Corporate Officers NOT Liable for TX Franchise Tax -- Why Not?

In this case (Paccar Financial Corp. v. Potter, Texas Court of Appeals, Fifth District, No. 05-05-00403-CV, October 31, 2007), the individuals who had been corporate officers when a corporation's Texas franchise tax report was due had actually resigned before the corporate debt was incurred after the report was not filed. As a result they were not personally liable for the corporation's debts.

That is somewhat of a surprising result, but good news for the officers. The states have been generally successful in attaching personal liability to corporate officers, but in this case, they were able to escape the pain. Good for them!

It's not necessarily a good thing to be a corporate officer these days. Lots of potential liabilities. As the old saying goes, "you can't know what you don't know".

Legal Experts Say High Court Will Not Dare Upset the Municipal Bond Market

In an earlier post, we discussed the pending US Supreme Court case on the issue of whether KY can tax out-of-state municipal bond income while exempting in-state bond income. It seems unconstitutional on its face. But according to this article in the Wall Street Journal, legal experts are pretty much agreeing the Court will let the states continue to tax them that way.

Everything's Bigger in Texas -- But This New Franchise Tax Is No Joke

Many of you know that Texas has recently enacted sweeping changes to its corporate income tax. Oh I know, Texas has no income tax – that would be unconstitutional. I’ve been asking myself -- How did we get to this?

Not that long ago, Texas had no income tax on individuals or corporations. There used to be a tax on the amount of “capital” a business employed in the state, which was poorly formulated and a few court cases and subsequent policy changes basically gutted it. Next they introduced the income component of the tax back in about 1991 or so. Still it was only applicable to certain business entities, because the Texas Constitution prohibits an individual income tax.

Now they have revised the tax once again. Somewhat curiously, they’re making a big to do about this not being a new tax or even a “margin tax” as some people call it. They say it’s merely a revised “franchise” tax. I guess they’re strategy is to minimize complaints, I’m really not sure. Their chief argument for it being the same old franchise tax, just slightly modified, is that it is still found in Chapter 171 of the Texas Tax Code. This all seems sort of silly – like they want to make the argument out to be what the tax is called. Who care’s what it’s called? The truth is this is a Texas-sized change in corporate taxation. For right now we’re stuck with it and we have to be ready for it since it is effective for reports due on or after January 1, 2008.

We are tax advisors and that the old saying within the industry is that any change in the tax law is good for business. However, I have a hard time taking off my Joe Citizen and Joe Business Owner hat and speaking strictly as a Tax Advisor when something as bad as this new tax is offered up by our elected officials.

Problem is, in speaking with many other business owners over the last several months, I’ve realized that very few people are even aware of this new tax and what it means to them. So we decided to inform people of this new tax and how it operates. That’s the reason for this newsletter and we will also be offering seminars on the new tax. Stay tuned and we’ll let you know when to tune in.

Here’s the basics:

This new franchise tax is basically a tax on the total revenues of a business with only a few deductions. The total revenues of the business are determined by adding up all the receipts of the “unitary combined group” – which is a totally new concept in Texas taxation. You are allowed the choice of two deductions. You can choose to deduct cost of goods sold or compensation. Then you multiply the net “margin” by the Texas apportionment factor giving you the taxable “margin”. Then finally you apply the applicable tax rate (either 1% or .5%)

Sounds simple and straight forward right? It’s not.

For example, here are just a couple issues that immediately come to mind:

• What is a combined/unitary group? First of all, it starts with 50% ownership, and it appears that “unitary” will be very broadly defined. That’s not good.
  
• The election of using cost of goods sold or the compensation deduction applies to all members of the group. What if some members of the group are service entities and others are manufacturers?

This tax will be a menace to businesses in Texas. But for now, this is what we’re stuck with. We will continue to stay on top of changes as they occur in this tax over the next few years and beyond.

She's Married with Children in New York - Or is she?

One and one is two, unless you're an accountant or an official with any department of revenue. I saw this summary of a recent NY case on CCH (Ilyaich, New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 820875, October 18, 2007).

"A taxpayer was entitled to claim head of household filing status, for New York personal income tax purposes, despite being legally married during the years in question. The taxpayer met the requirements under IRC Sec. 7703(b) to be considered unmarried for the years in question because she: (1) did not live with her husband; (2) solely and individually maintained an apartment that was the principal place of abode for her minor children; and (3) was otherwise entitled to claim a deduction for a personal exemption for her minor children."

Supreme Court Ruling Could Roil Municipal Bond Markets

The Supreme Court will hear arguments Nov. 5 on whether Kentucky violates the Constitution by taxing income earned on out-of- state bonds while exempting interest on ones issued by its own cities, school districts and other debt-issuing authorities. According this article from Bloomberg.com, "barring such preferential treatment would force 42 states, including New York and California, to either tax their own bonds or give identical breaks to out-of-state bonds. "

Most states tax the income from other states' municipal bonds while exempting the income from their own state's bonds. This would certainly seem to be an infringement on interstate commerce. The power to regulate interstate commerce is reserved for the Congress. States have been routinely prohibited from taxing out-of-state income more than they tax in-state income. So it would seem that the Court will rule against Kentucky in this case also.

If they do go against KY, then states would most likely have to decide whether they will tax all municipal bond income, or exempt it all. Either of those choices would seem to make the bonds from these 42 states immediately less valuable relative to bonds issued in the other states that presumably offered a higher yield relative to these 42 states.

It will be very interesting to see how this goes. There's one more aspect to this case that is very intriguing and that is, what if Justice Roberts continues on with this new argument that if a state has legitimate goals in mind and isn't just trying to favor commercial interests, it may be able to tax out-of-state income more than in-state. See the Bloomberg article for a great discussion on this. But if that reasoning takes hold, brace yourself for a whole new world in state taxation as states figure out ways to tax out-of-staters and exempt in-staters. It's so easy to tax non-voters isn't it?

The Extended Moratorium on Taxation of Internet Access Has Some Income Tax Implications

You might not immediately think of the recently signed Internet Access taxation ban as having anything other than an effect on state sales taxes, but there was a potential loophole in it that states like Texas smoked out.

As you probably know, Texas has enacted a sweeping new state income tax. They would like to call it simply a "modification to existing franchise taxes", but it's a big new tax -- but I digress. Some might call it a new tax. There was some concern evidently that the grandfathering provisions of the ban, would prevent Texas from imposing their modified franchise tax on Internet Service Providers. But, as we say here in Texas -- Don't Mess With Texas. It's not only Texas that might have been impacted. Michigan might have been affected with its business tax. So might also Ohio, with its commercial activity tax, and Washington's business and occupation tax might have been affected as well.

They made sure to get some language in the bill to clarify that it does not apply to state general business taxes, such as gross receipts taxes, that are structured in such a way as to be a substitute for or supplement the state corporate income tax.

These guys are on top of things.

By the way, you can get an actual copy of the bill from us. Just ask.