By Charles Moster & Rick Ressler
In 2007 the Texas legislature passed a new bill which has significantly changed the method for computing tax liabilities – and which may continue to cause changes in taxes for all companies doing business in Texas. Importantly, the change could require your business to pay tax even if you are not profitable.

This new bill took effect January 1, 2008 and as a business owner or manager it’s important that you consider the impact the Margin Tax is having on your business.

As a result of this change businesses may have different tax liabilities and entities operating with the relatively cumbersome limited partnership structure will no longer have the same tax advantages as under the previous laws. These limited partnerships have lost their tax advantages while still having more structural, operational and administrative complexities than other comparable business entities.

(It should be noted that partnerships classified as “passive entities” are not be subject to this tax. A passive entity is generally a non-business trust or partnership that derives 90 percent or more of its income from passive items other than rents, such as dividends, interest and royalties.)

The new Texas Margin Tax can have a significant impact on your business’ tax liability. However, it will not apply if you owe less than $1,000 in taxes or if your total revenue is less than $300,000.

The Margin Tax is computed by determining your entity’s taxable margin, which is your entity’s total revenue, minus deductions, multiplied by either 1.0 percent or 0.5 percent.

When computing taxable margin, your entity will be able to choose whether to deduct from total revenue either: (1) the cost of goods sold; (2) total compensation up to $300,000 per employee plus employee benefits; or (3) 30 percent of total revenues. (If the entity does not sell goods, it is required to use the deduction for compensation.) The resulting figure is the gross margin.

The business will then compute the Texas apportionment factor, which is the percentage of Texas gross receipts out of your Total gross receipts, and the gross margin and the apportionment factor are multiplied to determine the taxable margin. Once the business’ taxable margin is calculated, a one percent rate is applied to that margin or a 0.5 percent rate is applied if the taxable entity is categorized as a retailer or wholesaler by statute. The resulting amount is paid as the margin tax.

Bottom line: it is very likely that your business is now incurring tax liabilities of either 0.5 percent or 1.0 percent of your taxable margin for the 2008 tax year and you will face a tax regardless of your profitability level.

Recommendations to Consider

Where the limited partnership structure successfully lowered its owner’s tax liabilities, while still providing limited liability protection for nearly a decade, the new margin tax has erased these benefits. As a result, the current structure of most limited partnerships is unnecessarily complicated due to the requirement of having a general partner.

In order to alleviate this now unnecessary burden, clients formed as limited partnerships to avoid the franchise tax should consider converting to another type of business entity, such as a Limited Liability Company (LLC) that can better align the benefits of limited liability protection with an easy-to-operate business structure.

Furthermore, the new required computation may expose all businesses, regardless of the type of legal entity, to different tax liabilities. All companies may benefit from proactive planning for the changes in tax law, based on the nature of your business and the short-term and long-term goals of you and your management teams.

With the new Texas Margin Tax, the primary question for any business is this: What is your estimated liability under the new tax law?

We encourage you to utilize the online calculator provided by the Texas Comptroller. It is available for you to estimate your upcoming tax liability. Please visit this website to download this helpful tool: http://www.window.state.tx.us/taxinfo/taxforms/HB3Calc.pdf.

We suggest you gather the following before visiting the website: for 2008 Revenue: Pro forma financial statements or estimates for 2008 revenues. For 2008 Deductions: Either (1) Estimated costs of goods sold or (2) Compensation for 2008.

Tip: Compensation expense includes wages and employee benefits, but wager over $300,000 for an employee may not be included. Other: Estimate of percentage of 2007 Texas-based operations, and income tax returns if the business suffered losses for one or both of the past two years.

Remember: This new margin tax does not take into consideration the profitability of your business. Please take action by contacting your attorney or CPA to determine your projected exposure and what you should be doing to protect your business assets.