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STARTING AND OPERATING A BUSINESS IN TEXAS Copyright © 2008, Michael D. Jenkins CHAPTER 18
CONTENTS OF THIS CHAPTER:
I. INTRODUCTION I. INTRODUCTION Texas, which has the nation's second largest labor force and is the second largest state in terms of population and area, has some of the lowest taxes of the 15 largest U.S. states, among the lowest energy costs of any state, and a world-class infrastructure of highways and airports, plus low labor costs that average about 15% below the national average. Texas has a somewhat unusual tax and legal structure under which most businesses must operate, and a very pro-business government, making it an excellent place to start or operate a business. Like most states, Texas has long imposed a franchise tax (based on income or capital, whichever yields the higher tax) on corporations but also on limited liability companies (LLC's), a sales and use tax, various excise and severance taxes, with property taxes imposed at the local level. The state has adopted a limited liability company (LLC) law, and a limited liability partnership (LLP) law, so that businesses that operate in Texas in LLC or LLP form may obtain all the advantages of limited liability, without incorporating or becoming subject to federal corporate taxation, generally. The most significant feature of the Texas business tax environment has been that Texas was one of the few remaining states that did not impose an income tax on either individuals or unincorporated businesses -- except for LLC's, which were subject to the franchise tax like corporations. However, under legislation passed by the Texas Legislature in 2006, the state franchise tax has now been expanded to cover limited partnerships, limited liability partnerships, and other limited liability business entities (but not sole proprietorships and general partnerships), effective January 1, 2008, for reports originally due after December 31, 2007. However, the new version of the franchise tax is more like a gross receipts tax than a tax on net income. Taxes raised by this measure are to be used to reduce property taxes. See Section IV(a) for details on the revised and expanded franchise tax. Texas is unique in that it is the only state that does not generally require a business to have workers' compensation insurance, although few businesses that have employees will dare to take the risk of operating without workers' compensation coverage. The state saw some very hard years after the "oil bust" that began in the mid-1980s, but has rebounded strongly in recent years. At present, the state's economy is reasonably robust, in terms of the level of unemployment and other economic measures. Its unemployment rate in September, 2008 stood at 5.1%, which was somewhat lower than the national rate of 6.1%, but was up significantly from 4.3% a year earlier. One additional benefit of operating a business in the state is that Texas has a relatively low cost of living, compared to national averages. To view the latest federal Bureau of Labor Statistics unemployment rate data for Texas or any other state, visit the BLS website. II. LEGAL ENTITIES -- FILING FEES AND REPORTING REQUIREMENTS. (a) In General. A business that operates in Texas can operate as a sole proprietorship, a general or limited partnership, a corporation, or a limited liability company. S corporation tax status is generally not important for state tax purposes, as there is no income tax in Texas, and since S corporations are fully subject to the Texas franchise tax. However, under the old franchise tax that is being replaced, certain S corporations were allowed to compute the tax in a somewhat simplified manner that could sometimes result in a lower effective tax rate than for other corporations. Even this slight difference in the franchise tax treatment of S corporations has been eliminated by the franchise tax law changes enacted in 2006, which went into effect in reports filed in 2008 (based on 2007 results). Texas also provides for limited liability partnerships, in which no partner is liable for debts of the partnership, in general, as in the case of a corporation or LLC, but with fewer legal formalities than are required for either a corporation or an LLC. The new franchise tax will apply equally to corporations (including S corporations), limited partnerships, limited liability partnerships, and LLC's. Each of the above entities is discussed below, along with the basic requirements for forming such an entity and any general ongoing (non-tax) reporting requirements that are applicable to it. The tax treatment of each form of legal entity is discussed in Section IV below. (b) Sole Proprietorships. In general, sole proprietorships in Texas can be established with no formalities. However, as discussed in Section IV(b), it will generally be necessary to obtain one or more local business licenses from cities or counties in which you operate and, in some cases, state licenses, as well. In addition, if your business has employees, you will be required to register as an employer for purposes of the Texas unemployment tax on employee wages, as discussed in Section V(b). Also, if you sell any kind of tangible personal property at retail or provide certain types of services, you may be required to obtain a sales tax license and collect sales tax, as discussed in Section IV(d). Doing business as a sole proprietor in Texas is generally much simpler than operating as any other kind of business legal entity. No separate state income tax form filing is required for a sole proprietorship, since there is no state income tax in Texas on individuals. Sole proprietorships are particularly attractive from a tax standpoint now that the new, expanded franchise tax is in effect, imposing the tax on both corporations and unincorporated limited liability entities. Only sole proprietors and general partnerships remain exempt from the expanded tax, except for relatively small businesses. Also, as a sole proprietor, if you have no employees, you are not required to pay any unemployment taxes or withhold any income taxes from wages. However, if your sole proprietorship operates under an assumed or fictitious business name (trade name), it will be required to register the name with each county where you have business premises, as discussed in Section IV(g). Even if you do have employees, Texas is the one state that generally does not require employers to obtain workers' compensation insurance coverage for their employees, as discussed in Section V(c). (c) Partnerships. The Texas partnership laws allow creation of either a general partnership, in which all partners are liable for the debts of the business, or a limited partnership, in which only the general partners are liable for debts, while the liability of limited partners is limited to the amount they have invested, usually. State law also allows for the creation of a limited liability partnership, in which no partner has personal liability (subject to certain exceptions). As is discussed in Section IV(b), it will also typically be necessary to obtain one or more local business licenses from cities or counties in which you operate and, in some cases, state licenses, for any type of partnership, including general or limited partnerships or limited liability partnerships. There is no personal income tax in Texas, so the income of a partnership is not taxed to the individual partners for state income tax purposes. Therefore, partnerships are not required to file annual tax information returns with the state. However, under the new franchise tax law enacted in 2006, limited partnerships and LLP's (but not general partnerships) are now subject to the franchise tax, at the partnership level, although certain small partnerships are exempted from the franchise tax. For more on the state tax treatment of partnerships, see Section IV(c). A partnership agreement, for any type of partnership, should spell out in considerable detail such matters as the following:
