Texas Margin Tax: Update and Discussion of Policy Issues

Transcription

1 Texas Margin Tax: Update and Discussion of Policy Issues John LaBorde, Partner Grant Thornton LLP May 1, 2009

2 TTARA The Texas Taxpayers and Research Association is the state s largest business organization focusing on Texas taxes and fiscal policy. Our members are businesses and trade associations representing a broad spectrum of Texas business community.

3 Agenda Enactment of the New Margin Tax Overview of the Revised Texas Franchise Tax ("RTFT", aka "Texas Margin Tax") Potential Issues Tax Accounting Constitutional Challenges How Have We Done? 3

4 The Margin Tax: Born from Turmoil Enacted in May 2006: Texas school finance system under attack in the courts Texas property taxes are among the nation s highest Texas chief business tax viewed as unfair by many businesses and policymakers

5 The Package School Property Taxes Rates reduced by $0.17 (schools may levy additional rate of $0.04 s) Rates reduced by another $0.33; cap reduced to $1.17. Legislature must provide additional funding to maintain low tax rates of $0.04 s) $1.17. low tax rates Franchise Tax Old franchise tax Old franchise tax New tax on margin; base extended to partnerships Cigarette Tax Tax increased by $1.00 per pack No further changes No further changes

6 TTARA Position TTARA supported the overall package of: School tax reductions Revised franchise tax Increased cigarette taxes Net Tax Cut ($5.8) billion $3.4 billion $0.7 billion ($1.7) billion Figures are original estimates for 2008.

7 But Remember, Tax Relief Was Not for Business Business Individuals New Taxes $3.4 billion $0.7 billion Property Tax Cut (3.0 billion) ($2.8 billion) Net Tax Change +$0.4 billion ($2.1 billion)

8 TTARA Comments on the Package of Tax Changes Positive: Was coupled with property tax relief, not increased spending Achieves tax equity, applying equally to all liabilityprotected businesses Negative: Concerns about ability to pay The franchise tax is too big especially relative to other state business taxes Property tax relief was oversold

9 Overview of the RTFT Entities subject to the Revised Texas Franchise Tax include: corporations general and limited partnerships joint ventures limited liability companies business trusts banking corporations and savings & loan associations professional associations 9

10 Overview of the RTFT Entities not subject to the Revised Texas Franchise Tax include: Entities with less than $300,000 total revenue or $1,000 tax (but a report must be filed) Sole proprietorships General partnerships entirely and directly owned by individuals Passive entities (specially defined) REIT s that do not directly hold real estate Real estate mortgage investment conduits (REMIC s) Nonprofit corporations and cooperative associations Estates of individuals 10

11 Overview of the RTFT Determination of Taxable Margin (i.e., the tax base) The lesser of: (1) 70% of Total Revenue; (2) Total Revenue less Cost of Goods Sold; or (3) Total Revenue less Compensation The method yielding the least amount of tax may be elected each year by the Taxpayer The election may not be changed by the filing of an amended return Note that a Taxpayer may have a Revised Texas Franchise Tax liability even if the Taxpayer has a loss for federal income tax purposes 11

12 Overview of the RTFT Cost of Goods Sold Deduction The Cost of Goods Sold Deduction election is: Generally available only to sellers and producers of tangible personal property Available only for tangible personal property that the Taxpayer actually or beneficially owns Also available to taxable entities that furnish labor or materials for the construction, improvement, remodeling, repair, or industrial maintenance of real property 12

13 Overview of the RTFT Compensation Deduction The Compensation Deduction includes: Wages and cash compensation up to $300,000 per employee Employee benefits provided to employees (not subject to $300,000 limitation) Wages and cash compensation are deductible to the extent reported on the Internal Revenue Service Form W-2 13

14 Overview of the RTFT Apportionment Multi-state Taxpayers apportion their Taxable Margin to Texas under a single factor receipts formula that is substantially similar to the prior Texas franchise tax apportionment formula Key to note: No throwback rule for the Revised Texas Franchise Tax The location of payor rule still exists The combined filing requirement may limit the applicability of the location of payor rule 14

