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Navigating the Texas Margin Tax: RTFT Calculations,
Entity Issues, Combined Reporting and Credit Optimizations
TUESDAY, JUNE 28, 2016, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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FOR LIVE PROGRAM ONLY
June 28, 2016
Navigating the Texas Margin Tax
Karen Harriger Currie, Partner
Jones Day, Dallas
Bill Crow, JD, Chief Operating Officer
Dan Martinez & Associates, Sugar Land, Texas
Christina A. Mondrik, Esq., CPA
Mondrik & Associates, Austin, Texas
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
Section I. Margin Tax Calculation Options
Navigating the Texas Margin Tax
6
• Is There a Reason Texas Has to be so Unconventional?
• “INCOME TAX” IS A FOUR-LETTER WORD IN TEXAS…
• The Texas Constitution, Article VIII, Section 24. “PERSONAL INCOME TAX; DEDICATION OF PROCEEDS” provides:
A general law enacted by the legislature that imposes a tax on the net incomes of natural persons, including a person's share of partnership and unincorporated association income, must provide that the portion of the law imposing the tax not take effect until approved by a majority of the registered voters voting in a statewide referendum held on the question of imposing the tax. The referendum must specify the rate of the tax that will apply to taxable income as defined by law.
• Legislature Cannot Unilaterally Impose Income Tax on Natural Persons
• Why Texas had a “Franchise” Tax on “taxable capital” and “earned surplus” until the “Revised” Franchise Tax passed in 2006
• Also why that “Revised” Franchise Tax is imposed on “Margin” and not “Net Income”
• Are the Cynics Correct? Is “Margin” just a Euphemism for “Net Income” (like “earned surplus” before it)?
I. MARGIN TAX CALCULATION – INTRODUCTION WHAT’S A “MARGIN TAX”??
I. MARGIN TAX CALCULATION – INTRODUCTION MARGIN TAX BASICS
• Virtually all entities subject to tax, including limited partnerships
• Generally, based on total revenues minus costs of goods sold or compensation (capped at $360,000 per individual for report years 2016 and 2017)
• Mandatory unitary combined reporting • Single gross receipts factor • Change: Tax rate 0.75% (for reports originally
due on or after 1/1/16, previously 1.00%-0.95%) for most businesses; 0.375% (for reports originally due on or after 1/1/16, previously 0.50%- 0.475%) for retailers and wholesalers
• Many special rules
7
I. MARGIN TAX CALCULATION – WHO PAYS?
ENTITIES SUBJECT TO TAX
Tax imposed on each “taxable entity” doing business or chartered and organized in the state including, but not limited to (legal form, not federal classification):
• Partnerships (including General) • Corporations • Banking (Corps, Associations, S&Ls) • Limited Liability Companies • Business Trusts and Associations • Joint Ventures • Holding Companies
• WHAT’S THE TAXING THEORY? Limited Liability?
8
I. MARGIN TAX CALCULATION – WHO PAYS?
ENTITIES NOT SUBJECT TO TAX Includes:
• Most sole proprietorships (not check-the-box/SMLLCs)
• General partnerships owned entirely by natural persons (except LLPs)
• Unincorporated Passive Entities (as defined)
• Certain REITS and qualified REIT subsidiaries
• Real estate mortgage investment conduits
• Certain Grantor Trusts, Estates of Natural Persons
• Certain other entities per Tex. Tax Code 171.0002(b)
• “Tax on the Net Incomes of Natural Persons”? JUST IN CASE… 9
I. MARGIN TAX CALCULATION
GENERAL COMPUTATION OF TAX
(LESSER OF…)
Total Revenue from Entire Business
minus
Costs of Goods Sold or
Compensation
or
$1,000,000 X
Sales Factor X
Tax Rate
=
Tax
OR
Total Revenue from
Entire Business
X
70 percent
X
Sales Factor
X
Tax Rate
=
Tax
10
I. MARGIN TAX CALCULATION:
TAX DISCOUNTS • No-Tax-Due Threshold:
• $300,000 (reports due 1/1/08-12/31/2009)
• $1,000,000 (1/1/10-12/31/11)
• $1,030,000 (1/1/12-12/31/13)
• $1,080,000 (1/1/14-12/31/15)
• $1,110,000 (1/1/16- 12/31/17)
• Percentage Discount (reports due 1/1/08-12/31/09):
• 60% ($400k-$500k), 80% (300k-400k)
• 40% of tax due if total revenue > $500,000 & < $700,000
• 20% of tax due if total revenue > $700,000 & < $900,000
• E-Z Computation - Combined groups with total revenue of less than or equal to $20 million (previously $10 million) may elect to pay a gross receipts tax