As a rule, general partnerships in Texas can be formed with no formalities, other than to register the partnership with the county in which you will be located. Although it is highly advisable to have a written partnership agreement, there is no legal requirement that you do so. However, as discussed in Section IV(b), it will also typically be necessary to obtain one or more local business licenses from cities or counties in which you operate and, in some cases, state licenses, as well. In addition, any partnership or other business that has employees will generally have to register for, and pay, state unemployment tax on wages paid, as discussed in Section V(b). General partnerships in which all the partners are natural persons (individuals) are not subject to the new franchise tax on LLP's and limited partnerships, as discussed in Section IV(c). A limited partnership, in which there is at least one general partner (who is liable for partnership debts) and at least one limited partner (who is not liable for the debts of the partnership), may also be formed under Texas law. Unlike a general partnership, a limited partnership must generally have a written partnership agreement, and must file a certificate of limited partnership with the secretary of state, together with a filing fee of $750. Foreign limited partnerships must also register before being allowed to do business in Texas, and must also pay a registration fee of $750. Both domestic and foreign limited partnerships are required to file a periodic report with the secretary of state not more frequently than every four years, and pay a fee of $50. For information on limited partnership filing requirements, see the contact information for the offices of the Corporations Section, Texas Secretary of State, listed in Section VI(a). Under the new, revised franchise tax law enacted in 2006, limited partnerships are for the first time subject to the state franchise tax, which formerly applied only to corporations and LLC's. See the discussion of the new franchise tax law in Section IV(a). LIMITED LIABILITY PARTNERSHIPS Limited liability partnerships (LLP's) are a relatively new form of partnership permitted under the laws of Texas. Like an LLC, an LLP provides limited liability for its owners, while retaining the tax advantages of a partnership for federal income tax purposes. Under the new, revised franchise tax law enacted in 2006, LLP's are for the first time subject to the state franchise tax, which formerly applied only to corporations and LLC's. See the discussion of the new franchise tax law in Section IV(a). As several other states have done, Texas has enacted legislation that allows a limited partnership to also become a limited liability partnership -- a limited liability limited partnership, or LLLP. This law became effective January 1, 2006. An LLLP is a regular limited partnership that has elected LLP status, so that the general partners in the LLLP are given the same liability protection as partners in an LLP. A general partnership or the general partners in a limited partnership can obtain a significant degree of limited liability by simply registering the partnership with the state as an LLP. However, becoming an LLP will not affect the liability of a partner in an LLP for his or her own omissions, negligence, wrongful acts, misconduct or malpractice or that of any person under his or her direct supervision and control, but will protect him or her from liability resulting from actions of another partner, unless he or she had notice or knowledge of an omission or misconduct of another partner and failed to take reasonable action to prevent or cure the error. IMPORTANT NOTE: Unlike an LLC, an LLP typically operates like a regular partnership, and is not required to file articles of organization, but must register as a "registered limited liability partnership." To register a Texas partnership as an LLP in Texas, you must file a registration form and pay a filing fee of $200 per partner to the secretary of state. Foreign LLP's, those created under the laws of another state, must also register with the secretary of state and pay a fee of $200 per partner located in Texas, with a minimum of $200 and a maximum of $750. Every LLP doing business in Texas, including both domestic and foreign LLP's, must annually renew its registration and pay a fee computed in the same manner as for the initial registration. Every LLP that does business in Texas must carry at least $100,000 of liability insurance to cover errors, omissions, negligence, incompetence or malfeasance, or else must segregate $100,000 or more as security for any such claims, or obtain an equivalent letter of credit or insurance bond. For more information on LLP registration and reporting requirements, see the contact information for the offices of the Texas secretary of state, listed in Section VI(a). Note that one potential drawback of LLP's, if you will do business in other states besides Texas, is that some states, like California and New York, only recognize certain types of professional partnerships as LLP's. If yours is not such a professional partnership, those other states may simply treat your LLP like an ordinary general partnership, with no limitation of liability. (d) Corporations. To form a corporation in Texas, you must file articles of incorporation with the secretary of state and pay a filing fee of $300 for a certificate of formation. A foreign corporation (one formed under the laws of another state or a foreign country), must obtain a certificate of authority before it may legally conduct business in Texas, by filing an application for a certificate of authority and paying a filing fee of $750. For more information on filing articles of incorporation or applying for a certificate of authority to do business in Texas, see the contact information for the offices of the Texas secretary of state, listed in Section VI(a). In addition, once your corporation is formed, it must file an annual public information report with the State Comptroller of Public Accounts, along with the annual franchise tax return. There is no fee required in connection with filing this report. In addition to paying federal income taxes on its income, a corporation that does business in Texas must also file corporate franchise tax returns with the state. The state franchise tax is no longer similar to an income tax, but is now more like a gross receipts tax, at a tax rate of 1% or less. See Section IV(c) for a discussion of state corporate franchise tax rates and tax return filing requirements and for a description of the franchise tax law changes enacted in 2006. While corporations, other than S corporations, must pay federal income taxes on their taxable income, there is no state corporation income tax, as such, in Texas, although the franchise tax was somewhat similar to an income tax in its previous form (before the new 2006 franchise tax law enactments went into effect, generally after 2006). The new franchise tax, which is more like a gross receipts tax than a tax on net income, applies equally to C corporations and S corporations. For tax forms and more information on corporate franchise taxes in Texas, see the contact information for the offices of the Texas Comptroller of Public Accounts, listed in Section VI(a). (e) S Corporations. An S corporation is simply a regular corporation that has elected, for federal or state income tax purposes, or for both, to be taxed somewhat like a partnership, with its income, losses and tax credits flowing through to its owners, who report such income, losses, or credits on their individual tax returns. Since there is no individual income tax in Texas and since S corporations have long been subject to the Texas franchise tax on income and/or capital, the existence of a federal S corporation election is not