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Texas adopts economic nexus rule for franchise tax purposes

Jan 10, 2020

On December 29, 2019, the Texas Comptroller of Public Accounts (“Comptroller”) adopted amendments to the regulations for the Texas franchise tax (gross margin tax) that create an economic nexus standard for that tax.

Under the amended version of Texas Admin. Code Sec. 3.586, any “foreign” entity (one not formed under Texas law) with no physical presence in Texas has franchise tax nexus for any particular federal income tax accounting period during which it has Texas-sourced gross receipts of at least $500,000.

This new nexus standard first applies to an entity’s first federal income tax accounting period ending in 2019 (that is, to the entity’s first franchise tax return due on or after January 1, 2020).

Discussion

Even though economic nexus is now one more way that a company may become subject to Texas’s franchise tax, it is not the only way. Under this new regulation, a foreign entity will establish franchise tax nexus on the earliest of the following dates:

  • The date it establishes a physical presence in Texas
  • The date it obtains a Texas use tax permit
  • The first day of the federal income tax accounting period in which its Texas-sourced gross receipts equal $500,000 or more

By asserting that companies have franchise tax nexus if they obtain a Texas use tax permit, Texas is acknowledging that its franchise tax and sales/use tax economic nexus standards are largely the same. Effective October 1, 2019, remote sellers were required to register for Texas sales/use tax purposes if, during the prior 12 months, their gross Texas sales (both taxable and exempt sales) exceeded $500,000.

Takeaways

Before registering for Texas franchise tax or sales/use tax by virtue of meeting these new economic nexus standards, businesses should first evaluate whether they may have had physical presence nexus in Texas for prior periods. This is because all companies who register to do business with the Texas Secretary of State will receive a Franchise Tax Accountability Questionnaire. Any companies who disclose a nexus-creating activity on that questionnaire will generally be disqualified from participating in the state’s Voluntary Disclosure Agreement program.

Texas generally uses the same sourcing rules for tangible personal property (TPP) under the franchise tax and sales/use tax for measuring those taxes’ $500,000 Texas gross receipts thresholds. However, service providers and financial institutions should carefully consider how the franchise tax’s sales apportionment rules of Texas Admin. Code 3.591 apply to sales of items other than TPP, to confirm whether or not they actually have Texas-sourced gross receipts under those rules.

Author(s)

Daniel N. Kidney, CPA, JD
Director
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