Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states, corporations are subject to a corporate income tax while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
Currently, four states (Nevada, South Dakota, Washington, and Wyoming) do not have a corporate income tax, and the same four states, along with Alaska, Florida, and Texas, have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Texas has a franchise tax (“margin tax”) that applies to most Texas businesses other than sole proprietorships and certain general partnerships. At the same time, Texas has no personal income tax. Thus, while your Texas business itself may be subject to the franchise tax, any remaining income after these taxes that passes through to you personally, for example from an S corporation, LLC, or limited liability partnership (LLP), will not be subject to further taxation on your personal state tax return.
The Texas franchise tax rate for most businesses is 1.0% of the “taxable margin.” However, for qualifying wholesalers and retailers (meaning, generally, businesses primarily engaged in wholesale or retail trade), the rate is 0.5%. Also, for businesses with $10 million or less in total revenue that elect to use the so-called E-Z Computation, the rate is 0.575%. (E-Z Computation is not covered here.)
The “taxable margin,” on which the franchise tax is based, is equal to the least of the following three amounts:
- 70% of total revenue
- 100% of total revenue minus cost of goods sold (COGS); or
- 100% of total revenue minus compensation.
There is no minimum franchise tax. Moreover, if your business’s taxable margin is less $1,000, or your business’s annualized total revenue is less than or equal to $1,030,000, then you do not owe any franchise tax. Franchise tax returns are due each year on May 15th.
Note that various possible state credits and discounts that may apply to your particular business are not covered here.
Let’s briefly look at additional details for five of the most common forms of Texas business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Texas corporations are subject to the franchise tax.
Example: For the 2012 tax year, your Texas corporation had annualized total revenue of $500,000. Because this amount is less than $1,030,000, your corporation will owe no franchise tax.
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation is not subject to separate federal income tax. Furthermore, most states also do not subject S corporations to a separate income tax, and instead tax each individual shareholder on the portion of the corporation’s annual net income he or she receives. In other words, in most states, S corporations are pass-through entities. While Texas does recognize the federal “S” election, S corporations are nevertheless subject to the state’s franchise tax. An individual shareholder, however, does not owe state tax on whatever portion of the corporation’s net income he or she ultimately receives.
Example: For the 2012 tax year, your S corporation had annualized total revenue of $500,000. Because this amount is less than $1,030,000, your corporation will owe no franchise tax. Moreover, individual shareholders will not owe tax to the state on their respective portions of the corporation’s net income.
Limited Liability Companies (LLCs). In most states, standard LLCs are pass-through entities that are not required to pay either federal or state income tax. Instead, income from the business is distributed to individual LLC members, who then pay federal and state taxes on the amount distributed to them. In Texas, however, LLCs are subject to the franchise tax. An individual member does not owe state tax on whatever portion of the company’s net income he or she ultimately receives.
(Note that, while by default LLCs are classified for federal tax purposes as either partnerships or disregarded entities, it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would be subject to federal corporate income tax. However, this change in classification would not affect the LLC’s franchise tax obligations.)
Example: For the 2012 tax year, your multi-member LLC, which has the default tax classification of partnership, had annualized total revenue of $500,000. Because this amount is less than $1,030,000, your LLC will owe no franchise tax. Moreover, individual LLC members will not owe tax to the state on their respective portions of the company’s net income.
Partnerships. There are various types of partnerships, such as general partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs), among others. In Texas, most partnerships are subject to the franchise tax. Generally speaking, the only exception is a general partnership directly and solely owned by natural persons. Regardless of the type of partnership, individual partners personally owe no state tax on partnership income distributed to them.
Example: For the 2012 tax year, your limited liability partnership had annualized total revenue of $500,000. Because this amount is less than $1,030,000, your partnership will owe no franchise tax. Moreover, individual partners will not owe tax to the state on their respective portions of the partnership’s net income.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay federal tax on that income. However, because Texas has no personal income tax apart from interest and dividends, you will not owe tax to the state on your business’s income.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Texas. However, if you’re doing business in several states, you should be aware that your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Texas, it may be subject to Texas taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Texas’s franchise tax, check the Comptroller of Public Accounts website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).