generally relevant for state income tax purposes in Texas. However, S corporations and certain other closely-held corporations could qualify for use of a simpler accounting method for computing their Texas franchise taxes under the old franchise tax law that was recently phased out, and did not need to add back to income their federal tax deductions for officers' compensation, which could in some cases reduce their franchise tax liability, depending on the company's particular circumstances. In addition, the starting point for computing "earned surplus" under the Texas franchise tax was generally federal taxable income, with certain adjustments for a C corporation, but was the amount of federal taxable income reportable to shareholders of the S corporation for an S corporation. Note, however, that the Texas franchise tax law was revised in a major way in 2006 legislation and that the new version is more like a tax on gross receipts than an income tax or a tax on capital, and provides no special tax advantages for S corporations, as is discussed in Section IV(a). Thus, for S corporations operating in Texas, an S corporation election is only relevant for federal income tax purposes. (f) Limited Liability Companies. Texas, like every other state in the U.S., has adopted a limited liability company (LLC) law. Thus, in addition to the traditional choices of a sole proprietorship, partnership, or corporation, a business that operates in Texas may also choose to operate in the form of an LLC. LLC's are very attractive entities for many small businesses, in that they offer much the same protection as a corporation from creditors for debts of the business, while offering much of the flexibility plus the flow-through tax treatment of a partnership for federal tax purposes, and in most states (but not in Texas, which subjects LLC's to the franchise tax, as in the case of corporations and other limited liability entities). See Section IV(c) for a discussion of the income tax (franchise tax) treatment of LLC's under Texas tax laws and see the discussion of the new franchise tax law, as amended in 2006, in Section IV(a). To form an LLC under the laws of Texas, one or more persons must file articles of organization with the secretary of state, which must be accompanied by a filing fee that, since January 1, 2006, is the same as for filing corporate articles of formation ($300 at present). Texas state law allows formation of one-owner LLC's, which will now qualify for treatment as sole proprietorships for federal tax purposes. Foreign LLC's, those formed under the laws of another state, must obtain a certificate of authority to do business in Texas, by filing an application for a certificate of authority with the secretary of state and paying a filing fee that, since January 1, 2006, is the same as for a corporation ($750 at the time of this writing, in October, 2008). In addition to initial filing fees, an LLC formed in Texas must subsequently file annual public information reports (no fee is required) with the State Comptroller of Public Accounts, along with the annual franchise tax return. Professionals such as lawyers, accountants, and dentists, are permitted to operate professional LLC's in Texas. While such professionals obtain the same degree of limited liability protection as in the case of a professional corporation, they remain individually liable for their own negligence, malpractice or other misconduct. For more information on filing articles of organization for an LLC, see the contact information for the offices of the secretary of state, listed in Section VI(a). III. BUSINESS ACQUISITIONS (a) In General. When acquiring an existing business, there are a number of state legal and tax issues you or, preferably, your business attorney, should attend to before closing the purchase. These include matters such as doing a title search for any real property that is being acquired, checking for any recorded security interests on personal property items, and thoroughly researching county, state, and federal records for any judgment liens, tax liens, or other liens, before property is acquired. You will also benefit from consulting a tax advisor before the agreement of sale is negotiated, in order to seek a structuring of the agreement so that the purchase price is allocated among the assets in a way that favors you. You may be able to obtain considerable tax savings if the purchase price is allocated in a way that gives you the best possible tax results under federal and state income and franchise tax laws and other state tax laws, such as sales/use tax or property tax laws. Depending upon the state (or states) in which the seller's assets are located, you may also have to comply with state bulk sale or bulk transfer laws. You should also obtain tax releases from various state taxing agencies, as discussed below. (b) Bulk Sale Laws. Typical bulk sale laws require either publication of legal notices to all creditors in advance of the sale and recording of such notices in some cases, or maintenance of detailed lists of the property to be transferred, for inspection by the public. Texas is one of the business-friendly states that has repealed its bulk sale laws, so you no longer have to be concerned with that requirement when buying a business in Texas. (c) Tax Releases. When you acquire an existing business, you will want to make sure that you do not unwittingly become liable for any unpaid taxes owed by the seller. Typically, to protect yourself, you will need to receive a tax release or releases from various state taxing agencies, for such taxes as sales and use tax, income tax withholding, and state unemployment taxes, in each state in which the seller does business. If you fail to obtain such a release or written statement from the tax agency that the seller is not delinquent on any tax payments, you will be held responsible for such tax if it is not withheld from the purchase price proceeds and paid to the state at the time the sale of the business transpires. In Texas, you should obtain a tax release for state sales and use tax, a statement from the Texas Comptroller of Public Accounts that will tell you how much, if any, sales and use tax liability of the seller you should withhold from the purchase price, or, if no tax need be withheld, you will be issued a Certificate of No Tax Due. Also, require the seller to obtain written confirmation from the Texas Workforce Commission that there is no unpaid state unemployment tax that must be withheld from the purchase price. (d) Unemployment Tax Rating of Seller. In addition to obtaining tax releases, you may find it to be advantageous to succeed to the seller's unemployment tax experience rating, if the seller has a tax rate lower than you would otherwise obtain as a new business. In Texas, if you already have an unemployment tax experience rating, you continue to use your rating until the end of the year. If you do not already have an experience rating, you will succeed to that of the seller. PLANNING POINT: EXAMPLE: For more information on whether you can or must obtain the seller's experience rating as a successor employer, contact the Texas Workforce Commission, at the address listed in Section VI(a). IV. TEXAS TAXES AND OTHER GENERAL REQUIREMENTS. (a) In General. Texas has consistently been rated as having a very favorable tax structure, ranking 3rd lowest among the states in per capita state taxes in a recent survey. This is in large part due to the fact that there is no state income tax on either corporations or individuals. However, there is a state franchise tax, discussed in Section IV(c), which was much like an income tax, but until recently it has applied only to corporations (including S corporations) and LLC's. Thus, if a business was conducted as a partnership or as a sole proprietorship, its business profits were not taxed at all by the state of Texas in 2006 and earlier years, generally. However, under