taxes

Franchise Tax Frequently Asked Questions

Passive Entities

If a limited liability company (LLC) converts to a limited partnership, can the entity qualify for passive if it meets the 90 percent passive income test?

To qualify as a passive entity, the entity must be a partnership or trust, other than a business trust, for the entire accounting period on which the tax is based. The entity may not qualify as passive for the accounting period during which the conversion occurs even if it meets the 90 percent income test. The entity may qualify as passive for subsequent reports.

Is rental income considered passive income?

No. However, if an entity meets the criteria as a passive entity, the entity may qualify as passive even if the entity has some rental income. Texas Tax Code (TTC) 171.0003(b).

Is the recapture of depreciation under Internal Revenue Code (IRC) Sections 1245, 1250 and 1254 considered passive income?

To the extent the IRC treats the recapture of depreciation under these sections as ordinary income, the recaptured amount is not passive income when computing the 90 percent test under TTC 171.0003(a)(2). Note that the term "Section 1250 recapture," which is treated as ordinary income for federal tax purposes, should not be confused with the term "unrecaptured Section 1250 gain," as defined in IRC Section 1(h)(6), which is treated as a capital gain for federal tax purposes and qualifies as passive income when computing the 90 percent test under TTC 171.0003(a)(2).

Do passive entities have to file reports?

Passive entities that are registered or are required to be registered with either the Texas Secretary of State (SOS) or the Comptroller's office are required to file Form 05-163, Texas Franchise Tax No Tax Due Report, to affirm that the entity qualifies as passive for the period upon which the tax is based. A passive entity is not required to file an Ownership Information Report.

If a partnership or trust qualifies as a passive entity for the period upon which the franchise tax report is based, is not registered and is not required to register with either the SOS or the Comptroller's office, then it will not be required to register or file a franchise tax report with the Comptroller's office.

Is the recapture of net Section 1231 losses considered passive income?

IRC requires that a taxpayer who has a net Section 1231 gain for the tax year review the five preceding tax years for possible recapture of net Section 1231 losses for the prior years. If there were any net Section 1231 losses during the period, the taxpayer must treat the current year's net Section 1231 gain as ordinary income to the extent of the amount of unrecaptured net Section 1231 losses for the past period. As a result, the recapture is not considered passive income when computing the 90 percent test under TTC 171.0003(a)(2).