RSM Resources

On June 17, 2007, GovernorRick Perry signed House Bill 3928 into law. House Bill 3928 effectively provides technical corrections to previouslyenacted margin tax statutes.  It isexpected the Comptroller will release rules interpreting the margin taxstatutes in late August of 2007.  We haveprovided a summary of the highlights of House Bill 3928 below.  For more information, please contact MikeWilliams, State and Local Tax Director in our Dallas office, at (972)764.7025 or at mike.williams@rsmi.com.

Changes and Modifications toExisting Statutes

Controlling interest - Acontrolling interest is now defined for an entity as a more than 50 percentinterest, either directly or indirectly, of the total combined voting power ofall classes of stock of the entity or more than 50 percent owned directly orindirectly, of the beneficial ownership interest in the voting stock of thecorporation.  Previously, this was an 80percent threshold. 

Internal revenue code - Theadoption of the Internal Revenue Code date is modified to the Internal RevenueCode of 1986 in effect for the federal tax year beginning on January 1, 2007,not including any changes made by federal law after that date.  Previously, the Internal Revenue Codeadoption date was in effect for tax years beginning January 1, 2006.

Lending institution - A lendinginstitution now includes entities regulated by the Commodity Futures TradingCommission and the Office of Thrift Supervision.  In addition to making loans, a lendinginstitution may include an entity that is: 1) licensed by, registered with, orotherwise regulated by the Department of Savings and Mortgage Lending; 2) a“broker” or “dealer” as defined by the SEC Act of 1934; or, (3) providesfinancing to unrelated parties solely for agricultural production.

Natural person - A naturalperson is defined as a human being or the estate of a human being.  The term does not include a purely legalentity given recognition as the possessor of rights, privileges, orresponsibilities, such as a corporation, limited liability company,partnership, or trust.

Limited liabilitypartnerships - The definition of taxable entities includes limited liabilitypartnerships.

General partnerships - Thedefinition of a general partnership not considered a taxable entity is clarifiedto mean a general partnership with:

• Natural persons as partners
• No limited liability understate law, including registration as a limited liability partnership.

Revenue modification - Someminor changes to revenue were added.  Inaddition to specific line references for revenue items, the definition requiresthat the line items be “reportable” as income on the federal returns to theextent the amount entered complies with federal income tax law.

Non-taxable entities - Severaltrusts have been added as non-taxable entities: 1) A nonprofit self-insurancetrust created under Chapter 2212, Insurance Code; 2) a trust qualified underSection 401(a) of the IRC; 3) a trust or other entity that is exempt under501(c)(9) of the IRC.

Tangible personal property -“Tangible personal property” now includes live and prerecorded television andradio programs. 

Passive income - Previously,gain from the sale of real property was included as passive income.  The language has been modified to specify“capital” gain from the sale of real property is passive income.

Active trade or business - Holdinga seat on the board of directors of an entity does not by itself constituteconduct of an active trade or business.

Gross revenue - Gross rentalincome from line 17 of Form 8825 is includable as income for partnerships.  Previously, partnerships included net rentalincome as reported on Form 1065.

Temporary credit - On thefirst report originally due under this chapter on or after January 1, 2008, ataxpayer must notify the comptroller in writing of its intent to take thetemporary credit against tax due on taxable margin.  The amount of the credit is computed bydetermining the amount of business loss carryforwards of the taxable entity forthe report due on the last period before January 1, 2008.  Multiply the business loss carryforward by4.5 percent.  For reports originally dueon or after January 1, 2008 and before January 1, 2018, the credit is limitedto 2.25% per year.  For reportsoriginally due on or after January 1, 2018 and before September 1, 2027, thecredit is limited to 7.75%.  The annuallimitation is further limited by the franchise tax computed on margin and maynot be carried forward to reports originally due on or after September 1,2027.  A taxable entity loses the rightto claim the credit if the entity changes combined groups after June 30, 2007.

A taxable entity may notclaim the credit unless the taxable entity was, on May 1, 2006, subject to the franchisetax.  A taxable entity that is a combinedgroup may claim the credit for each member entity that was, on May 1, 2006,subject to the franchise tax. 

Transition rules - For anentity that is: 1) not doing business in Texas on January 1, 2008; 2) would besubject to the franchise tax as amended if it were doing business in Texas onor after January 1, 2008, but would not have been subject to the franchise taxas it existed before the margin tax enactment; and 3) was doing business inthis state at any time after June 30, 2007, and before January 1, 2008, for theprivilege of doing business in Texas after June 30, 2007 and before January 1,2008, file a final report and pay an additional tax of the entity’s taxablemargin based on the period beginning on the later of January 1, 2007 or thedate the entity began doing business in Texas and ending on the date the entitybecame no longer subject to the tax.

General Additions toExisting Statutes

Discounts from tax liabilityfor small businesses – A taxable entity is entitled to a discount of the margintax based on the following total revenue:

• Greater than $300,000 butless than $400,000, the discount is 80 percent
• Greater than $400,000 butless than $500,000, the discount is 60 percent
• Equal to or greater than$500,000 but less than $700,000, the discount is 40 percent
• Equal to or greater than$700,000 but less than $900,000, the discount is 20 percent

Methodology election - Forthe determination of taxable margin, a taxable entity shall notify thecomptroller of its methodology election not later than the due date of theannual report.  Previously, the statuteallowed the entity to change the methodology election by filing an amendedreport but this phrase was removed from the statute.