15 Overview of the RTFT Tax Rates Revised Texas Franchise Tax Rates 0.5% for Retailers and Wholesalers (Less than 50 percent of the taxpayers retail or wholesale revenue comes from products produced by the affiliated group) 1.0% for all other Taxpayers 0.575% EZ Rate election (<$10 million Revenue) Any increase in the Revised Texas Franchise Tax Rates requires voter approval 15

16 Overview of the RTFT Credits Against RTFT Economic Development Credits repealed effective January 1, 2008 Established credit installments and carryforwards may be used against the Revised Texas Franchise Tax 16

17 Overview of the RTFT Combined Reporting Taxable Entities that are part of an affiliated group engaged in a unitary business are required to file a Combined Group report based upon the combined group s business There must be a controlling interest (> 50%) The Combined Group includes all entities in the affiliated group (unless specifically excluded); not just those entities with nexus for the Revised Texas Franchise Tax 17

18 Overview of the RTFT Combined Reporting Cost of Goods Sold and Compensation Deduction elections are made on a Combined Group basis For apportionment purposes, combined Texas gross receipts include only those receipts of group members that have nexus for Revised Texas Franchise Tax purposes (i.e., the Joyce method currently applicable for California income/franchise tax purposes) Finnigan information reporting 18

19 Potential Issues Deduction Methods COGS versus Compensation Method is an election that cannot be changed with an amended return A trap for the unwary If claimed COGS and it is disallowed on audit, you are not allowed the compensation deduction 30% deduction still applies 19

20 Potential Issues Combined Reporting Broad Definition of Unitary Business Combined Reporting Rebuttable Presumption of Unity and Instant Unity with Common Control Indicates Comptroller's position on unitary relationships Combined Group Subject to One Deduction Method Subject to One Tax Rate 20

21 Tax Accounting Classification as an Income Tax The FASB effectively decided not to formally address whether the Revised Texas Franchise Tax is an income tax for GAAP purposes The FASB Staff suggested that the Revised Texas Franchise Tax is clearly an income tax The FASB Staff interpretation differs from that of the Texas Legislature The franchise tax imposed by Chapter 171, Tax Code, as amended by this Act, is not an income tax and Pub. L. No does not apply to the tax. HB3 (79S3), Section 21 21

22 Tax Accounting Issues Defer Revised Texas Franchise Tax only on temporary differences related to items reported, or to be reported, on the Texas Return Items of revenue (e.g., federal income tax installment sale reporting) Items in the Cost of Goods Sold deduction (e.g., depreciation timing differences) Items in the Compensation deduction (e.g., pension expense and payments) 22

23 Constitutional Challenges? Bullock Amendment: 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. 23

24 Constitutional Challenges? The RTFT Law specifically provides that the tax is not an income tax and is not subject to Public Law The Law provides that the Texas Supreme Court has exclusive jurisdiction over Constitutional challenges to the Texas Margin Tax, and that the Court must rule within 120 days of any challenge filed 24

25 How Have We Done? Property Taxes

26 Property Tax Relief: $7 Billion Tax Cut HB1 passed in 2006 reduced school maintenance and operations taxes by one-third over the next two years; for most school districts this reduced rates to $1.00 By vote of school board, districts rate could be set as high as $1.04 With approval of local voters, rate could be set as high as $1.17

27 Tax Relief Obscured 1. Many schools opted to add to their maintenance and operations tax rates 2. Additional school debt taxes came onto the rolls (with more to come) 3. Appraisals rose even more than usual 4. City, County, and Special District taxes rose even more than usual

28 School M&O Tax Rates as of 2008 Tax Rate Number of Districts $1.00 or below 78 Above $1.00 but below $ $ Above $1.04 up to $ $1.17(or higher) 147 Total 1,025

29 Property Values & Economic Measures: Homeowners Period Average Sales Price Average Assessed Price % 6.2% 5.2% 7.5%

30 Property Values & Economic Measures: Business Period Gross State Product Assessed Value of Business Property % 5.1% 8.0% 13.3%