• Computation: Total Revenue
x Apportionment Factor
x .331%
Margin Tax
• May subtract applicable discount
• No other offsets to tax allowed (e.g. deduction, credit)
11
I. MARGIN TAX CALCULATION:
COMPUTATION OF TAX KEY POINTS
• Total revenue generally based on federal entity classification
• Each term is statutorily defined
• Example-Costs of goods sold does not follow Treas. Reg. 1.263A-1
• Certain items included for federal may not be included for Texas purposes
• Election to deduct costs of goods sold or compensation made on annual report
• Timing
• Can be changed each year
• Entities filing a combined report must make a single election for the combined group (can change on amended return –policy change, then statutory change H.B. 500)
12
I. MARGIN TAX CALCULATION – HOW/WHEN? OTHER PROVISIONS – FILING DATE
• Due date:
• May 15th, if no extension (if first extension to 8-15, must pay 90% of current tax or 100% of prior year)
• August 15th, if proper first extension (if second extension to 11-15, must pay 100% of current year)
• November 15th if proper second extension
• Second extension required for taxpayers with mandatory EFT payments (most taxpayers)
• “Properly Extended”
• Fiscal Year Taxpayers – Due Date?
13
Section II. 2015 Changes to Tax Rates and Structure
Navigating the Texas Margin Tax
15
• RATES (next slide)
• ELECTRONIC FILING OF NO TAX DUE REPORTS:
• Required beginning 1/1/16
• $1 MILLION (TOTAL REVENUE) NO TAX DUE THRESHOLD:
• $1,110,000 for Reports Originally Due 1/1/16 through 1/1/18
• COMPENSATION DEDUCTION LIMITED:
• $360,000 PER PERSON (1/1/16-1/1/18)
• REPORTING REQUIREMENTS OF LPs and PROFESSIONAL ASS’Ns:
• File Public Information Reports instead of Ownership Information Reports (to Comptroller still)
II. 2015 CHANGES TO TAX RATES AND STRUCTURE WHAT’S NEW FOR 2016??
II. 2015 CHANGES TO TAX RATES AND STRUCTURE LOWER RATE – H.B. 32 (2015)
• On June 15, 2015, Texas Governor Greg Abbott signed H.B. 32 (Franchise Tax Reduction Act of 2015) permanently reducing the Texas Franchise Tax (Margin Tax) rates by 25%
• Rates:
• Retail/wholesale rate now 0.375% (was 0.5%)
• All other taxpayers now 0.75% of taxable margin (was 1%)
• EZ tax rate now 0.331% (was 0.575%)
• Threshold is no more than $20 million in total revenue (was $10 million)
• When:
• Reports originally due on or after January
1, 2016
16
II. 2015 CHANGES TO TAX RATES AND STRUCTURE LOWER RATE? – 2016 Proposed Rule §3.584 §3.584.Margin: Reports and Payments. (b) Definitions…
(2) Primarily engaged in retail or wholesale trade--A taxable entity is primarily engaged in retail or wholesale trade only if:
(A) the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas.
(B) the total revenue from the taxable entity's activities in retail and wholesale trade is greater than the total revenue from its activities in trades other than retail and wholesale trade; and
(C) less than 50% of the total revenue from the taxable entity's activities in retail or wholesale trade comes from the sale of products the taxable entity produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs, except for those businesses under Major Group 58 (eating and drinking establishments). For purposes of this subparagraph only:
(i) A taxable entity produces the product that it sells if the taxable entity acquires the product and makes modifications to the product that increase the sales price of the product by more than 10%.
(ii) A taxable entity produces the product that it sells if the taxable entity manufactures, develops, or creates tangible personal property that is incorporated into, installed in, or becomes a component part of the product that it sells. For example:
(I) A taxable entity produces an electronic device that it sells when the taxable entity produces a computer program, such as an application or operating system, that is installed in the device, even if the device is manufactured by an unrelated party.
(II) A taxable entity produces a drug that it sells when the taxable entity produces the active ingredient in the drug, even it the drug is manufactured by an unrelated party.
(iii) A taxable entity does not produce a product that it sells if the product is manufactured by an unrelated party to the taxable entity's specifications.
