1. The “Revised” Texas Franchise Tax

2. The Basics Broader Base and Lower Rate
Applies to a broader range of business types
The Capital and Earned Surplus Tax Bases are replaced with a Margin Tax Base
The Tax Rates are reduced to 1% and .5% for retailers and wholesalers
Timing – Reports due on or after January 1, 2008

3. Who’s in? Entities with Liability Protection
Applies to entities with liability protection
Includes:
Limited Liability Partnerships
Limited Partnerships
Business Trusts
Corporations
Limited Liability Companies
Professional Associations
Professional Corporations
Commission – Privilege Tax for the right to do business as a liability protected entity

4. Who’s out?
Sole proprietorships and general partnerships owned by natural persons
Partnerships that qualify as passive entities
Grantor trusts
Entities currently exempt from franchise tax
Taxable entities that owe less than $1,000 in tax
Taxable entities with $300,000 or less in total revenue
Estates of natural persons
Escrows
REIT
REMIC

5. What is a passive entity?
A Passive Entity is:
A General or Limited Partnership or non-Business Trust
Meets 90% Passive Income Test
90% of income must be Passive Income
Examples: Dividends, Mineral Royalties, LLC Income, Interest, Distributive Shares of Partnership Income, Gains from Sales of Real Property and Securities
No more than 10% of gross income from conducting active trade or business
Rental income is not considered passive income

6. How is the tax calculated?
An Entity’s Taxable Margin is calculated as:
The Lesser of:
70% of Total Revenue; or
Total Revenue less either
Cost of Goods Sold, or
Compensation
Times
Apportionment Factor
Tax Rate
The election to deduct either Cost of Goods Sold or Compensation is done on an annual basis
No Taxpayer’s taxable margin would be greater than 70% of Total Revenue – Every taxpayer gets at least a standard deduction equal to 30% of Total Revenue

7. Total Revenue Gross Receipts/Sales less returns & allowances Dividends
Interest
Gross Rents
Gross Royalties
Net Capital Gains
Other Income
Refunds of taxes deducted in prior years
Ordinary income from trade or business activities of a partnership, LLC, or S-Corp
What is included in Total Revenue
How do you arrive at Total Revenue
Pulls revenue amounts from IRS forms
Correct line references are
Form 1065 Lines 1(c), and 4-7
Schedule K, Lines 3(a), 5-11
Form 8825, Line 17

8. Total Revenue
Specific provisions for Health Care, Legal, and Staff Leasing industries
Specific provisions to reduce gross revenues to net revenues
Specific allowable subtractions from Total Revenue to limit:
Total Revenue to Water’s edge revenue
Double Taxation of receipts
How do you arrive at Total Revenue
Pulls revenue amounts from IRS forms
Correct line references are
Form 1065 Lines 1(c), and 4-7
Schedule K, Lines 3(a), 5-11
Form 8825, Line 17

9. Cost of Goods Sold Statutorily defined - similar to Federal definition
COGS deduction generally can only be taken by entities selling goods (TPP or real property)
Expenses that can be included in COGS:
Raw materials
Labor directly related production
Depreciation related to production
Indirect and administrative overhead costs that are allocable to the acquisition or production of goods limited to 4% of total indirect and administrative overhead costs

10. Cost of Goods Sold Enumeration of Items in COGS Allowances:
Certain expenses for mining industry, such as depletion or geological costs
Interest expenses for Lending Institutions
Cost of Goods Sold expenses for several specific rental businesses
Prohibitions:
Selling expenses
Officer compensation
Advertising
Outbound transportation

11. Compensation
Compensation is defined as wages and salaries and employee benefits
Wages - Medicare wages and tips box on W-2, plus:
Distributions to natural person from entities treated as partnerships and S-Corporations
Federal tax deductible Stock Awards and Options
Limited to $300,000 per employee
Benefits - federal tax deductible benefits (not subject to $300,000 cap)
Health care
Retirement
Worker’s compensation

12. Apportionment Changes?
Limited changes – Current apportionment rules and policies are meant to apply to Margin Tax
Single Gross Receipts Factor remains the standard
Mortgage Loan Services – Receipts from the servicing of loans secured by real property are sourced based on the location of the real property
No Throwback Rule
Generally, sales of TPP sourced to Texas if delivered in the state and receipts from services performed in the state are sourced to Texas.

13. Tax Rates General Rule: 1% tax rate for all entities
Exception: ½% tax rate for entities primarily engaged in retail and wholesale trade (includes restaurants)
Primarily engaged in retail and wholesale trade if:
Total Revenue from retail and wholesale trade is greater than Total Revenue from non-retail and wholesale trade activities,
Less than 50% of the Total Revenue from retail and wholesale trade activities comes from the sale of products produced by the entity or an affiliated entity, AND
The entity does not provide retail or wholesale utilities such as telecommunications, electric, or gas

14. Unitary Combined Reporting
Water’s edge unitary combined reporting is required
Taxable Entities in a unitary affiliated group must file a combined report
An affiliated group is a group of one or more entities owned by common owner(s)
Controlling interest is 80% or more ownership
Unitary definition is adapted from MTC model language for unitary reporting
Same general line of business
Vertically or horizontally integrated
Strong centralized management
Same election of COGS or Compensation for all members
Can include partnerships

15. Filing Periods & Accounting Periods
The traditional “privilege period” concept in the Tax Code is preserved
The new “margins” tax base replaces the traditional tax bases of Taxable Capital and Earned Surplus for reports due on or after January 1, 2008 and would be based on Federal income tax accounting periods ending in 2007

16. Franchise Tax Credits in the Future
Investment, Jobs, & R&D Credits
Established credits can be taken against margin tax liability
No new credits can be established.
Toyota Provision – State makes good on all contracts signed with the State before June 1, 2006
Business Loss Carryforwards
March 1, 2007 notification required
Current language requires technical corrections

17. Information Report Requirement
Information reports must be filed by certain entities by February 15, 2007
What must be filed?
An information report that would be completed as if the “margins tax” were already in effect for reports that would have been due on May 15, 2006
Who must file?
The largest 1,000 franchise tax taxpayers
The largest 1,000 entities in the State based on gross receipts
The largest 1,000 entities in the State based on employment
The largest 1,000 entities in the State based on the amounts of school maintenance property taxes paid

18. What does the future hold?
Technical Corrections – HCR 51 & Senate Bill 6
HCR 51
Partnership clarification
Corrections of line references for determining total revenue for partnerships
SB 6
Clarification of Unitary Business
Clarification of tier partnership language
Clarification of “business loss carryforward” language
Clarification of transition language related to partnerships ceasing to do business

19. Future Issues?
Other proposed changes for 2007 Legislative session based on SB 6
Apportionment – Which standard will be used for unitary combined reports?
Joyce or Finnegan
50% vs. 80% control for affiliated groups
Cost of Goods Sold – Should it be extended to service industry?
Tax Credits – Re-establish investment, jobs, and R&D credits

20. Thank You