, 2003. It covered a total privilege period running (as the Comptroller stated it) from September 26, 2001 through December 31, 2002.
• Taxable capital (Schedule A). Use September 30, 2002 - the last accounting-period ending date that is at least 6 months after the start date and 60 days before the due date.
• Earned surplus (Schedule B). Use September 26, 2001 through September 30, 2002 - ending on the last accounting-period ending date for federal income tax purposes that is at least 60 days before the due date.

First annual report

• Due date / privilege period. Due May 15, 2003, for the privilege period January 1 - December 31, 2003.
• Taxable capital. Ending date September 30, 2002 - the last accounting period that ends in the year before the year in which the tax is due (Tax Code Section 171.153(c)).
• Earned surplus. Runs from October 1, 2002 through September 30, 2002 - beginning the day after the previous report's earned-surplus ending date and ending on the last federal accounting-period ending date in the year before the report is due (Section 171.1532(b)). Because the start month coincides with the year-end month, this produces an effectively negative period and therefore no tax due on the earned-surplus component.
• Gross receipts for apportionment. For taxable capital on the annual report, the corporation reports a full 12 months of gross receipts based on the last accounting period ending in the year before the tax is due - here October 1, 2001 through September 30, 2002 (Comptroller's Rule 3.549(d)(1)).

Extensions, penalties, and amendments

• An extension is not granted if proper payment did not accompany it.
• Penalty and interest abatement requires a separate waiver request explaining the situation, sent to the Comptroller's Revenue Accounting Division (Securities and Determinations Section).
• Amending prior reports is governed by Comptroller's Rule 3.544(d).

Currency note: These reporting-period mechanics are part of the pre-2008 taxable-capital/earned-surplus franchise tax, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008, which has its own reporting rules. Treat as historical.

What this means for you

New corporations and their preparers

The initial and first-annual franchise tax reports for a fiscal-year filer did not use one tidy year. Each component (taxable capital vs. earned surplus) had its own ending-date rule, and an unlucky alignment between the start month and the fiscal year-end could yield a "negative" earned-surplus period with no tax on that component - while taxable capital still used a full 12 months of gross receipts. Mapping the dates precisely mattered.

Accountants and tax professionals

Compute each component separately: taxable-capital ending dates under the "6 months after start / 60 days before due" (initial) and Section 171.153(c) "year before" (annual) rules; earned-surplus periods under the federal-accounting-period and Section 171.1532(b) rules. Use a full 12 months of gross receipts for annual taxable-capital apportionment (Rule 3.549(d)(1)). And remember an extension is void without proper payment - abatement of resulting penalty and interest requires a written waiver request; amendments follow Rule 3.544(d).

Common questions

Q: Do taxable capital and earned surplus use the same accounting-period dates?
A: No. They are keyed to different ending-date rules, so they frequently differ on the same report.

Q: Why was there no earned-surplus tax on the first annual report?
A: The earned-surplus period ran from October 1, 2002 to September 30, 2002 - effectively a negative period - so the earned-surplus tax computed to zero (Section 171.1532(b)).

Q: How many months of gross receipts go into the annual taxable-capital apportionment?
A: A full 12 months, based on the last accounting period ending in the year before the tax is due (Rule 3.549(d)(1)).

Q: I filed an extension but didn't pay - am I covered?
A: No. An extension is not granted without proper payment; you must submit a written waiver request to seek abatement of penalty and interest.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.153(c) (taxable capital ending date for an annual report)
• Tex. Tax Code Sec. 171.1532(b) (earned surplus reporting period for an annual report)
• 34 Tex. Admin. Code Sec. 3.549(d)(1) (12 months of gross receipts for taxable-capital apportionment)
• 34 Tex. Admin. Code Sec. 3.544(d) (procedures for amending previous reports)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200306943L

Original ruling text

June 13, 2003

TO: **

Dear **:

Thank you for your email regarding the proper reporting periods and dates for
your client's, ** (COMPANY), Texas franchise tax reports.

The statutes and rules I mention, as well as other related materials, are
available online at http://www.window.state.tx.us/taxinfo/franchise/index.html.