tax laws enacted by the Texas Legislature in 2006, the state franchise tax has been expanded to cover limited partnerships, limited liability partnerships, and other limited liability business entities (but not to sole proprietorships or general partnerships), effective January 1, 2008, for reports originally due after December 31, 2007. Certain family limited partnerships and passive investment limited partnerships are exempt from the new franchise tax. Thus, the expanded tax generally applies to the tax year 2007 and later. The new legislation also makes significant changes in the way the franchise tax is computed and will lower the tax rate, generally. Small businesses are exempted. That is, the franchise tax will not apply to taxable entities whose franchise tax, as computed, is less than $1,000 or whose total gross receipts are less than $300,000. Former Texas Comptroller Strayhorn estimated that the new version of the franchise tax would require some 200,000 (unincorporated) businesses that were not previously taxable to file franchise tax returns and, in many cases, pay franchise taxes, and that total franchise taxes collected would increase by $6 billion. Critics of the new tax point to its potential for taxing a single product multiple times. For example, the tax can pyramid on sales of gasoline when fuel is sold and resold from suppliers to distributors to consumers at the pump, who then will have to pay higher prices to cover the extra costs of the franchise tax that is imposed at each level -- a tax on tax, over and over. Instead of the previous, highly complex manner of computing the franchise tax, a different and somewhat simpler method is now used, which results in a "taxable margin" (the amount taxable) that is equal to one of three "margin" calculations:
Whichever of the three above calculations yields the lowest "margin" is the taxable amount. The tax that will apply to this amount is 0.5% for retailers or wholesalers (which includes eating and drinking establishments) or 1% for all other businesses. Taxable entities will generally have to file a return and pay the annual tax by May 15th each year after the initial period. The new Texas franchise tax law has already been amended in 2007 in a number of ways, most of which will reduce the tax burden on small businesses. These changes include:
Each of the above law changes became effective as of January 1, 2008. In 2009, for businesses newly subject to the new franchise tax, the initial report is due one year and 90 days after the registration date of a Texas taxable entity. For a non-Texas taxable entity, the due date is one year and 90 days after the taxable entity began doing business in Texas. After an initial report is filed, the entity will file an annual report each May 15. A letter will be mailed to you at least 30 days before the due date with filing instructions. IMPORTANT NOTE: Texas State Comptroller Susan Combs issued a press release on September 17, 2007, regarding the new franchise tax, which stated that, based on calculation formulas and discounts, entities with total revenue of $434,782 or less and entities that calculate they owe less than $1,000 in franchise tax will not be required to pay the tax, but they will still be required to file a report. In computing the COGS tax, increased federal depreciation (50% bonus depreciation) that was enacted in the federal Economic Stimulus Act of 2008 is not allowed for purposes of the Texas franchise tax. Texas localities impose property taxes on both real property and tangible personal property, but there is no tax on intangible personal property, except in the case of certain regulated industries like savings and loan associations, mutual insurance companies, railroads and other transportation companies. Texas property taxes are considered to be some of the highest in the United States, but unlike most other states, Texas does not impose any conveyance fees or taxes on transfers of real estate. As a major oil- and gas-producing state, Texas imposes a wide range of severance taxes on production of hydrocarbons. UPDATE NOTE: For state tax forms and tax information, see the contact information for the Texas Comptroller of Public Accounts in Section VI(a). (b) State and Local Licensing. Nearly any business, operated anywhere in the United States, will have to have at least one government license of some kind. In most cases, this will be a local license, issued by your city or county. Before you open your business, contact your local city or county hall and find out if your particular business needs one or more local licenses. Most kinds of local business licenses are granted upon payment of a fee, with no further requirements, except possibly for annual or other periodic renewal fees. However, if you are engaging in any kind of food business, you will usually need to also obtain a health department permit and show that you are in compliance with health department food-handling requirements. In addition, be sure to check with an attorney or local government zoning or planning department officials to determine if your business will be in compliance with all local zoning and planning restrictions. If you own or rent any type of facility, you will generally need fire department permits, showing that you meet fire safety codes and any construction or improvements to an existing structure will usually require a building permit. If you intend to simply operate your business from your home, you may be in violation of local zoning requirements, but this is less likely to be a concern if you don't have clients, customers, suppliers, or employees coming to your house on business, on a regular basis. State governments have traditionally required special licenses for many kinds of professionals, such as physicians, dentists, lawyers, and accountants. To further protect consumers, Texas has expanded the list of occupations that must be licensed by the state to include many other occupations. Most state licenses not only require payment of fees, but are only issued for a given profession or occupation upon showing that you have completed certain educational or experience requirements, or passed certain tests, or some combination of the foregoing. For assistance with state licensing and business registration requirements in Texas, see the contact information for the offices of the Small Business section, Office of the Governor, Division of Economic Development and Tourism, listed in Section VI(a). (c) Income and Franchise Taxes. Texas is one of the few states that does not have either a corporate or individual income tax. It does have a corporate franchise tax, discussed below, that was similar in many respects to an income tax, which until recently (the end of 2006, generally) had only applied to corporations and LLC's. However, as discussed in more detail in Section IV(a), the franchise tax was completely revised and expanded under 2006 legislation and later amendments to include all limited liability business entities, including LLP's and limited partnerships, effective in 2007 (or earlier, in some cases). As revised, it is more of a gross receipts tax than a tax on net income or capital. TAXATION OF SOLE PROPRIETORS AND PARTNERSHIPS Because there is no individual state income tax, Texans do not need to be concerned with filing a state income tax return, only a federal return. Sole proprietors report their business income only on their federal income tax return, Schedule C of Form 1040. Sole proprietors are not subject to the existing franchise tax or the new franchise tax that generally went into effect in 2007. General partnerships are not subject to any state tax themselves, as separate taxable entities, and individual partners are also not taxable, since there is no individual state income tax in Texas. Note, however, that a limited liability partnership (LLP) must pay an annual renewal fee of $200 per partner to maintain its status as an LLP (limited to $750 in the case of a foreign LLP -- one formed in a state other than Texas). In addition, under the recently enacted (2006) franchise tax law, limited partnerships and LLP's (but not general partnerships) are fully subject to the revised and expanded franchise tax. See the discussion of the new franchise tax law in Section IV(a). As noted above, there is no corporate income tax in Texas, as such, but in 2006 and earlier there was a state franchise tax that applied to both corporations and LLC's, but which was replaced after 2006 by a new franchise tax (discussed in Section IV(a)). The old (2006 and earlier) state franchise tax on corporations and LLC's had two components:
