History of the Texas Franchise Tax
While commonly referred to as the “margin” tax, the formal name of Texas’ business tax is still the Texas Franchise Tax—a tax that Texas has levied in some form since the 1800s. The tax is typically assessed in return for the “privilege” of doing business in a state, similar to a fee (in fact, the U.S. Bureau of the Census in its recap of state finances classifies Texas’ franchise tax as a fee). As a part of its privilege, the owners of the business receive liability protections under state law—the business is a legal entity separate and apart from them.
Throughout most of the 20th Century, the franchise tax was calculated based on each corporation’s net taxable capital—total assets less debt. With the advent of modern accounting principles, the state’s definition of “debt” came under fire in the courts resulting in huge amounts of tax refunds in the 1980s. In 1991, the tax was rewritten to apply to “earned surplus”—essentially defined as corporate profits plus compensation paid to officers and directors. The taxable capital calculation was retained, but for all intents and purposes was relegated to being an alternative minimum tax.
The biggest change to note was made on May 18, 2006, when Texas Governor Rick Perry signed a package of legislation implementing property tax reform mandated by the Texas Supreme Court. Included in the package of legislation was Texas H.B. 3, which replaced the old Texas Franchise Tax with the “taxable margin” tax system. The rewrite of the tax was intended to accomplish a number of policy goals:
FUN FACT: This is a gross receipt tax and it only exists in 5 states.
Throughout most of the 20th Century, the franchise tax was calculated based on each corporation’s net taxable capital—total assets less debt. With the advent of modern accounting principles, the state’s definition of “debt” came under fire in the courts resulting in huge amounts of tax refunds in the 1980s. In 1991, the tax was rewritten to apply to “earned surplus”—essentially defined as corporate profits plus compensation paid to officers and directors. The taxable capital calculation was retained, but for all intents and purposes was relegated to being an alternative minimum tax.
The biggest change to note was made on May 18, 2006, when Texas Governor Rick Perry signed a package of legislation implementing property tax reform mandated by the Texas Supreme Court. Included in the package of legislation was Texas H.B. 3, which replaced the old Texas Franchise Tax with the “taxable margin” tax system. The rewrite of the tax was intended to accomplish a number of policy goals:
- Align the tax with a modern economy
- Create a simpler business tax
- Eliminate tax planning opportunities
- Raise roughly $3 billion in new state revenue annually
FUN FACT: This is a gross receipt tax and it only exists in 5 states.