17
II. 2015 CHANGES TO TAX RATES AND STRUCTURE LOWER RATE? – 2016 Proposed Rule §3.584 Retailers/Wholesalers - Didn’t Realize you were a Producer/Manufacturer?
(i) INCORPORATED INTO/COMPONENT PART (TOTALLY NEW):
• No materiality threshold (should it be 10%)
• Privately-owned car dealerships?
• Does AT&T/Verizon/Etc. install apps on iPhones?
(ii) ‘MODIFICATIONS’ THAT INCREASE SALES PRICE BY 10% (NOT NEW):
• Car Dealers: Tint, pin-striping, and VIN etching (better not add those bigger wheels…)
• “Modifications” - Means any Changes (not “material” or “substantial”)
• Plural – what if you make one change?
• Causal Relationship to Price Increase?
• Is it “modifications that (cause) increase” or “modifications that (precede) increase”?
• What if Price Increases 10%, but Modifications are itemized and increase 9%?
• What if “Sales Price” increases by 10%, but Modifications add No Value?
• What if “Sales Price” increase 10% and Modifications has unknown impact?
• Are Modifications presumed to increase sales price if sales price is increased 10%? [Add a ribbon. Move to better store. Increase price 10%.]
• Retailer - Does a “Sales Price“ increase starting price become the wholesale purchase price for a retailer in that circumstance??
18
II. 2015 CHANGES TO TAX RATES AND STRUCTURE H.B. 3230 – Credit for Rehab. of Historic Structures
• Beginning on January 1, 2015, a tax credit for rehabilitation of certified historic structures is available
• Equals 25 percent of total eligible costs and expenses incurred
• Credit may be earned by any property owner
• Freely transferrable to other entities
• Credit is also available for costs incurred by certain tax exempt entities
• Change is effective for reports originally due on or after January 1, 2016
19
II. 2015 CHANGES TO TAX RATES AND STRUCTURE H.B. 2896 – Broadcaster Apportionment
• Numerator of the apportionment factor includes receipts arising from licensing income from broadcasting or otherwise distributing film programming by any means only if the legal domicile of the broadcaster’s customer is in Texas.
• The term “broadcaster” does not include a cable service provider or a direct broadcast satellite service, but does include:
• Television station licensed by the Federal Communications Commission;
• Television broadcast network;
• Cable television network; or
• Television distribution company
• “Customer” defined as a person, including a licensee, that has a direct connection or contractual relationship with the broadcaster under which the broadcaster derives revenue
• “Film programming” defined as all or part of a live or recorded performance, event, or production intended to be distributed for visual and auditory perception by an audience
• “Programming” defined as news, entertainment, sporting events, plays, stories, or other literary, commercial, educational, or artistic works
• Change to Texas Tax Code §171.106 is effective for reports originally due on or after January 1, 2018
20
II. 2015 CHANGES TO TAX RATES AND STRUCTURE NOT 2015, BUT RECENT– R&D CREDIT
• If research and development credit established under old franchise tax (prior to 1-1-08), credit can be carried forward.
• For reports originally due on and after 1-1-14, a credit is provided for qualified research expense (“QRE”) (as defined by IRC Sec. 41) conducted in Texas and is equal to:
• 5% of the difference between QRE during current tax period and 50% of the average amount of QRE in prior three tax periods.
• 2.5% of current tax period QRE (if no QRE in any of three prior tax periods)
• 6.25%/3.125% if QRE with one or more public or private institutions of higher education for the performance of qualified research.
