Does a federally tax-exempt nonprofit have to file and pay Texas franchise tax, and how is its unrelated business income handled?

Plain-English summary

The Comptroller answered an e-mail about how the franchise tax treats a federally tax-exempt organization with some unrelated business income. Texas has no income tax, but it does levy a franchise tax on "each corporation that does business in this state or that is chartered or authorized to do business" here (Tex. Tax Code § 171.001), and "corporation" includes nonprofit corporations (as well as S corporations, close corporations, professional corporations, LLCs, banking corporations, and savings-and-loan associations). Partnerships and sole proprietorships were not subject to the tax.

The letter also laid out the tax's pre-2008 shape: two components — taxable capital (a corporation's equity, taxed at 0.25% per year) and earned surplus (federal taxable income with modifications, taxed at 4.5%), each apportioned by a single gross-receipts factor, with the corporation paying the greater of the two. If the computed tax is under $100, no tax is due, "but a franchise tax report must be filed."

Key holdings: a federally exempt nonprofit corporation doing business in Texas is subject to the franchise tax and "is required to file and pay franchise tax until an exemption is granted by the comptroller" (applying under § 171.051 and Franchise Tax Rule 3.541). And to the extent the organization's unrelated business income is part of its federal taxable income, that income "would be included in the calculation of the earned surplus component."

Important currency note: This 1999 letter describes the franchise tax before the 2008 overhaul into the current margin tax, and STAR marks it partially superseded on the taxation of partnerships. The durable point — a nonprofit is not automatically exempt in Texas and must apply — still holds; confirm the current mechanics with the Comptroller.

What this means for you

Nonprofit and tax-exempt organizations

An IRS exemption does not carry over automatically. If your nonprofit is incorporated and doing business in Texas, plan to apply separately to the Comptroller for a Texas franchise-tax exemption, keep filing until it is granted, and remember that a report is required even when no tax is due.

Accountants and tax professionals

The two enduring points: Texas franchise tax reaches nonprofit corporations and exemption is by application, not automatic; and unrelated business income flowing into federal taxable income was captured by the earned-surplus base. The base and components changed in 2008, so verify current filing and exemption procedure.

Common questions

Q: Is a federally tax-exempt nonprofit automatically exempt from Texas franchise tax?
A: No. A nonprofit corporation doing business in Texas must apply to the Comptroller for a Texas exemption (§ 171.051; Rule 3.541) and must file and pay until the exemption is granted.

Q: Do I have to file even if I owe nothing?
A: Yes. Under this letter, even when the computed tax is under $100 and no tax is due, a franchise tax report must still be filed.

Q: How was unrelated business income taxed?
A: To the extent it was part of the organization's federal taxable income, it was included in the earned-surplus component of the pre-2008 franchise tax.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.001 (franchise tax imposed on corporations doing business in Texas)
• Tex. Tax Code § 171.051 (application for exemption from franchise tax)
• Franchise Tax Rule 3.541 (exemptions — application process)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9910266L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/15/14
Issue(s) that caused the document to be superseded — Taxation of partnerships
Reason(s): The Franchise Tax Code was amended by House Bill 3 and House Bill 3928,
Acts 2007, 80th Legislative Session, effective January 1, 2008 and affected Franchise
tax reports due on or after January 1, 2008. One of the many changes to this Tax Code
subjected partnerships (previously not required to file) to the franchise tax reporting
requirement.

October 14, 1999

To: **

Dear **:

Thank you for your e-mail regarding unrelated business income tax for federally
tax-exempt organizations.

Texas does not have an income tax. It does have a franchise tax that is
imposed on "each corporation that does business in this state or that is
chartered or authorized to do business in this state." See Sec. 171.001 of the
Texas Tax Code (TTC). Corporations are defined to include Non-Profit
corporations, S Corporations, Close Corporations, Professional Corporations,
Limited Liability Companies, Banking Corporations and Savings & Loan
Associations. Partnerships and sole proprietorships are not subject to the 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 using a
single gross receipts factor and then 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.

If your tax-exempt organization is a non-profit corporation that is doing
business in Texas, it will be subject to the Texas franchise tax. However,
Section 171.051 of the TTC states that a "corporation may apply for exemption
under this subchapter by filing with the comptroller...evidence of the
corporation's qualifications for the exemption." Franchise Tax Rule 3.541
(Exemptions) sets out guidelines for the application process.

The non-profit corporation is required to file and pay franchise tax until an
exemption is granted by the comptroller.

In addition, to the extent that the unrelated business income of the tax-exempt
entity is part of taxable income for federal income tax reporting purposes, the
income would be included in the calculation of the earned surplus component of
the franchise tax.

The statute and rule cited above can be viewed via the Comptroller's Window on
State Government at . Click on the heading "Texas
Taxes", then "the Franchise Tax." On "the Franchise Tax" page, you'll see a
link to " Franchise Tax Rules from the Texas Administrative Code at the Texas
Secretary of State" and a link to "Chapter 171 of the Tax Code."

For the rules, click on the "Texas Administrative Code" link and you'll be
connected to the Texas Secretary of States website. At the top of that page,
you'll see the "Texas Administrative Code Viewer." Click on this, then enter
the rule number and the rule title or heading.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 3-4612.

Sincerely,

Janet Spies
Tax Policy Division