You have indicated that COMPANY received a certificate of authority on
September 28, 2001 and began doing business on that day. COMPANY is a
fiscal-year taxpayer with an accounting year-end of September 30.

The initial franchise tax report was due on December 26, 2002. Since COMPANY
properly filed an extension, the initial report was due on February 10, 2003.
This report would cover a total privilege period beginning September 26, 2001
through December 31, 2002. For taxable capital (Schedule A), COMPANY will use
September 30, 2002 because this date is the last accounting period ending date
that is at least 6 months after the start date and 60 days before the due date.
For earned surplus purposes (Schedule B), COMPANY should use September 26,
2001 through September 30, 2002 because that is the last accounting period
ending date for federal income tax purposes that is at least 60 days before the
due date of the report.

The first annual report was due on May 15, 2003. The privilege period for this
report is January 1, 2003 through December 31, 2003. For taxable capital, the
ending date will indeed be September 30, 2002, because this is the last
accounting period that ends in the year before the year in which the tax is
due. See Texas Tax Code Sec. 171.153(c). For earned surplus, the beginning
date will be October 1, 2002, and the ending date will again be September 30,
2002, because this information is based on a period beginning with the day
after the last date upon which net taxable earned surplus on a previous report
was based and ending with the last accounting period ending date for federal
income tax purposes in the year before the year in which the report is
originally due. See Texas Tax Code Sec. 171.1532(b). Under these
circumstances, there will be no tax due on the earned surplus component.

In calculating gross receipts for taxable capital on the first annual report, a
corporation must report 12 months of gross receipts based on the business done
by the corporation during its last accounting period that ends in the year
before the year in which the tax is due. See Comptroller's Rule Sec.
3.549(d)(1). Therefore, COMPANY will need to use the amount of gross receipts
from October 1, 2001 through September 30, 2002 in calculating the
apportionment factor for net taxable capital.

Unfortunately, if proper payment was not made at the time an extension was
filed, an extension cannot be granted.

As for abatement of penalties and interest, you will need to send a waiver
request explaining the situation to the following address: State Comptroller of
Public Accounts, Revenue Accounting Division, Securities and Determinations
Section, P.O. Box 13528, Austin, Texas 78711-3528. The phone number for this
section is 512-463-4560. If you need to file any amended reports, Comptroller's
Rule Sec. 3.544(d) provides a detailed explanation for amending previous
reports.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our on-line survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you need any additional information, please feel free to call me at
1.800.531.5441, extension 34629.

Sincerely,

Lowell Olsen Dunn
Tax Policy Division

On Tue, 3 Jun 2003 21:57:04 -0700 ** wrote:

Message
To the Texas Office of the Comptroller:

** (COMPANY), Texas Taxpayer number **, received a
Texas Notice of Delinquent Franchise Tax dated April 18, 2003. The reason
stated for the delinquency was that the 2002 initial report was not filed. We
became a provider of tax services to COMPANY in October, 2002 to prepare tax
returns for the period ended September 30, 2002.

Due to the complexity of the initial Texas Franchise Tax Report, we called
the office of the Comptroller several times to verify the correct privilege
periods, accounting periods, and initial report calculation. Based on several
discussions, we received conflicting information . Accordingly, we are
writing to confirm our understanding of the 2002 Initial Report and the 2003
Annual Report.

Initial Report:

As we understand the facts, COMPANY received a certificate of authority on
September 28, 2001. We have reason to believe COMPANY may have had payroll for
a Texas employee beginning on September 26, 2001. The 2002 initial report was
filed based on the following assumptions. The first privilege period for the
initial report runs from the date business began in Texas to the day before its
anniversay, in COMPANY'S case from September 28, 2001 through September 27,
2002. The second privilege period runs from the anniversary of the start date
to December 31 of the year of the anniversary date. Therefore, the second
privilege period runs from September 28, 2002 to December 31, 2002.

The initial franchise tax report was due 90 days after the end of the first
privilege period, or December 26, 2002. A 45 day extension was filed, making
the 2002 initial report due February 10, 2003 as February 9 was a Sunday.