Farm income - Income fromcertain farming activities reported on Schedule F of Form 1040 are includableas total revenue.

Pharmacy co-op - A taxableentity that is a pharmacy cooperative shall exclude from its total revenue,flow-through funds from rebates from pharmacy wholesalers that are distributedto the pharmacy cooperative’s shareholders.

Combined group liability - Eachmember of the combined group shall be jointly and severally liable for the taxof the combined group.

Tiered partnershipadjustments - The tiered partnership reporting methodology was amended toreflect that upper tier entities, such as partnerships or S corporations, areallowed to report the margin of the lower tiered entities.  In the previous legislation, the language ofthe statute transposed upper tier with lower tier.

Alternative tax for smallbusinesses - A taxable entity whose total revenue from its entire business isnot more than $10 million may elect to pay an alternative tax.  The tax is computed by determining totalrevenue from its entire business, apportioning the revenue based on currentapportionment rules and multiplying the apportioned revenue by .575percent.  A taxable entity that elects topay this alternative tax may not take a credit, deduction, or other adjustmentagainst the tax.

Information reporting onFinnegan receipts - All combined group filings shall include an informationreport which discloses each member of the combined group that does not havenexus with Texas the gross receipts, all Texas sourced receipts and all Texassourced receipts subject to taxation in another state under a throwback law orstatute.

Sale of loans - If a loan or security is treated asinventory of the seller for federal income tax purposes, the gross proceeds ofthe sale of that loan or security are considered gross receipts.

Business tax advisorycommittee - A Business Tax Advisory Committee is created to study the tax.

Cost of Goods Sold Deduction

Depreciation, depletion andamortization - For the cost of goods sold deduction, a clarification was addedfor depreciation, depletion, and amortization. The clarification stipulates that depreciation, depletion andamortization, as reported on the federal income tax return will be allowed as adeduction to the extent associated with and necessary for the production ofgoods.

Additionally, a taxableentity that is allowed a subtraction for cost of goods sold and that is subjectto IRC Section 263A, 460 or 471 may capitalize that cost in the same manner andto the same extent that the taxable entity capitalized that cost on its federalincome tax return.  The entity may also expensethese costs.  If the taxable entityelects to capitalize costs, it must capitalize each cost allowable under Texas statute that itcapitalized on its federal income tax return. If the taxable entity later elects to begin expensing a cost that may beallowed under this section as a cost of goods sold, the entity may not deductany cost in ending inventory from a previous report.  If the taxable entity elects to expense acost of goods sold that may be allowed under Texas statute, a cost incurred before thefirst day of the period on which the report is based may not be subtracted as acost of goods sold.  If the taxableentity elects to expense a cost of goods sold and later elects to capitalizethat cost of goods sold, a cost expensed on a previous report may not becapitalized.

A taxable entity shalldetermine its cost of goods sold in accordance with the methods used on thefederal income tax return of the taxable entity for the report period. 

Lending institution - If ataxable entity is a lending institution that offers loans to the public andelects to subtract cost of goods sold, the entity, other than an entityprimarily engaged in an activity described by category 5932 of the 1987Standard Industrial Classification Manual published by the federal office of Managementand Budget, may subtract as a cost of goods sold an amount equal to interestexpense.  An entity engaged in lending tounrelated parties solely for agricultural production is specifically included.

Film, recording,broadcasting industry - Added to the cost of goods sold was a sectionaddressing companies that deliver films, sound recordings, video tapes, liveand prerecorded television and radio programs and other similar industriesdescribed in the statute.  These types ofbusinesses will be allowed to elect cost of goods sold in determining marginutilizing costs described in the statutes in relation to the property andinclude depreciation, amortization, and other expenses directly related to theacquisition, production, or use of the property, including expenses for theright to broadcast or use the property.

Wage Deduction

Distributive income - Includedin the allowable deduction for wages is net distributive income from a limitedliability company treated as a sole proprietorship for federal income taxpurposes, but only if the person receiving the distribution is a naturalperson.

Small employers – Smallemployers, as defined by Section 1501.002 of the Insurance Code, have specialhealth care benefit deduction rules under House Bill 3928.  Small employers that have not provided healthcare benefits to any of their employees in the calendar year preceding the beginningdate of their reporting period and elect to subtract compensation to compute theirtaxable margin may subtract health care benefits provided to their employeesfor that period, subject to the $300,000 limitation discussed below. Thesesmall employers may also subtract the following for computing taxable margin:

An additional amount equalto 50 percent of the cost of health care benefits for the first 12 month periodon which margin is based and in which the taxable entity provides health carebenefits to all of its employees; and

An additional amount equalto 25 percent of the cost of health care benefits provided to its employees forthe second 12 month period on which margin is based and in which the taxableentity provides health care benefits to all of its employees. 

$300,000 limitation - Forpeople that are paid by more than one entity of a combined group, the combinedgroup may not deduct more than $300,000 per person.

Mike Williams is a Directorin the RSM McGladrey Stateand Local Tax Practice.  For moreinformation, contact him at (972) 764-7025 or mike.williams@rsmi.com.