Once the taxpayer corporation or LLC computed the tax both ways, it had to then pay the higher of the two amounts. A corporation was not required to pay the old franchise tax if its gross receipts from its entire business for taxable capital purposes and for taxable earned surplus purposes was less than $150,000 for the tax year. Also, if the amount of tax computed was less than $100, no tax was due. (Under the new franchise tax, corporations with less than $1,000 of computed tax or with gross receipts of $300,000 or less pay no franchise tax.) "Earned surplus" was somewhat similar to federal taxable income, but with numerous adjustments, such as adding back (disallowing) any deductions for compensation of officers and directors. However, certain "close corporations" with 35 or fewer shareholders and S corporations were not required to add back such compensation in computing earned surplus. In addition, the starting point for computing "earned surplus" under the old Texas franchise tax was generally federal taxable income, with certain adjustments for a C corporation, but was the amount of federal taxable income reportable to shareholders of the S corporation for an S corporation. Actual calculation of the tax was inordinately complex, involving an amalgam of various concepts, including calculations of gross receipts according to generally accepted accounting principles (GAAP), or income as shown on the federal income tax return, and under special methods for other items, as determined by accounting rules set forth by the State Comptroller. The new franchise tax, based essentially on gross receipts with few deductions, is much simpler to compute than the old franchise tax. The state corporation franchise tax return had to be filed each year by the 15th day of May, regardless of when the company's fiscal year ended. The State Comptroller sent each corporation a preprinted form for filing every year. However, a corporation's initial report was due one year and 89 days after the corporation's beginning date in Texas. Corporations were not required to make estimated tax payments of their state franchise tax in advance. S corporations were generally treated like any other corporation for purposes of the old Texas franchise tax, except that S corporations and certain "close corporations" (those with 35 or fewer shareholders) were granted a few tax breaks in computing the tax, as was noted above with regard to the add-back of officers' or directors' compensation (which was not required for S corporations or close corporations) and the ability to elect to compute gross receipts, surplus, assets and debts under the federal income tax accounting method. Note that the foregoing discussion of the franchise tax does not apply after 2006, generally. A new version of the franchise tax, more in the nature of a gross receipts tax, has been enacted and applies in 2007 (or earlier, for some fiscal year taxpayers). See the discussion of the new franchise tax law in Section IV(a). While an S corporation, under the old franchise tax law, had some modest tax advantages over a C corporation, the new tax law enacted in 2006 has eliminated any distinctions between S corporations and C corporations under the Texas franchise tax. TAXATION OF LIMITED LIABILITY COMPANIES In Texas, unlike most other states, limited liability companies (LLC's) are taxed like corporations for state income tax purposes. That is, like corporations, they are fully subject to the Texas franchise tax, which until recently was a tax based in part on income and in part on capital. Like a corporation, an LLC paid the higher of the tax of 0.25% on stated capital and surplus, or a tax of 4.5% on "earned surplus" (roughly equivalent to income). This franchise tax law no longer applies after 2006, as a new and somewhat simplified franchise tax has been enacted and is more in the nature of a gross receipts tax, with deductions for cost of goods sold or compensation (or 30% of gross revenue), whichever deduction is higher, generally first becoming applicable in 2007 for calendar year LLC's and other limited liability business entities. Single-member LLC's that may be disregarded for federal tax purposes are not disregarded under the Texas franchise tax law and are fully subject to franchise tax, like other limited liability legal entities. See the discussion of the new franchise tax law in Section IV(a). (d) Sales and Use Tax. Texas imposes a general sales tax on retail sales of tangible personal property and various types of services, as well as leases of tangible personal property, at the statewide rate of 6.25%. A number of Texas cities also impose local sales and use taxes, in addition to the special sales taxes that are collected in certain metropolitan transit areas to finance mass transit or for other special uses. The total combined state and local tax rate can be as high as 8.25%. All of the foregoing state and local sales and use taxes are administered by the State Comptroller of Public Accounts, which is the main state taxing agency in Texas. Any person wishing to do business as a seller in Texas must file an application for a sales tax permit with the Comptroller. File on Form AP-201, Texas Application for Sales and Use Tax Permit. The applications for permits can also be filled out on-line, at the Comptroller's website. A separate permit is required for each place of business. No charge is made for obtaining permits, but you may be required to post a bond or other security to obtain this permit. When submitting your application for a sales and use tax permit, you are required to fill out a Sales and Use Tax Bond-Security Information Worksheet, on which you must estimate the amount of taxable sales you will generate. The Comptroller's office will review the information you provide and inform you if you need to post a bond or other security. The state of Texas requires direct sales organizations to collect and remit state and local sales and use taxes on sales made by their distributors in Texas. Since the direct sales company is regarded as the retailer, permits are not issued to distributors and the direct sales organizations are required to collect sales tax from the independent distributors rather than accept resale exemption certificates. In general, although certain occasional or "casual" sales may be exempt from sales tax, anyone who makes more than two sales of taxable items in a 12-month period is considered a "seller" and must collect sales tax. Some of the major categories of goods and services that are subject to sales or use tax in Texas include:
Major categories of goods or services that are exempt from sales tax in Texas include:
