The original expansion of the Texas Franchise Tax in 2008 was one of the largest tax increases on Texas businesses in the state’s history.
The Texas Legislature and Gov. Greg Abbott approved and signed into law three items that will affect many businesses in the latest session:
• A permanent 25 percent cut in the Texas Franchise rate;
• A reduction in the EZ Franchise tax rate to 0.331 percent from 0.575 percent, and an increase in the EZ rate qualifying revenue threshold to $20 million from $10 million, and;
• An increase in the minimum revenue threshold - whereby businesses are subject to taxation - to up to $4 million from $1 million.
Businesses of all sizes will benefit from tax savings. Those engaged in retail as well as wholesale businesses will experience a reduction in rate to 0.375 percent from 0.5 percent, while all other businesses will see a reduction to 0.75 percent from 1 percent.
Though a 0.125-point change seems minor – particularly for businesses in the retail industry – organizations will see noticeable reductions in the amount of Texas Franchise Tax due next year.
For example, an average new car dealership in Texas that has $30 million in annual sales revenue would have owed approximately $24,000 in Texas Franchise Tax under the old rate after deducting cost of sales and adding other income.
Under the new rate, this dealership’s average taxes would reduce to $18,000. On a larger scale, a commonly-owned group of dealerships with $500 million in combined sales would see their average Texas Franchise Tax decrease from approximately $538,000 to $403,500. Texas businesses with $1-plus billion in sales revenue will enjoy the largest tax reduction in terms of dollars, possibly resulting in seven figure tax savings.
Next, a business that has historically used the EZ Franchise tax rate will see its rate decrease by 42.43 percent.
As an example, a business with $10 million in total revenue that uses the EZ rate will notice a tax reduction from $57,500 under the old rate down to $33,100 under the new rates, which will apply next year. Also, more businesses with revenues below $20 million will qualify to use the EZ rate.
Small businesses will see the most perceived benefit in terms of bottom line profit. The Franchise Tax expense is often a much larger percentage of a smaller organization’s bottom line net profit as opposed to larger businesses.
The expansion of minimum revenue threshold to $4 million from $1 million will eliminate the tax expense entirely for small businesses across Texas that have less than $4 million in revenue and other income. This includes sales revenue; rent income; dividends, interest, royalties, gains, and losses; and other income.
For example, under the old rules, a small business with $3.8 million in revenue and approximately 45 percent of that amount in allowable compensation deductions would owe $10,450 in Texas Franchise Tax.
This amount of tax would apply even to businesses that had a bottom line net operating loss for the year. Using the same small business revenue scenario but under the newly approved legislation, the entire $10,450 tax would be wholly eliminated.
The original expansion of the Texas Franchise Tax in 2008 was one of the largest tax increases on Texas businesses in the state’s history. Unlike federal income taxes, the Texas Franchise Tax is not based on net income.
Therefore, if an organization has net operating losses caused by large operating expenses that do not qualify as deductible cost of sales or compensation, the business is likely still paying thousands in Texas Franchise Tax. Many perceive this as an unfair burden to the affected small businesses; however, the new rate reductions and increase to the minimum revenue threshold should help alleviate that burden.
The effective date for applying these new rules is Jan. 1, 2016. It is in taxpayers’ best interest to begin adjusting their accruals now as the reported tax is based on 2015 activity.
Kevin Gilbreath is a CPA and CFP who serves as a tax manager in the Fort Worth office of DHG. He has more than 12 years of public accounting experience, and his practice focuses on tax planning and strategic consulting for owners and enterprises in the automotive dealership industry.