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8701 Research Blvd., Suite E
Austin, Texas 78758
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The "New" Texas Margin Tax

The Texas Margin Tax became effective January 1, 2007. Almost all forms of business are subject to the new tax. The Margin Tax is based on a company's gross receipts minus either compensation or the cost of goods sold. The first Margin Tax returns will be due May 15, 2008 (based on 2007 business.) Companies that owe less than $1000 in margin tax and those with total revenues of $300,000 or less are exempt from tax.

Entities Subject to the Margin Tax

Most forms of doing business are subject to the Margin Tax, including a partnership, corporation, banking corporation, savings and loan association, limited liability company, business trust, professional association, business association, joint venture, joint stock company, holding company, or other legal entity. It applies to all such entities chartered or doing business in Texas.

Excluded Entities

Some business are excluded from the margin tax. This includes a sole proprietorship, sole proprietorship, general partnership (owned solely by natural persons) , a particular type passive income entity. A partnership that earns over 90% of its income from investments is exempt as a passive income entity. an entity exempted (grantor trust, escrow, REIT that does not directly hold real estate, and REMIC) under current franchise tax provisions . However, it is important to note that Rent is not considered passive income, so most entities that own investment properties are subject to the tax.

Entity Selection

The Margin Tax changes the type of business entity type that most companies now select. Under the "old" law, many business entities converted to limited partnerships, which are exempt from the state franchise tax. Since the Margin Tax applies to a much broader base of business entities, including limited partnerships, state tax avoidance is no longer a major reason to select one entity type over another. This is particularly true since the tax rate is "only" 1% of an entity's "taxable margin (.5% for retailers and wholesalers).

It is true that you can select either a sole proprietorship or a general partnership and not be subject to the Margin Tax. However, both those business form do not offer the "limited liability" shield that spurs most businesses to select an artificial entity in the first instance. Further, since the initial threshold is relatively high, this tax is not an important topic for most new businesses.

Affiliated Groups

Companies cannot avoid the Margin tax by creating a series of companies. Companies are considered part of an "affiliated group" if they are engaged in a "unitary business" A unitary business is a single economic enterprise in which the entities are sufficiently interdependent, that together they provide a synergy or mutual benefit. and controlling ownership is owned by one or more common owners. All the companies of an affiliated group file a single return and must choose a single method of calculating their Margin.

Calculating the Margin Tax

The new tax is not difficult to compute, but it does require explanation and new terminology. (The best way to get a complete understanding of the Margin Tax is to discuss the matter with your CPA.)Here are the basics:

Step 1- Determine your "Margin.

There are three methods each company can use to determine its Margin. (Select the one that creates the "lowest" margin for your company.)

Margin = Total Revenue Total revenue is the company's total income as reported on IRS Form 1120 (for corporations) or IRS Form 1065 (for partnerships and other pass-through entities), plus dividends, interest, gross rents and royalties, capital gain net income minus bad debt, foreign royalties and foreign dividends, and income from a related entity, to the extent already included. Certain items are specifically excluded from total revenue, such as payments made to other entities within an affiliated group.

- (the Larger of A, B, or C below)

A. Cost of Goods Sold Cost of Goods Sold covers the direct costs of acquiring or producing goods, including labor, materials expenses, handling costs, storage costs, depreciation, cost of renting or leasing equipment, facilities or real property, repairs, and research and development costs. Selling costs, distribution costs, advertising costs, idle facility expenses, re-handling costs, bidding costs, interest, income taxes, and officer compensation are excluded. For purposes of deducting the cost of goods sold, goods are defined as real or tangible personal property sold in the ordinary course of business. Services are not included. Up to 4% indirect or overhead costs may be deducted if the company can show such costs are allocable to the acquisition or production of goods. Cost of goods sold must be capitalized in the same manner as used for federal purposes.
B. Compensation (up to $300,000 per employee) Compensation includes wages and cash compensation paid to officers, directors, owners, partners, employees, and the cost of all benefits provided. Compensation does not include social security or Medicare contributions. There is a limit of $300,000 compensation for each individual, and compensation paid to undocumented workers is excluded.
C. 30% of Total Revenue
Cost of Goods Sold covers the direct costs of acquiring or producing goods, including labor, materials expenses, handling costs, storage costs, depreciation, cost of renting or leasing equipment, facilities or real property, repairs, and research and development costs. Selling costs, distribution costs, advertising costs, idle facility expenses, re-handling costs, bidding costs, interest, income taxes, and officer compensation are excluded. For purposes of deducting the cost of goods sold, goods are defined as real or tangible personal property sold in the ordinary course of business. Services are not included. Up to 4% indirect or overhead costs may be deducted if the company can show such costs are allocable to the acquisition or production of goods. Cost of goods sold must be capitalized in the same manner as used for federal purposes.