A shadow tax, the use tax, is also imposed at the same rate as the sales tax. It is primarily intended to tax property that is acquired from sources outside of the state, in transactions not subject to sales tax, when such property is used or consumed within Texas. Use tax may also apply to items purchased on an exempt basis, such as for resale, if such items end up being used or consumed, instead of being resold. Businesses making sales that are subject to state sales or use tax must file monthly tax returns, generally, with the State Comptroller of Public Accounts, to pay over the taxes. Businesses with small amounts of tax to pay will be allowed to file quarterly, or annually. A discount of 0.5% of the tax collected is allowed if the taxes are paid on time, or are prepaid, as a way of compensating the retailer for collecting the tax. For more information on Texas sales and use tax registration and compliance, see contact information for the offices of the Texas Comptroller of Public Accounts in Section VI(a). (e) Real and Personal Property Taxes. In Texas, as in every other state, any business real estate you own will be subject to real property taxes. In general, there is little that you must do, unless you wish to challenge your assessed valuation, since the assessor will bill you for each year's property taxes as they come due. Texas has some of the highest property taxes in the nation, but the new, expanded franchise tax legislation in 2006 also provided for a cut of 33% in Texas school property taxes. Texas also imposes personal property taxes on tangible personal property. ("Personal property" is any kind of property that is not real estate.) Business inventories are not exempt from personal property tax in Texas, unlike many other states. A person who owns property on January 1 of the year is personally liable for the property tax for that year, even if the person no longer owns the property after that date. While Texas generally taxes tangible personal property, it does not impose a property tax on intangible personal property, such as stocks, bonds, promissory notes, and other such paper assets, except in the case of certain financial institutions and transportation industries. (f) Other Business Taxes. Texas imposes a number of excise and other taxes on businesses, including:
Unlike most other states, Texas does not impose a tax on real estate conveyances or recordation of real estate documents. (g) Trade Names. A trade name, also known as a fictitious or assumed name, is any name used in the course of business that does not include the actual legal names of all the owners of the business. Thus, if your business goes by any name other than your own real name, it is operating under an assumed name. For a sole proprietor or a general partnership, an assumed name might also be one that suggests the existence of additional owners, by using such words as "company," "associates," or "group." In the case of a corporation, limited partnership, LLP, or LLC, it will be considered to be using an assumed business name if it operates under a name other than its legal name. In most states where you do business, it will be necessary to register a trade, fictitious, or assumed name, so that people who do business with you can find out who the actual owners of your business are. However, a fictitious name filing often provides very little protection for trademarks or the right to use a trade name. Thus, you may also want to register any such trade name, or trademark, as a means of protecting against other companies usurping that particular trade name. Like most states, Texas requires businesses that operate under a fictitious or assumed name to file an assumed name certificate. Unlike most other states, however, the Texas law has real teeth in it, as failing to file such a certificate when required to do so is a Class A misdemeanor. However, beginning April 1, 2009, this penalty is repealed, and the only penalties for failure to file are the inability to bring a court action in the Texas courts to enforce a contract in which the unregistered name was used or, when an action is brought against an unregistered business as a defendant, a court may award the other party to the lawsuit the costs (including attorney fees) incurred in locating and effecting service of process on the defendant. Sole proprietors and general partnerships that do business under an assumed name in Texas must file an assumed name certificate with the county clerk in each county where the business has or will maintain business premises or, if none, in each county where it does business. All corporations, LLC's, LLP's, and limited partnerships that operate in Texas under an assumed business name must file an assumed name certificate (Form 503, 1-06 revision) with the Corporations Division of the Texas Secretary of State's office, and must also file with the appropriate county clerk. The secretary of state charges a fee of $25 to file an assumed name certificate. V. EMPLOYER REQUIREMENTS IF YOU HAVE EMPLOYEES (a) Employer Registration and Withholding. Once you hire the first employee in your business, you must comply with numerous Federal and state laws. One of the first things you will need to be concerned about as a new employer is the requirement that you withhold personal income taxes from the wages of your employees. As an employer, you are responsible for withholding the taxes and paying them over to the government on behalf of the employee. If you have any employees, you will be withholding federal income tax and FICA taxes from their wages. However, since Texas has no state income tax on wages, you will not need to be concerned with any obligation to withhold state income tax. However, if you pay more than a minimal amount of wages, you will most likely be required to pay state unemployment tax, and will have to register with the state as an employer for unemployment tax purposes, as described in Section V(b). (b) Unemployment and Other State Payroll Taxes. If your business employs one or more individuals in each of 20 weeks during the current or prior calendar year or if your payroll amounts to $1,500 in any calendar quarter, in the current or previous year, you will be required, as an employer, to pay state unemployment tax based on the amount of such wages paid. Employers subject to the Texas unemployment tax are required to register with the Tax Department of the Texas Workforce Commission on Form C-1, Status Report. New employers are required to pay tax at a rate of 2.7% in 2008 on the first $9,000 of wages paid to each employee. After you have had employees for a while, you will develop an unemployment tax experience rating. This rating is based on the number of employees you terminate who then claim unemployment benefits and the amount of such benefits paid to those former employees, under complex formulas. The Texas Workforce Commission will inform you when they have assigned you an individual tax rate based on your firm's experience rating. That rate may be higher or, if you have had relatively few benefit claims charged to your account, may be lower than the standard new employer tax rate you initially were paying. Rates may vary, depending on your industry classification. All state unemployment taxes are imposed upon you as the employer, and, under Texas law, cannot be charged to your employees or withheld from their wages. Quarterly returns must be filed by the end of the month after the end of each calendar quarter, on Form C-3. For more information on your Texas unemployment tax obligations as an employer, see the contact information for the offices of Tax Department, Texas Workforce Commission, listed in Section VI(a). (c) Workers' Compensation. Workers' compensation insurance is a state-mandated insurance requirement for most employers, in almost every state. Texas is the one exception to this rule, as it has no such requirement, except for businesses that enter into construction or building contracts with a government entity. Employers who choose not to obtain workers' compensation coverage are required to notify the Workers' Compensation Division of the Texas Department of Insurance of such decision. Failure to do so constitutes a separate Class D administrative violation for each day the employer operates without giving such notification. Formerly, notice of non-coverage was to be given to the Texas Workers' Compensation Commission, but that agency was abolished on September 1, 2005 and its functions