Texas Margin Tax

Date: March 15, 2008
To: Texas BOMA
From: Robrt D. Miller, Gardner Pate
Subject: Texas Margin Tax

With the start of 2008 came a new tax for Texas businesses: The Margin Tax. The Margin Tax, enacted in 2006 and revised in 2007, officially became operational on January 1, 2008. It applies to businesses for their 2007 tax year. This memorandum explains the purpose of the Margin Tax, how it is calculated, and important dates for 2008. The information contained in this memorandum should not be construed as legal advice. Texas BOMA members are advised to consult with their own legal or tax advisors regarding the Margin Tax and its application to their businesses.

Historical Context
In 2005, the Texas Supreme Court declared the Texas public school funding system unconstitutional. The system as it existed in 2005 relied heavily on local property taxes to finance the schools. The Court gave the legislature a deadline of June 1, 2006, to fix school finance. The Court’s ruling forced the issue of tax reform to the forefront of the legislative agenda. Governor Rick Perry appointed a tax reform commission to study the tax problem and recommend a solution. He called a special legislative session in 2006, where legislators adopted the Margin Tax, fixing the constitutional problem. In the 2007 Regular Session, legislators made technical corrections to the Margin Tax.

There were two primary reasons to adopt the Margin Tax. The first was an over-reliance on property taxes to fund schools. Many elected officials, as well as the public at large, were growing tired of the constant increases in property taxes, either via a higher tax rate or increasing home values. As enacted, the Margin Tax was used to “buy down” property tax M&O rates from $1.50 per $100 of valuation to $1.00 per $100 of valuation. The second reason for its adoption was to create a tax that would better align itself with the service economy in Texas. The Margin Tax accomplished this by encompassing many more businesses than did the Franchise Tax, including non-capital intensive businesses.

The Franchise Tax
The Margin Tax specifically replaced the Franchise Tax as it existed in 2006. The Franchise Tax required corporations and limited liability companies to pay for the privilege of organizing or operating in Texas. The tax amounted to a tax on either the net income or the net worth of a business. This tax excluded many forms of businesses, including limited partnerships, general partnerships, and sole proprietorships. As time passed, many businesses adopted different organizational forms to circumvent the Franchise Tax. As a result, the tax base for the Franchise Tax shrank, forcing revenues from other taxes to fill the void. This helped create the over-reliance on property taxes that the Supreme Court found unconstitutional in 2005.

Margin Tax Basics
The Margin Tax, as adopted, is technically a revision of the Franchise Tax. The Margin Tax is a tax on the gross revenues, less some deductions, of almost every business entity organized or operating in this state.

The Margin Tax is 0.5% of the “taxable margin” for businesses engaged primarily in retail or wholesale trade. For all other taxable entities, the Margin Tax is a full 1% of the taxable margin. Most Texas BOMA members will fall into the 1% category. The state determines the taxable margin by taking a business entity’s gross revenue and removing certain expenditures. A business may deduct the greater of (a) their cost of goods sold if they produce a tangible product (this does not apply to the leasing of real property); (b) total cash compensation for employees (up to $300,000 per person, not including amounts paid to independent contractors or payroll taxes paid by the employer) plus benefits; or (c) 30% of total revenues. The Margin Tax, therefore, is not really a tax on either gross revenue or net income. Instead, it is a tax on gross revenues less a statutorily-authorized deduction. Most Texas BOMA members will likely take the 30% of revenues deduction.

There is a sliding scale that excludes a percentage of revenues for small businesses. A business with revenue less than $300,000 will still pay no tax. A business with revenue greater than $300,000 but less than $400,000 will receive an 80% discount on its tax bill. A business with revenue of $400,000 or more but less than $500,000 will receive a 60% discount. A business with revenue of $500,000 or more but less than $700,000 will receive a 40% discount. A business with revenue of $700,000 or more but less than $900,000 will receive a 20% discount. A business with revenue of $900,000 or more will pay the full tax. In addition, any business with a Margin Tax bill of less than $1,000 will owe no tax.
Businesses with less than $10 million in revenue may file an “E-Z” return by multiplying their gross revenue by 0.575% to determine their tax. Because of the graduated discount based on revenues, the 0.575% E-Z tax rate, and the fact that an entity with a Margin Tax bill of less than $1,000 will owe no tax, the Comptroller’s proposed rules state any entity with revenues of $434,782 or less will owe no Margin Tax.

Comptroller’s Rules
In late 2007, the Comptroller of Public Accounts released the administrative rules that regulate the details of the Margin Tax. Those rules may be accessed online at the Comptroller’s website, www.cpa.state.tx.us/taxinfo/franchise/ft_revised.html.