• Cannot exceed 50% of franchise tax due on the report • Unused credit carryforward for up to 20 consecutive
reports • Also Clean Energy Project Credit (eff. 1-1-09)
21
Texas Franchise
Tax 2016 Update Christi Mondrik, CPA, Esq. TBLS Board Certified – Tax Law
Strafford Webinars
June 28, 2016
www.mondriklaw.com
Calculation Options
Margin = Revenues minus
Cost of goods sold OR
Compensation OR
30% of revenues OR
$1 million dollars
Whichever brings you to the smallest result
This section focuses on Revenues and Deductions
www.mondriklaw.com
23
Revenues
Derived from federal tax returns (prior year)
Based on 1986 Internal Revenue Code in effect for
2007
Gross revenues
Revenue exclusions
General (e.g. bad debts and sales tax)
Industry specific
www.mondriklaw.com
24
Total Revenues
Travel agency example – revenue net of costs
Comptroller Letter No. 200704932L (April 26, 2007)
Landlord expenses – generally part of revenues so
part of margin
Tax Policy News (April 2008)
www.mondriklaw.com
25
Change in Accounting Method
Must actually amend federal tax return to affect
franchise tax
IRC Sec. 446 requirements:
Change in overall method of accounting (e.g. cash
accrual)
Change in treatment of “material item”
IRS views materiality broader than GAAP
See Treas. Reg. 1.446-1(e)(2)
www.mondriklaw.com
26
Change in Accounting
Method
Automatic change request
Published guidance allows
automatic change
Change is included in requested
year
Taxpayer is within scope of
procedures
Advanced consent request
Separate user fee per request
Each request on separate form
IRS issues letter ruling
www.mondriklaw.com
27
General Revenue Exclusions
Bad debt
Sales tax
Federal obligations
Foreign royalties /
dividends
IRC Sec. 78, 951-964
Foreign gross-up income
CFC income
Dividends received
deduction
Form 1120, Schedule C
Disregarded entity
revenue
LLC Federal distributions
Tax basis of underwritten
securities and securities
and loans sold
www.mondriklaw.com
28
Taxes Excluded from Revenues
Collected from customers:
Sales and use tax
Hotel occupancy tax
Mixed beverage sales tax
Not excluded:
Mixed beverage gross receipts tax
Franchise tax
www.mondriklaw.com
29
Industry Exclusions
Certain sales commissions (realtors, manufacturers’
representatives)
Real estate contractors
Health care providers and institutions
(government program payments and
uncompensated cost of care)
Pharmacy cooperatives
Low producing wells
Attorneys’ pro bono costs, trust account items,
reimbursed costs, and subcontractor expenses
www.mondriklaw.com
30
Industry Exclusions
Special Circumstances
Destination Management Companies
Live Event Promotions
Qualified same-day courier services
www.mondriklaw.com
31
Real Estate Subcontractors
Payments mandated by contract or subcontract to
be distributed to subcontractors
Reasonable relationship between the actual or
proposed design, construction, remodeling, or
repair of improvements on real property and the
services, labor, or materials for which
subcontractors receive payment
www.mondriklaw.com
32
Titan Transportation
Revenue exclusion for subcontractor payments
Hauling, delivering, and depositing aggregate at
real property construction sites
Audit covered periods before revenue exclusion for
aggregate haulers
Refund opportunity!
www.mondriklaw.com
33
Choosing Deductions
Cost of Goods Sold
Must sell goods
Special Texas computation
Compensation Deduction
Wages and cash compensation + benefits
Employees and partners
Distributive net income
www.mondriklaw.com
34
Cost of Goods Sold
www.mondriklaw.com
Direct
Costs
Other
Costs
Nondeductible
Costs
Indirect
Costs
Direct costs of acquiring /
producing goods
Other listed costs
4% cap on indirect costs
(mixed service costs)
Capitalization / Expense
Methods
35
Mixed Transactions
www.mondriklaw.com
36
Combs v. Newpark Resources
Combined group of entities eligible for
cost of goods sold deduction
Integrated oilfield services company
Manufactured, sold, injected, removed
drilling mud
www.mondriklaw.com
37
Hegar v. CGG Veritas
Geoseismic service provider
Oil and gas wells are real property
improvements
Seismic data acquisition and processing
was labor furnished to a project for the
construction of real property
Cost of goods sold deduction applied
www.mondriklaw.com
38
AMC Cinema, Inc. v. Hegar
Movie theaters
Broad category of costs
All costs related to space contributed to
viewing experience
Focus on definition of “tangible personal
property”
… perceptible to the senses …
www.mondriklaw.com
39
Compensation Deduction
Wages and cash compensation
$360,000 per person effective 1/1/2016
Indexed for inflation
Net distributive income – natural person
partners
Loss reduces compensation
Benefits
No 1099 contractor payments
www.mondriklaw.com
40
Special Circumstances
Professional Employer Organizations
(formerly Staff Leasing companies)
Temporary help services
Management companies
Taxable entity
Manages business or business segment
Cost reimbursement + management fee
www.mondriklaw.com
INVOICE Wages – Managed Employees … $ XXX
Benefits – Managed Employees ... $ XXX
SS / FICA … $ XXX
Expense Reimbursements … $ XXX
Management Fee … $ XXX
Total $ XXX
41
Questions?