transferred to a new division of the Department of Insurance. Whether or not you provide workers' compensation insurance coverage for your workers, you must post a notice in the workplace that informs employees as to whether you are providing them such coverage. Workers' compensation provides wage loss and medical benefits to employees injured on the job and it protects you, as an employer, from legal action for damages for injuries or job-related illnesses suffered by your employees. In effect, it is a "no-fault" insurance system for work-related injuries or illnesses. Thus, if you fail to obtain required workers' compensation insurance, and an employee is injured on the job, you will have opened yourself to unlimited liability and severe legal consequences, so it is very important to obtain workers' compensation insurance for your employees. Accordingly, you would be well advised to obtain workers' compensation insurance as soon as you hire employees, even though Texas law does not (generally) require you to do so. The Division of Workers' Compensation estimates that about 70% of Texas employers provide workers' compensation coverage for their workers, and that about 80% of all workers in the state are covered. Be aware that neither general liability nor health and accident insurance can properly substitute for workers' compensation insurance, and neither provides income replacement for the period in which the injured employee is unable to work. For more detailed information regarding the Texas workers' compensation laws, contact your insurance carrier or see the contact information for the offices of the Texas Department of Insurance, Division of Workers' Compensation, listed in Section VI(a). (d) State Wage and Hour Laws. Some employees of certain small firms not engaged in interstate commerce are not covered by the federal minimum wage and overtime laws. However, even if few or none of your employees are covered by the federal wage-hour laws, if, for example, because your firm does less than $500,000 a year in gross sales and the employees in question are not deemed to "...engage in (interstate) commerce...," they will still generally be subject to the Texas wage-hour laws, which provide for a state minimum hourly wage that is the same as the federal minimum wage, which is currently $6.55 an hour, as of July 24, 2008 (increasing to $7.25 on July 24, 2009). Note that, as under federal wage-hour laws, certain classes of executive, administrative, and professional employees and outside salespersons are exempted from the Texas wage-hour rules. Besides the federal wage-hour posters that you must display in the workplace, you must also display a state wage-hour poster, which you can obtain from the Texas Workforce Commission. (See contact information in Section VI(a).) In addition to wage-hour laws, most businesses are subject to federal child labor laws, which put numerous restrictions on the working hours and kinds of work in which minors under the age of 18 may engage. Your business must also be cognizant of similar state child labor laws, in Texas, which prohibit hiring minors when doing so would violate the state's compulsory school attendance laws. The Texas child labor laws generally prohibit hiring children under age 14, except for child actors, and hiring of 14- and 15-year-olds is strictly limited, in terms of total hours that may be worked or the time of day when work is permitted during school session. Texas has adopted as its rules the federal laws that govern the employment of 14- and 15-year-olds, even in cases where the federal law is inapplicable. Generally, 14- and 15-year-olds may not work more than 8 hours a day or 48 hours a week, or between the hours of 10 p.m. and 5 a.m. if the next day is a school day (midnight and 5 a.m. otherwise). For 16- and 17-year-old children, Texas also generally follows the federal child labor law rules, except that under the Texas law, some driving of vehicles by such children is defined as "non-hazardous," while any such operation of a motor vehicle by minors under age 18 is generally prohibited by the federal child labor laws. (e) State Occupational Safety and Health Laws. Employers in Texas must comply with state and federal job safety laws designed to prevent injuries resulting from unsafe or unhealthy conditions in the workplace. The U.S. Department of Labor, Occupational Safety and Health Administration (OSHA) enforces health and safety standards in the state of Texas, as the state relies on the federal OSHA agency, rather than having its own standards and enforcement agency, as is the case in more than half of the states. Note that while you may obtain a free safety consultation from federal OSHA experts, they must and will cite you for any violations they discover at your workplace. This is not the case with state safety inspections. If you request a safety consultation from the Workers' Health and Safety Division/OSHCON, or the Texas Division of Workers' Compensation, and they detect violations, they will not cite you if you promptly correct the unsafe conditions. If you are in compliance with federal standards and employ 150 or fewer workers, you will then be exempt from any further inspections for the next 12 months. For information on your job safety and health obligations as an employer, required posters, and possible on-site safety consultations, see the contact information for the Austin offices of the Workers' Health and Safety Division of the Division of Workers' Compensation, which is listed in Section VI(a). (f) Other Miscellaneous State Labor Laws. Other Texas labor laws you need to be aware of, as an employer, include the following: (1) Wage payments to terminated employees. State law requires that you pay wages at least twice a month to your nonexempt employees, or monthly in the case of certain administrative, executive and other employees who are exempt from federal overtime pay requirements. A discharged employee must be paid his or her final wages within 6 days and other employees who leave your employment must be paid by the next regular payday. Employers must post notices indicating the paydays in conspicuous places in the workplace. Otherwise, the designated paydays must be the 1st and 15th of each month. You may obtain the Texas Payday Poster from the Texas Workforce Commission, at the address for that agency listed in Section VI(a), or you may download the form from their website. (See the Workforce Commission Internet web link at Section VI(c).) (2) Right-to-work laws. About half the states have enacted "right-to-work" laws, which guarantee that no person may be denied employment for refusing to join a union or for not paying union dues, thus banning either "union shop" or "agency shop" agreements, or both. In a union shop, an employee not belonging to a union may be hired but then must join the union, usually within 30 days. In an agency shop, an employee need not join the union, but to remain employed, must pay union dues. Texas has a right-to-work law, which makes it an attractive place to do business, for many employers. Under this law, employment may not be denied based on membership or non-membership in a labor union. (3) State anti-discrimination laws. In addition to complying with federal anti-discrimination laws, employers must also be aware of and comply with state civil rights laws in Texas. State law prohibits employers from discriminating on the basis of race, color, national origin, disability, religion, sex or age. An employer is subject to this law if the employer has had 15 or more employees for each working day during 20 weeks of the year, generally. The law also prohibits discriminatory notices or advertisements of any kind in connection with employment, except where disability, religion, sex, national origin, or age is a bona fide occupational qualification. Employers may (optionally) post a Texas civil rights poster in the workplace, "The Law in