On June 15, Texas Governor Greg Abbott signed legislation which will permanently reduce the Revised Texas Franchise Tax (RTFT) rates by 25 percent.1 As a result of the enactment of this law, beginning with 2016 reports (generally based upon business done during federal income tax periods ending in 2015), the tax rate will be reduced from 1.0 percent to 0.75 percent for businesses other than retailers and wholesalers. The tax rate for businesses primarily engaged in the retail or wholesale trades will be reduced from 0.5 percent to 0.375 percent. Further, the alternative E-Z tax rate available to certain taxpayers will be significantly reduced. The reduced rates raise immediate tax accounting issues that should be addressed in order to properly reflect the RTFT in an entity's financial statements.

Background and Development

As originally enacted in 2006, the RTFT rates were set at 1.0 percent for businesses other than retailers and wholesalers, 0.5 percent for most retailers and wholesalers, and 0.575 percent for taxpayers with total revenue of not more than $10 million.2

Legislation enacted in 2013 allowed taxpayers to elect reduced rates of 0.975 percent and 0.4875 percent for retailers and wholesalers in their 2014 RTFT reports (generally federal income tax years ending during 2013), and 0.95 percent and 0.475 percent for retailers and wholesalers for their 2015 RTFT reports (generally federal income tax years ending during 2014).3 The reduced rates were simply elected by calculating the tax on the applicable RTFT report forms pursuant to those rates.

The reduced tax rates under the 2013 legislation were designed to be temporary in nature. Without further action by the state, the RTFT rates would have reverted to 1.0 percent and 0.5 percent beginning with 2016 RTFT reports. The Texas legislature and the governor engaged in debate and negotiations earlier this year to prevent the reversion from taking place. Referring to the RTFT and its original purpose of easing the burden on the property tax to fund Texas schools, the Texas legislature proclaimed its legislative intent in this bill, stating that the RTFT "has not provided sufficient reliability for property tax relief. It is the intent of the legislature to promote economic growth by repealing the franchise tax."4

As a means toward achieving this goal, the enacted legislation reduces the RTFT rates to 0.75 percent and 0.375 percent for retailers and wholesalers, beginning in their 2016 RTFT reports (generally federal income tax years ending during 2015).5 The alternative E-Z tax rate of 0.575 percent for taxpayers with total revenue of not more than $10 million will be reduced to 0.331 percent for their 2016 RTFT reports.6 Simultaneously, the maximum total revenue threshold to utilize the E-Z tax rate is being increased from $10 million to $20 million.7

The 0.75 percent, 0.375 percent and 0.331 percent RTFT rates remain in place unless and until modified by future legislation. The legislation also provides for the Texas Comptroller to conduct a study "to identify the effects of growth on future state revenues," including options to repeal the franchise tax.8 The Comptroller is to report the results to the governor and the Legislative Budget Board no later than September 30, 2016. The 85th Regular Texas Legislative Session is scheduled to convene in January 2017.

Tax Accounting Ramifications

Even though the legislation takes effect on January 1, 2016,9 the legislation was enacted into law on June 15, 2015. Accordingly, the reduced tax rates become a second quarter of 2015 event for calendar-year financial issuers. Generally, the tax rate reductions should be applied to adjust current RTFT liabilities and assets beginning with the second quarter of 2015 for calendar-year enterprises. As the reduced tax rates are not further adjusted by existing law, the reduced rates should impact the measurement of temporary differences. Enterprises with fiscal accounting periods that do not coincide with the calendar year may have slightly more complex considerations.

Accounting Standards Codification (ASC) 740 (formerly known as Financial Accounting Standard No. 109 or FAS 109), Accounting for Income Taxes, provides:

  • A current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year.
  • A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards.
  • The measurement of current and deferred tax liabilities and assets is based on provisions of enacted tax law; the effects of future changes in tax laws or rates are not anticipated.
  • Deferred tax liabilities and assets should be adjusted in the period of enactment for the effect of an enacted change in tax laws or rates. The effect is included in income from continuing operations.10

ASC 740-270 (formerly known as FASB Interpretation No. 18 of FIN 18), Accounting for Income Taxes in Interim Periods, provides guidance for reporting income tax in interim periods, including such periods that include the effect of tax law changes. ASC 740-270 provides:

  • If new tax legislation prescribes changes that become effective during an enterprise's fiscal year, the effect of those changes shall be reflected in the computation of the estimated annual effective tax rate beginning with the first interim period that ends after the new legislation becomes effective.11

Accounting and tax practitioners of enterprises with significant Texas operations and/or RTFT liabilities or assets should collaborate to ensure the tax rate reductions are properly reflected in the financial statements and related disclosures.

Commentary

Texas has continued to enjoy budget surpluses, and the tax reduction tone of this year's legislative session was set by the newly elected governor's call to reduce taxes. Despite the state's rosy budgetary picture, the RTFT has consistently underperformed in generating the revenue that it was expected to bring to the state coffers, and has generated a great deal of controversy. Earlier bills in the session called for the elimination of the franchise tax, and while the legislature specifically noted its intent to eliminate the RTFT, a complete elimination did not garner enough political support for passage.

In accordance with the Texas Constitution of 1876, the Texas legislature is scheduled to meet every two years. The Texas legislature's 2017 session is scheduled to convene in January of that year, and will address the state budget for fiscal years 2018 and 2019. Should revenues continue to increase, the Texas legislature potentially may act to further reduce, or even eliminate, the RTFT.

The enactment of an E-Z tax rate that is available to a greater subset of taxpayers due to the increase in the maximum total revenue threshold will be welcomed by smaller businesses that may have been subject to outsized RTFT liabilities. Notably, the new E-Z tax rate will become lower than the reduced RTFT rate available to retailers and wholesalers.

It should be noted that the applicable RTFT rate for a taxable entity or a combined group is often complex, and is the source of significant controversy. The legislation does not impact the determination of who is eligible for the lower RTFT rate for retailers and wholesalers, and so one can expect controversies in this area to continue.

Footnotes

1 H.B. 32, Laws 2015.

2 TEX. TAX CODE ANN. §§ 171.002(a), (b); 171.1016(a), (b).

3 Ch. 1232 (H.B. 500), Laws 2013, enacting TEX. TAX CODE ANN. §§ 171.0022 and 171.0023. For further discussion of this legislation, see GT SALT Alert: Texas Enacts Franchise Tax Reform Legislation Temporarily Lowering Rates, Excluding Items from Tax Base and Enacting Research Credit.

4 H.B. 32, § 1(b).

5 TEX. TAX CODE ANN. § 171.002(a), (b),

6 TEX. TAX CODE ANN. § 171.1016(b)(3).

7 TEX. TAX CODE ANN. § 171.1016(a).

8 H.B. 32, § 5.

9 H.B. 32, § 6.

10 ASC 740, Accounting for Income Taxes, Financial Accounting Standards Board.

11 ASC 740-270, Accounting for Income Taxes in Interim Periods, Financial Accounting Standards Board.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.