Christi Mondrik
(512) 542-9300
www.mondriklaw.com
42
NAVIGATING THE TEXAS MARGIN TAX: APPORTIONMENT ISSUES AND REPORTING
Karen Harriger Currie
Apportionment
• Texas receipts / Everywhere receipts
• Sales of tangible personal property – where the item is shipped or delivered to the purchaser
• Services – where performed – Comptroller Hearing No. 107,606 (July 2014)
• Intangibles – Location of use or location of payor
• Receipts of businesses with no nexus in Texas excluded from Texas receipts (Joyce rule)
– Finnegan reporting repealed January 1, 2014 44
Hallmark Marketing Company, LLC v. Combs Tex. Sup. Ct., No. 14-1075 (4/15/16)
• Texas Supreme Court found only the net gain, not
the net loss, from investment and capital assets is
included in Texas gross receipts
• §171.105(b) If a taxable entity sells an investment or
capital asset, the taxable entity's gross receipts from
its entire business for taxable margin includes only
the net gain from the sale
• Comptroller netted gains and losses and, if net loss,
reduced gross receipts even if less than zero
• Regulation conflicted with statute
45
Multistate Tax Compact Litigation
• Graphic Packaging Corp. v. Hegar, No. 03-14-
00197-CV (Tex. App – Austin, July 2015, petition
pending). Taxpayer not entitled to use three factor
apportionment; franchise tax not an income tax
• Compare to Gillette (California), Health Net
(Oregon), Kimberly-Clark (Minnesota), and
IBM (Michigan)
• Comptroller of Public Accounts continues to reject
taxpayers’ use of the Compact election
46
Combined Reporting (Texas Style)
• Required if taxable entity and:
– Domestic (not 80% property/payroll outside US)
– Affiliated (greater than 50%); and
– Unitary (U.S. Constitution and Texas law)
• Single uniform margin computation election applies to
entire group
47
Combined Reporting (Texas Style)
• A single economic enterprise that is made up of separate parts of a single entity or of a commonly controlled group of entities that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts
48
Texas Unique Unitary Group
• Constitutional versus statutory analysis
• Presumption of unity
• Multiple groups
• Definition of Controlling interest
– More than 50% of the capital, profits, or beneficial ownership interest
• Exclude foreign corporations
– 80% or more of their property and payroll outside the United States
– If no property or payroll, 80% or more of revenues
• Joint & several liability 49
Comptroller Hearing No. 111,557 (October 2015)
• Entities not unitary and no centralized management structure in spite of common ownership and shared administrator
• Even if some centralized management, companies did not meet the required threshold of “strong” centralized management:
– The companies operated in completely separate lines of business
– The owner did not participate in day-to-day management of either company
– The companies shared no other employees
– The companies had only one client 50
Tax Sharing Agreements & Joint & Several Liability
• Need for Texas-specific tax sharing agreements
– Tax on flow through entities
– Unitary, combined filing
– Gross income tax
– Joint and several liability
51
Tax Sharing Agreements & Joint & Several Liability
• Acquired companies
• Distressed companies
52
Comptroller Hearing No. 110,062 (November 2014)
• Separate amended franchise tax returns filed by members of a combined group were not valid refund claims sufficient to prevent the running of the statute of limitations
• Because the members were required to file a combined return, an amended return should have been filed by the combined group itself to stop the statute of limitations from running
53
Comptroller Policy Alert
• Beginning in mid-October 2014, in situations where a
reporting entity for a combined group requests an
extension that includes affiliate that is not included when
the report is ultimately filed, the comptroller will notify the
reporting entity of the failure to report the affiliate
• Previously, a delinquency was created until the
discrepancy was resolved
54
Temporary Credit for Business Loss Carryforwards • Texas provides a temporary tax credit for entities with unexpired
business loss carryforwards recognized under the prior franchise
tax; the right to claim the credit is lost if a member of the group
changes combined groups after June 20, 2007
• Texas Tax Policy Division released guidance in 2014 regarding the
criteria for determining when an entity “changes combined groups”
– When the entity leaves a combined group
– When the entity joins an existing combined group
– When the entity’s acquisition results in the creation of a new combined group
– The members of the group do not lose the credit simply because of a change
in the identity of the common owner
• Comptroller Hearing No. 109,310 (November 2014)
– Change in combined group results in a loss of credit even if the
change occurs after the close of the short accounting year
55
