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 most often are flat regardless of the amount of income, generally range from roughly 4% to 10%. 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, six states—Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming—do not have a corporate income tax. However, four of those states—Nevada, Ohio, Texas, and Washington—do have some form of gross receipts tax on corporations. Moreover, five of those states—Nevada, South Dakota, Texas, Washington, and Wyoming—as well as Alaska, Florida, and Tennessee currently have no personal income tax. Individuals in New Hampshire 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 justified as a tax simply for the 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 that applies to most Texas businesses other than sole proprietorships and certain general partnerships (those where all partners are natural persons as opposed to businesses or other entities). At the same time, Texas has no personal income tax. So, 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 .75% of the taxable margin. However, for qualifying wholesalers and retailers (meaning, generally, businesses primarily engaged in wholesale or retail trade), the rate is 0.375%. Also, for businesses with $20 million or less in total revenue that elect to use the so-called E-Z Computation, the rate is 0.331%. (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 four amounts:
There is no minimum franchise tax. Moreover, if your business's total tax due is less than $1,000 or your business's annualized total revenue is less than or equal to the no-tax-due threshold ($1,230,000 in 2022 and 2023; adjusted every two years), 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.
Texas corporations are subject to the franchise tax.
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 they receive. 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 they ultimately receive.
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, including single member LLCs. An individual member does not owe state tax on whatever portion of the company's net income they ultimately receive.
(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.)
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.
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.
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 Frederick Daily (Nolo).
Updated February 9, 2022