How did the former Texas franchise tax apply to an S corporation?

Plain-English summary

An S corporation generally followed the same former Texas franchise-tax system as other corporations.

Section 171.001 imposed the tax on corporations doing business in Texas or chartered or authorized to do business there, and the letter said that definition included S corporations.

Under the 1997 framework, the corporation calculated two components:

• Taxable capital, described as corporate equity, at 0.25%.
• Earned surplus, based on federal taxable income with modifications, at 4.5%.

Each component was apportioned, and the corporation paid the greater tax. If the calculated amount was less than $100, no tax was due, but the corporation still filed a report.

The apportionment factor was Texas gross receipts divided by gross receipts everywhere. Taxable-capital receipts generally followed recognized revenues unless the S corporation elected the federal income-tax method under Rule 3.548. Earned-surplus receipts followed federal income-tax revenues. Rules 3.549 and 3.557 determined Texas receipts.

What this means for you

S corporations reviewing historical Texas obligations

Federal pass-through status did not remove the corporation from the former Texas franchise tax or its report-filing requirement.

Tax professionals

Treat all rates, thresholds, and form mechanics as historical, and keep the two components and their receipt definitions separate.

Common questions

Q: Was an S corporation exempt from the former tax?
A: No.

Q: Which component was paid?
A: The greater of the taxable-capital and earned-surplus taxes.

Q: Was a report required when the calculated tax was under $100?
A: Yes, although the letter said no tax was due.

Citations and references

• Texas Tax Code Sec. 171.001
• 34 Tex. Admin. Code Secs. 3.548, 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/9705432L

Original ruling text

May 20, 1997

Dear ***:

Thank you for your letter concerning the taxation of an S corporation in Texas.

Texas Tax Code (TTC) Section 171.001 states that a franchise tax is imposed on
"each corporation that does business in this state or that is chartered or
authorized to do business in this state." Corporations are defined to include
S Corporations, Close Corporations, Professional Corporations, Limited
Liability Companies, Banking Corporations and Savings & Loan Associations.
Corporations, such as the one you are inquiring about, who 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 taxes. If the
calculated tax due is less than $100, no tax is due, but a franchise tax report
must be filed.

The apportionment factor equals gross receipts in Texas divided by gross
receipts everywhere. Gross receipts everywhere for the taxable capital
component of the tax are revenues recognized under generally accepted
principles, unless the S Corporation chooses to file using federal income tax
methods (See Rule 3.548). Gross receipts everywhere for the earned surplus
component of the tax are those revenues recognized for federal income tax
purposes. Texas receipts are determined as prescribed by franchise tax rules
3.549 and 3.557.

I have enclosed copies of the rules mentioned above as well as a few others for
your review.

I have also enclosed a franchise tax report form for your review. This will
aid you in determining the amount of franchise tax that may be due on an annual
franchise tax report. The tax rate for the taxable capital component on an
initial report is prorated based on the date that you begin doing business in
Texas. Other than completing this report form and comparing the tax due to the
tax(es) due in Iowa, I do not know of any other process to determine the
comparative advantage of an Iowa vs. a Texas corporate location.
This response is based on current law and the facts presented. If there are
different or additional facts, the response may change.

If you have any questions about this or any other franchise tax matter, please
call me at
1-800-531-5441, extension 34612. My direct number is (512) 463-4612. You may
write me at Tax Policy Division, Comptroller of Public Accounts, Austin, Texas
78774.

Sincerely,

Janet Spies
Tax Policy Division

Enclosures