Disparities created by changes made to the Texas franchise tax.

New legislation was enacted in 1991 that radically changed the computation of Texas franchise tax liability. Under the new law, the franchise tax is determined by calculating two bases: net taxable capital (stated capital and surplus reduced by certain deductions) and net taxable earned surplus (net income)(Sections 171.001 and 171.0011 of the Texas Tax Code). Prior to the change, Texas applied its franchise tax to a capital base at the rate of 0.525% of taxable capital. Effective for the year 1992 (i.e., based on 1991 year-end figures) the capital base is taxed at 0.25% and the income base at 4.5% (Section 171.002(a)). Taxpayers must pay their capital base liability plus the amount of income base liability that exceeds the capital base liability (Section 171.002(b)). Effectively, taxpayers will pay on the higher of the two bases.

The major changes in the capital base are that deferred federal income taxes are no longer specifically excluded from taxation, and only taxpayers whose combined stated capital and surplus is less than $1 million may make the election to use Federal income tax accounting methods in determining surplus (Section 171.109(c)).

The new income base is essentially Federal taxable income before net operating loss deductions and after Schedule C special deductions (Section 171.110). Taxpayers may also deduct foreign dividends but must add back officers' and directors' compensation (Section 171.110(a)(1)). Business losses arising in years ending after Dec. 31, 1990 are calculated after modification and apportionment and may be carried forward for five years, but the loss deduction may only be taken against the income base (Section 171.110(e)). The apportionment formula for the income base is the same as for the capital base, single factor gross receipts (Sections 171.110(a)(2) and 171.106).

The addition of the income base has caused many disparities between the two bases, particularly for corporations new to Texas. New corporations file an initial report that encompasses an "initial period" and a "second period." The initial period (which ends on the first anniversary of the date taxable activity began in Texas) and the second period (which commences on the day after the initial period and ends the following December 31) are the same for both the capital and income bases (Section 171.151). For each, the tax on the initial report is based on the business done by the corporation during the period beginning on the date taxable activity began in Texas and ending on the last accounting year-end that is at least 60 days before the initial report is due (Section 171.1532(a)). For the tax on capital, the accounting year-end must be at least six months after business is commenced; if there is no such date, the 12-month anniversary period will be used as the measure (Section 171.153(a)). There is no such six-month requirement for the income base. As a result, the measure of the tax can be different for each base even though the corporation will pay tax on the higher of the two bases.

Another issue arising from the addition of the income base is nexus, both for taxability and for sales factor throwback purposes. Under PL 86-272, a state may not impose a tax based on or measured by income on companies whose only presence in the state is for the solicitation of tangible personal property and where orders are approved in and filled from another state. No such restriction is placed on states imposing a tax measured by capital. Therefore, some corporations could be in the position of paying only on the capital base even though their income base is higher. Furthermore, although each base is apportioned using a receipts factor, under the throwback rule, sales made to states where the corporation is protected under PL 86-272 may be considered to be Texas sales for the income apportionment calculation, while such sales are not attributed to Texas in the capital apportionment calculation.

Taxpayers may pay less tax under the new system if they are in a loss position or have a high capital base in relation to their income base. This will result from the new lower rate applied to taxable capital. Many taxpayers, however, will realize a higher tax burden. Planning opportunities exist for these taxpayers, but corporations must be aware that the Texas Comptroller's Office is planning to interpret the law in such a way that inadvertent "loopholes" will be closed by regulation.

From Sylvia Dennen, Chicago, Hi.