How did a Texas S corporation report recognized gain from land sold under threat of condemnation for former franchise tax?

Plain-English summary

Recognized net gain from the condemned land entered both former franchise-tax components and both receipt factors.

The Texas S corporation sold land under threat of condemnation and recognized the involuntary-conversion gain on its federal return instead of electing deferral.

For taxable capital, the gain entered surplus under either GAAP or the federal-income-tax reporting method. For earned surplus, it entered federal taxable income because it was reportable as taxable to the S corporation's shareholders.

For both components, the corporation included the net gain in Texas receipts and receipts everywhere. Only net gain was used because the land qualified as an investment or capital asset.

What this means for you

Businesses receiving condemnation proceeds

The former Texas treatment followed the recognized gain, not gross settlement proceeds, on these capital-asset facts.

S corporations

The lack of a federal deferral election was essential to including the gain in earned surplus.

Common questions

Q: Was the gain included in taxable capital?
A: Yes, as surplus.

Q: Was it included in earned surplus?
A: Yes, because it was recognized federally and reportable to shareholders.

Q: Did the receipts calculation use gross proceeds?
A: No. It used net gain because the land was an investment or capital asset.

Citations and references

• 34 Tex. Admin. Code Sec. 3.549(e)(8), (e)(3), (b)(1), and (b)(3), as cited in the letter
• 34 Tex. Admin. Code Sec. 3.557(e)(7), (e)(3), (b)(1), and (b)(6), as cited in the letter

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9609777L

Original ruling text

September 25, 1996

Dear **:

In your letter of September 18, you requested a determination regarding the
franchise tax treatment of condemnation proceeds.

You state that CORPORATION A is an S corporation which is incorporated in
Texas. The Texas Highway Department and the City of Amarillo have begun
construction of an overpass in front of the corporation's store. In connection
with the construction project, CORPORATION A underwent an involuntary sale
under threat of condemnation of a parcel of the company's land. In 1995, the
company received a settlement in connection with the involuntary sale of land.
The proceeds were recognized as income from involuntary conversion of land in
the federal income tax return because the company did not elect to defer the
recognition of the gain.

The gain on the involuntary sale would be treated as follows for each component
of the franchise tax:

1. For the taxable capital component, the gain would be included in surplus
   whether the corporation used the generally accepted accounting principles or
   federal income tax method for reporting purposes. Specifically, the gain would
   be income under either method. In addition, the gain from the involuntary sale
   would be used in computing Texas receipts and receipts everywhere as indicated
   in Rule 3.549(e)(8) and (e)(3) (enclosed). Only the net gain would be used
   because the land qualifies as an investment or capital asset (see Rule
   3.549(b)(1) and (b)(3)).

2. The gain would be included in the corporation's federal taxable income in
   computing taxable earned surplus because CORPORATION A did not elect to defer
   the gain for federal income tax purposes. In particular, the franchise tax
   statute defines an S corporation's reportable federal taxable income as "...the
   amount of the income reportable to the Internal Revenue Service as taxable to
   the corporation's shareholders." . In computing receipts, the gain from the
   involuntary sale should be used in computing Texas receipts and receipts
   everywhere (see enclosed Rule 3.557(e)(7) and (e)(3)). Only the net gain would
   be used because the land qualifies as an investment or capital asset (Rule
   3.557(b)(1) and (b)(6)).

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

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is 3-4662.
You may write me at Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division