Next is the determination of the proper accounting periods to use to calculate
the tax on earned surplus and taxable capital. To calculate the tax on earned
surplus for the initial period, the accounting period beginning date is the
date COMPANY began doing business in Texas, in this case September 28, 2001.
The ending date is "the corporation's last accounting period ending date for
federal income tax purposes that is at least 60 days before the due date of the
initial report." Therefore, for the 2002 initial report we used the accounting
period of September 28, 2001 through September 30, 2002 to calculate the tax on
earned surplus. To calculate taxable capital, the year end must be the first
accounting period ending date that is at least 6 months after the start date
and 60 days before the original due date of December 26, 2002, in this case
September 30, 2002.

2003 Annual Report.

The 2003 Annual Report for all corporations, regardless of their year end, is
May 15, 2003. "Earned surplus for an annual report must be reported beginning
with the day after the ending date on the previous franchise tax report and
ending with the corporation's last accounting period ending date for federal
income tax purposes in the calendar year prior to the calendar year in which
the report is due." For the COMPANY 2003 annual report, the day after the
ending date of the previous franchise tax report is October 1, 2002. The last
accounting period for federal income tax purposes before 2003 is the period
ended September 30, 2002. Based on a literal interpretation of the statute,
this would result in a year which has negative one day. After numerous
conversations with representatives of the Office of the Comptroller, advice
was given that the tax on earned surplus for the 2003 Annual Report would
indeed be based on the accounting period October 1, 2002 to September 30,
2002. As the tax on earned surplus is based on a "negative one day period", a
tax on earned surplus was computed to be zero. This strange result, based on
discussions with representatives of the Office of the Comptroller, will result
each time there is a start date in the same month as the end of the month of
the accounting period.

For purposes of the capital tax, after the initial report, taxable capital for
an annual report is based on the end of the corporation's last accounting
period in the calendar year prior to the calendar year in which the report is
due. For COMPANY, the last accounting period before 2003 was, again, the
period ended September 30, 2002. When calculating the apportionment, a
"negative one day period" was used to calculate the gross receipts.
Therefore, no gross receipts were allocated to Texas for the 2003 annual
report, and the result of these calculations was a "no tax due" return. We
therefore filed an extension via tele-file with no tax due for the 2003 Annual
Report.

Due to the oddity of this situation, we contacted the Office of the Comptroller
a seventh time and were told that using the period of September 28, 2001
through September 30, 2002 for the initial report would be allowable. We were
then informed, however, that taxable capital for the 2003 annual report is not
allocated based on gross receipts of the accounting period used to calculate
the tax on earned surplus. Based on the most recent discussions, gross
receipts used to calculate taxable capital for an annual report are apportioned
based on the accounting period ending with the date used to calculate taxable
capital. Therefore, the 2003 annual report should use gross receipts from
October 1, 2001 to September 30, 2002 when calculating apportionment. If this
is correct, then the tax due for the 2003 Annual Report will be the same as the
taxable capital tax reported on the 2002. Because no tax was paid when the
2003 Annual Report Texas extension was filed, we are concerned about the
imposition of penalties and late fees despite our attempt to obtain the
correct tax treatment through seven discussions with the Office of the
Comptroller.

Questions:

1. Whether COMPANY should use the period September 28, 2001 to September 30,
   2001 or the period September 28, 2001 to September 30, 2002 to calculate the
   tax on earned surplus for the initial report. Please note that for COMPANY,
   the total tax due will not change for either the 2002 initial report or the
   2003 annual report as the capital tax was higher than the tax on earned
   income.

2. Although the extension was timely filed, payment was not made . If a
   payment based on the 2002 capital tax is made within 30 days of the original
   due date (by June 15), given that no payment was made based on the advice
   received through more than reasonable efforts with the Office of the
   Comptroller, is there a procedure by which penalties and interest may be
   abated?

3. Under what procedure may a payment be made for an underpaid extension
   payment? The only voucher observed for such a payment is the TX C-3V Payment
   Voucher, which is normally used to pay interest and penalties.

We appreciate your continued assistance in this matter and look forward to your
response.