When does a Texas salesperson create franchise-tax nexus for an out-of-state seller, and does Public Law 86-272 protect it?

Plain-English summary

An out-of-state (New York) company sold products to Texas customers, shipping from New York by common carrier, and was thinking of hiring a Texas employee to solicit sales. It asked when this creates franchise-tax nexus and whether Public Law 86-272 protects it. The Comptroller walked through each scenario for the (pre-2008) franchise tax, which had two components - taxable capital and earned surplus.

• Shipping in only: no tax. If the company's only Texas contact is shipping merchandise from outside Texas to a Texas customer, it is not subject to Texas franchise tax.
• A solicitation employee triggers taxable capital. Once the company hires a Texas employee to solicit sales, it is doing business in Texas and owes the taxable-capital component (Rule 3.546(c)(4) - employees promoting or inducing sales constitute doing business).
• P.L. 86-272 can shield earned surplus. Public Law 86-272 applies only to the earned-surplus component and protects companies whose only Texas activity is soliciting orders for sales of tangible personal property (Rule 3.554(b), (d)(20)). So an employee who only solicits orders leaves the company protected from the earned-surplus component.
• Servicing accounts breaks the protection. If the employee's duties include servicing accounts, that goes beyond solicitation, P.L. 86-272 no longer applies, and the company owes both components.
• Apportionment once nexus exists. After establishing nexus, the company computes its liability on its entire business under Chapter 171, and all sales shipped into Texas are Texas receipts - whether or not the Texas employee generated or serviced the sale.

Note on the index label. STAR indexes this letter under "Throwback Rule - Public Law 86-272," but the letter itself decides nexus, P.L. 86-272 protection, and Texas-receipt sourcing (all shipments into Texas are Texas receipts); it does not apply a throwback rule. This page follows the letter's operative text.

Currency note: This is the pre-2008, two-component franchise tax. The current margin tax (House Bills 3 and 3928, effective January 1, 2008) has a single base and its own nexus rules; treat this as historical.

What this means for you

Out-of-state sellers considering Texas staff

Merely shipping into Texas did not create franchise-tax liability. A Texas salesperson did - but keeping that person to pure order solicitation preserved P.L. 86-272 protection against the earned-surplus component. Adding account servicing exposed the company to both components.

Accountants and tax professionals

Separate the two components: solicitation triggers taxable-capital nexus regardless of P.L. 86-272, while P.L. 86-272 only shields earned surplus and only for pure TPP order solicitation. Once nexus attaches, source all inbound Texas shipments to the Texas numerator. These component distinctions are specific to the pre-2008 tax.

Common questions

Q: Does shipping products into Texas create franchise-tax nexus?
A: No, not by itself. If shipping from outside Texas to a Texas customer is the only contact, there is no franchise-tax liability.

Q: My Texas employee only solicits orders - do I owe the earned-surplus component?
A: No. Pure solicitation of orders for tangible personal property is protected by Public Law 86-272, though the taxable-capital component still applies.

Q: What if the employee services accounts too?
A: Then P.L. 86-272 does not apply and the company owes both the taxable-capital and earned-surplus components.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.001(a) (franchise tax on entities doing business in Texas)
• 15 U.S.C. Secs. 381-384 (Public Law 86-272)
• 34 Tex. Admin. Code Sec. 3.546 (taxable capital: nexus)
• 34 Tex. Admin. Code Sec. 3.554 (earned surplus: nexus; P.L. 86-272 protection)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200409782L

Original ruling text

September 7, 2004

To: **

Thank you for your Tax Help inquiry concerning the filing of Texas franchise
tax.

You indicate your client is located in NYS and has customers they sell products
to in Texas. All orders are sent to the NY office for approval and the
merchandise is shipped from NY to Texas via common carrier. Your client is
thinking of hiring an employee in Texas that would solicit sales in Texas. You
ask if these activities constitute doing business in Texas and if it would
change the nature of all sales in Texas or only those generated by the
employee. You also ask if the employee services the accounts, would this
constitute doing business in Texas, and if so, would it apply to all sales in
Texas or only those generated by the accounts being serviced.

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

Texas Tax Code Section 171.001(a) imposes a franchise tax on each corporation
and each limited liability company that does business in this state or that is
organized under the laws of this state. Franchise Tax Rules 3.546, Taxable
Capital: Nexus, and 3.554, Earned Surplus: Nexus, list various activities that
constitute doing business in Texas. Rule 3.546(c)(4) provides that having
employees or independent contractors in Texas to promote or induce sales of the
foreign corporation's goods or services, regardless of whether they reside in
Texas, constitutes doing business for the taxable capital component of the
Texas franchise tax. Rule 3.554(d)(20) states that any activity listed as
doing business in Rule 3.546 that is not protected by Public Law 86-272
constitutes doing business for earned surplus. Public Law 86-272 applies only
to the earned surplus component of the Texas franchise tax and affords
protection to those companies whose only activities within this state is the
solicitation of orders for sales of tangible personal property. See Rule
3.554(b).

If the only contact your client has with Texas is the shipment of merchandise
from outside Texas to a customer in Texas, your client is not subject to Texas
franchise tax.

Once your client hires an employee in Texas to solicit sales, the corporation
is doing business in Texas and subject to the taxable capital component of the
franchise tax. If the employee only solicits orders, then the corporation will
be protected by Public Law 86-272 and will not be responsible for the earned
surplus component of the Texas franchise tax.

If the employee's duties include servicing the accounts, the activities of the
corporation are not protected under Public Law 86-272 as the employee in Texas
performs activities in Texas other than the solicitation of orders for sales of
tangible personal property. Therefore, the corporation would be subject to
both components of the franchise tax.

Having established nexus in Texas, the corporation must compute its franchise
tax liability on its entire business activities as provided for under Chapter
171 of the Tax Code. In calculating its apportionment factor, the corporation
should include as Texas receipts all sales shipped into Texas, regardless of
whether the sale was generated by the employee in Texas or if the employee in
Texas services the account.

This agency's publication, The Texas Franchise Tax on Corporations (96-114),
provides a concise summary of the franchise tax. The publication briefly
addresses the components of the tax, the tax rates, the apportionment of
receipts, the applicable reporting periods, and the due dates of the 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 have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 59952.

Sincerely,

Teresa Bostick
Tax Policy Division