31 Rising Levies Average Annual Increases Before and After Tax Relief 14.0% 12.0% % 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% Special District County City School -4.0%

32 School M&O Taxes $25 $20 $ Billions Without HB1, school taxes would have increased by $4.7 billion $7.0 Billion net tax savings $15 In fact, school taxes declined by $2.3 billion $10 $5 $ School M&O Taxes 2007 School M&O Taxes

33 Property Tax Relief Calculator To calculate your school district tax savings: Not For 1. Select school district in box 1 from drop-down menu Duplication 2. Enter TAXABLE value of your property in box 2 and press "enter" 1 Houston ISD 2007 School Tax Savings = $937 Click on cell and select your school district from dropdown list 2 $190,000 Enter 2007 ISD TAXABLE Value for your property in box above (eg ) Savings reflect the amount of additional school district property taxes that would have been paid if the Legislature had not passed HB 1 which reduced school district M&O tax rates by one-third. Savings do not reflect a 65+ tax freeze. "No Relief" M&O Rate is an estimated rate arrived at by adding $0.06 to the district's 2005 M&O Rate (capped at $1.50 except for special law districts.) "No Relief" I&S Rate is the district's 2007 I&S Rate M&O Rate $ I&S Rate $ Total Rate $ "No Relief" M&O Rate $ "No Relief" I&S Rate $ "No Relief" Total Rate $1.65 $2, Actual School District Taxes Paid $3, School District Taxes If Tax Relief Had Not Been Passed Data Source: ISD Self Reports, Comptroller's Property Tax Division Texas Taxpayers and Research Association (TTARA) Available at

34 How Have We Done? Franchise Tax

35 Various Concerns about the Franchise/Margin Tax Revenue fell short of state s expectations No profits sensitivity Huge tax increases for some businesses Independent contractors vs. compensation Combined reporting vs. separate entity

36 Who Pays the Franchise Tax? Amount Paid by Size of Business, Measured by Texas Receipts $1 Ml to $10 Ml. 12.8% Under $1 Ml. 1.9% Over $10 Billion 25.3% $10 Ml. to $100 Ml. 14.9% $100 Ml. to $1 Bl. 19.6% $1 Bl. to $10 Bl. 25.5%

37 How Tax Liability Changed (By Industry) Telecommunications Waste Management Arts, Entertainment & Recreation Health Services Accomodation Administrative & Support Svcs Truck Transportation Air Transportation Real Estate Water & Other Transportation Publishing, Software & Data Professional Services Warehousing & Storage Retail Trade Unidentified Construction Other Services Food Services Educational Services Management of Companies Manufacturing Utilities Financial Activities Wholesale Trade Agriculture Rail Transportation Mining % 0.0% 50.0% % % % % % %

38 How Tax Liability Changed (By Size of Business) 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% -20.0% $0-0.5 million $ million $ million $ million $10-50 million $ million $ million $250 $ mll-$1.0 billion bl. $ billion Over $10 billion -40.0% -60.0% -80.0% %

39 How Does the Margin Tax Affect Different Businesses? Rail Transportation Accomodation Telecommunications Real Estate Publishing, Software & Data Educational Services Arts, Entertainment & Recreation Air Transportation Waste Management Truck Transportation Health Services Professional Services Administrative & Support Svcs Unidentified Other Services Water & Other Transportation Financial Activities Management of Companies Warehousing & Storage Manufacturing Food Services Utilities Construction Mining Agriculture Retail Trade Wholesale Trade 0.00% 0.20% % 0.60% 0.80%

40 What s the Legislature to do? Increasing the small business exemption to $1 million likely the only margin tax legislation to pass this session Affects the group of taxpayer least harmed or most benefitted Leaves fewer businesses in the tax base than in 2006 A joint House/Senate committee will likely study the tax before the 2011 session

41 The World in 2009 Texas chief business tax viewed as unfair by many businesses and policymakers Texas property taxes are among the nation s highest Texas school finance system under attack over adequacy and meaningful discretion

42 Questions? 42

43 Grant Thornton Contact Information John LaBorde State and Local Tax Partner Houston, Texas (832)