How did the former Texas franchise tax apply to a new S corporation's expenses, apportionment, and filing duty?

Plain-English summary

The S corporation computed both former tax components, deducted expenses under their respective accounting rules, and filed even if tax was under $100.

The taxable-capital component used corporate equity; wages and other expenses reduced financial-accounting net income before affecting equity. Earned surplus began with federal taxable income with modifications and allowed expenses to the extent deductible under the Internal Revenue Code.

Both components were apportioned and taxed at the historical rates of 0.25% for taxable capital and 4.5% for earned surplus. The corporation paid the greater amount. If the result was less than $100, no tax was due, but a report was still required.

The apportionment factor was Texas gross receipts divided by gross receipts everywhere. The letter said no tax would be due if the corporation had no Texas receipts under Rules 3.549 and 3.557.

What this means for you

New S corporations reviewing historical reports

Federal pass-through status did not eliminate the corporate report or the two-component computation.

Tax professionals

Keep federal deduction rules for earned surplus separate from GAAP effects on taxable capital, and treat all rates and thresholds as historical.

Common questions

Q: Could expenses reduce earned surplus?
A: Yes, to the extent federal law allowed the deductions.

Q: How did wages affect taxable capital?
A: Through their effect on GAAP net income and corporate equity.

Q: Was a report required below $100?
A: Yes.

Citations and references

• 34 Tex. Admin. Code Secs. 3.549 and 3.557

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9703421L

Original ruling text

March 19, 1997

Dear ***:

Thank you for your recent e-mail request regarding the taxation of your new
corporation.

Corporations that elect "S" status under the Internal Revenue Code are
generally taxed in the same way as all other corporations under the Texas
franchise tax.

The franchise tax consists of two components: taxable capital and earned
surplus. The taxable capital component includes the equity (i.e. assets minus
debts) of the corporation. The earned surplus component includes federal
taxable income with modifications. Both components are apportioned and
multiplied by the appropriate tax rates (.25% for taxable capital and 4.5% for
earned surplus). A corporation will pay the greater of the two amounts. If
the tax due is less than $100, no tax is due, but a franchise tax report must
be filed.

For the earned surplus component of the tax, you will be allowed to deduct any
expenses to the extent that they are allowed as deductions under the Internal
Revenue Code. Because the taxable capital component is based on the equity of
the company, wages and other expenses will be deducted from net income for
financial accounting (based on GAAP) before your equity is effected.

The apportionment factor is gross receipts in Texas divided by gross receipts
everywhere. I have attached franchise tax rules 3.549 and 3.557 which will aid
you in determining Texas receipts. If the corporation has no Texas receipts,
as described in Rules 3.549 and 3.557, the corporation will not owe any tax.

Additional franchise tax information is available on the Comptroller's Web Site
by using a browser such as Netscape or America On-Line. The URL for our home
page is http://www.window.state.tx.us. Once our page is displayed on your
screen click on "Texas Taxes". You can then access numerous types of tax
information including rules, publications, and newsletters.

If you have questions about this, my internet address is
[email protected]. You may call me at (512) 463-4612 or toll-free at
1-800-531-5441, extension 3-4612.

Sincerely,

Janet Spies
Tax Policy Division

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