Is an out-of-state service company taxed on all services to Texas clients, or only on the services its employees perform in Texas?

Plain-English summary

An out-of-state Subchapter S corporation provided investment advice, executed securities orders, and offered consulting and bookkeeping services; an employee occasionally entered Texas to meet clients, but otherwise the work happened by phone and email. It asked whether it owes Texas franchise tax on all services to Texas clients or only on services its employees physically perform in Texas. The Comptroller's answer separates nexus from sourcing.

• Any service in Texas creates nexus. The franchise tax applies to each corporation doing business in Texas (Tax Code Sec. 171.001(a)(1)). Providing any service in Texas - regardless of whether the performers reside in Texas - creates nexus (Rules 3.546(c)(2)(A) and 3.554(d)(20)). So the corporation is subject to Texas franchise tax.
• But receipts are sourced to where the service is performed. In apportioning both the taxable-capital and earned-surplus components, the corporation counts the amount of business done in Texas, including any service performed in Texas (Secs. 171.103(2) and 171.1032(a)(2)). Service receipts are apportioned to the location where the service is performed.
• Split services use fair market value. When services are performed both inside and outside Texas, the Texas receipts are the fair market value of the services rendered in Texas (Rules 3.549(e)(38) and 3.557(e)(33)).
• Bottom line. The company is taxable because it performs some services in Texas, but it includes in Texas gross receipts only the fair market value of the services performed in Texas - not everything billed to Texas clients.

Currency note: This describes the pre-2008, two-component franchise tax and its service-sourcing rules. The current margin tax (House Bills 3 and 3928, effective January 1, 2008) sources receipts under its own rules; treat this as historical.

What this means for you

Out-of-state service firms with Texas clients

Having a client in Texas or occasionally visiting is enough to be subject to the tax, but you are not taxed on your entire Texas client book. Only the value of the work actually performed in Texas lands in the Texas receipts numerator.

Accountants and tax professionals

Keep nexus and sourcing separate: nexus attaches from performing any service in Texas, while the numerator includes only the fair market value of services performed in Texas, with a reasonable in-Texas/out-of-Texas split for services performed in both. Sourcing rules changed under the margin tax, so this is pre-2008 guidance.

Common questions

Q: My out-of-state firm has Texas clients - am I subject to Texas franchise tax?
A: If you perform any service in Texas (including occasional on-site work), yes, you have nexus and are subject to the franchise tax.

Q: Am I taxed on all my Texas-client revenue?
A: No. Only the fair market value of services actually performed in Texas is included in Texas gross receipts.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.001(a)(1) (franchise tax on corporations doing business in Texas)
• Tex. Tax Code Secs. 171.103(2), 171.1032(a)(2) (Texas receipts include services performed in Texas)
• 34 Tex. Admin. Code Secs. 3.546(c)(2)(A), 3.554(d)(20) (service in Texas creates nexus)
• 34 Tex. Admin. Code Secs. 3.549(e)(38), 3.557(e)(33) (service receipts sourced to where performed)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200408773L

Original ruling text

August 31, 2004

To: **

Dear **:

Thank you for your email regarding franchise tax for an out of state Subchapter
S corporation.

The statutes and rules I mention below, as well as other related information,
can be found at http://www.window.state.tx.us/taxinfo/franchise/index.html.

You have indicated that an out of state S corporation provides investment
advice, executes securities orders, and provides business consulting and
bookkeeping services. Occasionally, an employee of the corporation enters
Texas to consult or meet with a client. Otherwise, the transactions are
handled via telephone or electronic mail.

You have asked if the corporation is liable for the Texas franchise tax for all
of the services provided to Texas residents or only the services its employees
physically perform in the state of Texas?

A franchise tax is imposed on each corporation that does business in this
state. See Texas Tax Code Sec. 171.001(a)(1). Providing any service in Texas,
regardless of whether the employees, independent contractors, agents, or other
representatives performing the services reside in Texas will subject a
corporation to nexus for franchise tax purposes. See Comptroller's Rule Sec.
3.546(c)(2)(A) and Rule Sec. 3.554(d)(20). Therefore, the corporation is
subject to Texas franchise tax.

In apportioning both taxable capital and earned surplus, the corporation must
determine the amount of business done in this state, including any service
performed in this state. See Tax Code Sec. 171.103(2) and Sec. 171.1032(a)(2).
In calculating gross receipts, those receipts from a service are apportioned
to the location where the service is performed. If services are performed both
inside and outside of Texas, then such receipts are Texas receipts on the basis
of the fair market value of the services that are rendered in Texas. See Rule
Sec. 3.549(e)(38) and Sec. 3.557(e)(33). Consequently, the corporation will
include in Texas gross receipts the fair market value of the services that are
performed in this state.

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 online survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

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

Sincerely,

Lowell Olsen Dunn
Tax Policy Division