taxes

Franchise Tax Frequently Asked Questions

Compensation

Is the calculation for compensation similar to the federal reporting and industry calculations?

No, compensation is specifically defined for franchise tax reporting purposes in Texas Tax Code (TTC) 171.1013.

What is included in computing compensation?

The following components are included in the compensation deduction:

  • W-2 wages and cash compensation paid to officers, directors, owners, partners and employees (including net distributive income to natural persons) subject to the wage limitation, adjusted each even-numbered year using the consumer price index as required by TTC 171.006. The wage limitations, per 12-month period on which margin is based, are:
    • $370,000 per person for reports originally due in 2018 and 2019
    • $360,000 per person for reports originally due in 2016 and 2017
    • $350,000 per person for reports originally due in 2014 and 2015
    • $330,000 per person for reports originally due in 2012 and 2013
    • $320,000 per person for reports originally due in 2010 and 2011
    • $300,000 per person for reports originally due in 2008 and 2009
  • Benefits provided to all personnel to the extent deductible for federal income tax purposes, including workers' compensation, health care and retirement benefits.
Is a single-member limited liability company (LLC) treated as a sole proprietorship for federal tax allowed to include in compensation the compensation of the single member?

A single-member LLC treated as a sole proprietorship for federal tax purposes may include in compensation the net distributive income to the single member that is a natural person. Net distributive income is the net amount of income, gain, deduction or loss reportable on the sole proprietor's federal tax return to the extent that it relates to the LLC. It includes amounts from IRS Form 1040 to the extent the items relate to the LLC; for example:

  • Schedule C - line 31 (net profit or loss)
  • Schedule E - line 26 (total real estate and royalty income or loss)
  • Schedule F - line 34 (net farm profit or loss)
  • net capital gain or loss from Form 1040 line 13
  • other gain and losses from Form 1040 line 14
Is the employer's share of payroll taxes included in compensation?

No, the employer's share of payroll taxes cannot be included in wages and cash compensation or benefits.

Can Internal Revenue Service (IRS) Form 1099-MISC nonemployee compensation be included in compensation?

No. It cannot be included as compensation when calculating margin.

What is the net distributive income for computing compensation? How is it computed?

Net distributive income for a pass-through entity is the net amount of income, gain, deduction or loss reportable to the owners on an IRS Form K-1 for the tax year of the entity. (Actual distribution is not required.) Guaranteed payments to partners are included when computing net distributive income.

  • To compute net distributive income for a partnership:
    • From IRS Form 1065 K-1, add items 1, 2, 3, 4, 5, 6a, 7, 8, 9a, 10 and 11.
    • Subtract from that result the sum of items 12, 13 and 16; Code L (foreign taxes); and any depletion that the partnership included in its margin calculation.
  • To compute net distributive income for an S corporation:
    • From IRS Form 1120S K-1, add items 1, 2, 3, 4, 5a, 6, 7, 8a, 9 and 10.
    • Subtract from that result the sum of items 11, 12, and 14; Code L (foreign taxes); and any depletion that the S corporation included in its margin calculation.
If net distributive income (NDI) is negative, does it have to be included in compensation?

If an entity elects to subtract compensation in computing its margin, it must include all compensation as defined in TTC 171.1013. If NDI is a negative number, then we will treat it as a negative number in computing compensation.

How does the wage limitation for the wages and cash compensation component apply when W-2 wages and a K-1 are issued to the same person?

If an entity issues a W-2 and a K-1 to an individual, the wage limitation, per 12-month period on which margin is based, applies to the sum of the individual's W-2 and K-1.

If the accounting period on my report is less than 12 months, can I still deduct the full amount of the wage limitation in wages per person?

No. If the accounting period is more than or less than 12 months, the wage limitation must be prorated over the length of the accounting period. For example, if the 2016 report is based on the accounting period Jan. 1, 2015, to June 30, 2015, the deduction for wages and cash compensation is not $360,000, but rather is limited to $180,000 per person.

In determining the compensation deduction for franchise tax purposes, can a partnership include the costs of tax-qualified defined contribution and defined benefit retirement plans as well as health care costs ("benefit costs") that are deductible for federal income tax purposes on the individual partners' returns?

Benefit costs are treated differently based on how they are reported for federal tax purposes.

  • The benefit costs are reported on the federal partnership return, IRS Form 1065, on Schedule K, line 13.d and on Schedule K-1, line 13. The benefit costs are not deducted as guaranteed payments. The benefit costs may be included in the compensation deduction of the partnership for franchise tax purposes without regard to the wage limitation.
  • The benefit costs are deducted on IRS Form 1065 as guaranteed payments. The benefit costs may be included in the compensation deduction of the partnership for franchise tax purposes without regard to the wage limitation if and only if the amount deducted as a guaranteed payment is adjusted as may be necessary to prevent a double deduction of benefit costs.