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Franchise Tax
Frequently Asked Questions

Note: TTC means Texas Tax Code and IRC means Internal Revenue Code

Compensation

Rule 3.589

1. When must the election for Compensation be made and once made, can it be changed?
The election for Compensation must be made by the due date, the extended due date or the date the report is filed, whichever is latest. The election to use Compensation is made by filing the franchise tax report and deducting Compensation. The report may be amended to calculate margin using COGS, 70% of total revenue or the E-Z computation, if qualified. For reports due on or after Jan. 1, 2014, the report may also be amended to calculate margin by deducting $1 million from total revenue. The amended report must be filed within the statute of limitations. (Updated 12/03/13)
2. Is the calculation for compensation like the federal reporting and industry calculations?
No, compensation is specifically defined for franchise tax reporting purposes in TTC 171.1013.
3. What is included in computing compensation?
The following components are included in the compensation deduction:

1. W-2 wages and cash compensation paid to officers, directors, owners, partners and employees (including net distributive income to natural persons)subject to the following wage limitation per 12-month period on which margin is based:

  • $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

2. Benefits provided to all personnel to the extent deductible for federal income tax purposes, including workers' compensation, health care and retirement benefits. (Updated 12/03/13)

4. Is net distributive income included in compensation?
Yes, a partnership, trust or LLC that is treated as a partnership or S corporation for federal income tax purposes must include the net distributive income to natural persons in the wages and cash compensation component of compensation. The wages and cash compensation component of compensation is subject to the following wage limitation per 12-month period on which margin is based:
  • $350,000 for reports originally due in 2014 and 2015
  • $330,000 for reports originally due in 2012 and 2013
  • $320,000 for reports originally due in 2010 and 2011
  • $300,000 for reports originally due in 2008 and 2009
(Updated 12/03/13)
5. Is a single member 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. The wages and cash compensation component of compensation, which includes net distributive income, is subject to the following wage limitation per the 12-month period on which margin is based:
  • $350,000 for reports originally due in 2014 and 2015
  • $330,000 for reports originally due in 2012 and 2013
  • $320,000 for reports originally due in 2010 and 2011
  • $300,000 for reports originally due in 2008 and 2009

    See FAQ #10 for the computation of net distributive income.

(Updated 12/03/13)

6. What is included in compensation for an S Corporation with two shareholders/employees that pays a salary of $50,000 to each of the employees and reports on the K-1s to the shareholders/employees $100,000 in income?
The S Corporation includes in compensation $150,000 for each of the shareholders/employees.
7. In computing compensation does the net distributive income have to be distributed?
No, an actual distribution is not required.
8. 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. (Updated 07/22/10)
9. Can Internal Revenue Service (IRS) Form 1099-MISC nonemployee compensation be included in compensation?
IRS Form 1099-MISC nonemployee compensation cannot be included as compensation when calculating margin.
10. What is the net distributive income for computing compensation and 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. 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.

Net distributive income for a single member LLC treated as a sole proprietorship for federal tax purposes 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, and other gain and losses from Form 1040 line 14.

(Updated 02/15/12)

11. 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. (Updated 06/19/08)
12. 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. The wage limitation for report years 2014 and 2015 is $350,000. For the wage limitation of other report years, see FAQ #3. (Updated 12/03/13)
13. 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 2014 report is based on the accounting period January 1, 2013 to June 30, 2013, the deduction for wages and cash compensation is not $350,000, but rather is limited to $175,000 per person. (Updated 12/03/13)
14. Can a partnership include in the compensation deduction for franchise tax purposes 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 under the following two scenarios?
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. (Updated 07/22/10)
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