Texas," which is available from the Civil Rights Division of the Texas Workforce Commission. For more information on state civil rights laws in Texas, contact the Austin office of the Texas Workforce Commission, Civil Rights Division (formerly the Commission on Human Rights, before March 1, 2004). See the contact information for the Civil Rights Division in Section VI(a). (4) Reporting new hires. Under federal welfare reform laws, employers in all states are now required to report newly-hired (or rehired) employees to a designated state agency (the Texas Employer New Hire Reporting Program, in the office of the Attorney General, for Texas employers) within 20 days after the date of hire. Employers reporting new hires electronically must file reports twice a month (if needed) on dates that are not more than 16 days nor less than 12 days apart. See the address for reporting new hires in Section VI(a), or the Web link for reporting new hires online, in Section VI(c). VI. STATE SOURCES OF HELP AND INFORMATION (a) Key State Agencies Contact Information. Texas, as many states have done in recent years, has set up a "one-stop" center to help your new or existing business with the process of obtaining all necessary state licenses and permits. The Small Business section of the Governor's Office, Division of Economic Development and Tourism, acts as a central referral source and can help you jump-start your business, without your having to go from agency to agency to meet all the legal and regulatory licensing requirements. Their helpful website can walk you through the basics of the process of making sure you obtain all necessary state licenses and permits. Or, you may prefer to contact the various agencies that are mentioned in this book or listed below on an individual basis, to obtain needed forms, official posters, information, and other assistance from each such agency. A list of addresses and other contact information for such key agencies is set forth below for your convenience. BUSINESS STARTUP INFORMATION. A key agency that can provide helpful information on getting your business up and running in Texas is: Office of the Governor SECRETARY OF STATE. Contact the office of the secretary of state for information on:
Corporations Section TAXES. Obtain state franchise, sales and use tax, and other miscellaneous business tax forms, instructions and information from the Comptroller of Public Accounts, which is the main tax collection agency in Texas. A number of business registration and tax forms can now be completed on-line at their website. Tax Assistance Section STATE LABOR LAWS. Contact the following agency about your obligations as an employer under various state labor laws, including:
Texas Workforce Commission STATE LICENSES. There are a bewildering number of state agencies that issue state licenses or permits for various professions, occupations, and types of business activities. If you are not sure which agencies you need to obtain state licenses from, contact the Small Business section, of the Office of the Governor, Division of Economic Development and Tourism, at the address listed above for that agency. STATE SALES TAX. Obtain your sales and use tax license or permit and information on the Texas sales and use tax law, by requesting the registration form, Form AP-157 (for sole proprietors) or Form AP-201 (for other business entities), from the Comptroller of Public Accounts, at the address listed above for that agency, or to obtain forms for sales and use tax registration, call: 1-(800) 252-5555 (Toll-free nationwide) To request a Certificate of No Tax Due when buying an existing business, write to: Audit Division Headquarters Or fax your request to: (512) 475-0349 EMPLOYER WITHHOLDING. Since there is no state individual income tax law, employers in Texas do not need to be concerned with any state income tax withholding obligations. STATE UNEMPLOYMENT TAX. Contact the Tax Department of the Texas Workforce Commission, at the address listed above for that agency, to determine whether you are an employer subject to payment of state unemployment taxes, and for registration as an employer if you are subject. WORKERS' COMPENSATION INSURANCE. If you employ workers for whom you want to provide workers' compensation coverage (such coverage is not mandatory in Texas), contact the Division of Workers' Compensation of the Texas Department of Insurance for further information. (Note that the Texas Workers' Compensation Commission was abolished by an act of the legislature, as of September 1, 2005.) Texas Department of Insurance STATE NEW HIRE REPORTING. Report new hires within 20 days to the following state agency, or see the URL for the New Hire Reporting Operations Center in Section VI(c): Texas Employer New Hire Reporting Program STATE OSHA PROGRAM. There is no state OSHA program in Texas. The federal government provides federal OSHA enforcement instead. For required posters and information on federal occupational safety and health laws that affect you as an employer in Texas, contact the following federal OSHA office: U.S. Department of Labor/OSHA Or, to take advantage of free workplace safety consultations that are offered by the state, contact: Workers' Health and Safety Division Or, contact OSHCON at: (800) 687-7080 STATE ANTI-DISCRIMINATION LAWS. Contact the following state agency for more detailed information on Texas civil rights laws that may apply to your business, and to obtain an optional anti-discrimination notice you may wish to post in your workplace: Texas Workforce Commission (b) Small Business Development Centers. A number of Small Business Development Centers (SBDCs) are located throughout Texas to assist you. These centers, usually located on college campuses, provide a wealth of start-up information and sponsor frequent business-oriented seminars. Contact the following office below for information, or for the location of other Texas SBDCs nearer to you. SBDC: North Texas Region (c) Internet Sites. For anyone with access to the Internet, there is a wealth of state and even local business information provided by state and local governments. All states now have a state government Web page, and most major Texas state agencies also have sites on the Internet where you can obtain useful small business information on matters such as state taxes, financing sources, or the addresses and phone numbers (or e-mail addresses) of various state and federal agencies' offices in Texas. Since new sites are appearing frequently, you might also want to search for other Texas government Web sites by using one of the popular Internet search engines, such as Google, MSN, or Yahoo. To start your Internet search for Texas government information, you may want to begin with the following Internet sites: State of Texas Home Page: List of Texas state government agencies: Comptroller of Public Accounts (Texas state tax agency): Texas Resale Certificate form (interactive .PDF file): Texas Secretary of State, Corporations Section (incorporation, LLC and partnership filings): Office of the Governor, Economic Development and Tourism (small business assistance and other assistance for businesses): Texas Employer New Hire Reporting (information and reporting of new hires electronically): Texas Workforce Commission: (d) Financing Sources. For information and help on locating financing for your small business, contact the nearest U.S. Small Business Administration office in Texas, or contact the Governor's Office, Division of Economic Development and Tourism, listed in Section VI(a), for information on the Capital Access Program and other state financial assistance programs for small businesses. You can contact the U.S. Small Business Administration at any of several District Offices throughout the state or at the following Texas Regional Office: U.S. Small Business Administration |
Copyright © 2008 Michael D. Jenkins
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