Franchise Tax Frequently Asked Questions

No, compensation is specifically defined for franchise tax reporting purposes in Texas Tax Code Section 171.1013, Determination of Compensation.

The following components are included in the compensation deduction:

• W-2 wages and cash compensation paid to officers, directors, owners, partners and employees (including net distributive income assigned or disbursed to natural persons) subject to the wage limitation, adjusted each even-numbered year using the consumer price index as required by Texas Tax Code Section 171.006, Adjustment of Eligibility for No Tax Due, Discounts, and Compensation Deduction. The wage and cash compensation deduction for each 12-month period are as follows:
  • $450,000 per person for reports originally due in 2024 and 2025
  • $400,000 per person for reports originally due in 2022 and 2023
  • $390,000 per person for reports originally due in 2020 and 2021
  • $370,000 per person for reports originally due in 2018 and 2019
  • $360,000 per person for reports originally due in 2016 and 2017
  • $350,000 per person for reports originally due in 2014 and 2015
  • $330,000 per person for reports originally due in 2012 and 2013
  • $320,000 per person for reports originally due in 2010 and 2011
  • $300,000 per person for reports originally due in 2008 and 2009
• Benefits provided to all personnel, including workers' compensation, health care and retirement benefits, to the extent deductible for federal income tax purposes.

See Texas Tax Code Section 171.1013, Determination of Compensation and Rule 3.589, Margin: Compensation.

A single-member LLC treated as a sole proprietorship for federal tax purposes may include in compensation the net distributive income (NDI) assigned or disbursed to the single member that is a natural person. NDI is the net amount of income, gain, deduction or loss reportable on the sole proprietor's federal tax return, Form 1040, to the extent that it relates to the LLC. For example:

• Schedule C - line 31 (net profit or loss)
• Schedule E - line 26 (total real estate and royalty income or loss)
• Schedule F - line 34 (net farm profit or loss)
• net capital gain or loss from Form 1040 line 13
• other gain and losses from Form 1040 line 14

No, the employer's share of payroll taxes cannot be included in wages and cash compensation or benefits.

See Texas Tax Code Section 171.1013, Determination of Compensation and Rule 3.589, Margin: Compensation.

No. IRS Form 1099-MISC nonemployee compensation cannot be included as compensation when calculating margin.

See Texas Tax Code Section 171.1013, Determination of Compensation and Rule 3.589, Margin: Compensation.

Net distributive income (NDI) for a pass-through entity is the net amount of income, gain, deduction or loss reportable to the owners on an IRS Form K-1 for the entity’s tax year. Actual distribution is not required. Guaranteed payments to partners are included when computing NDI.

• To compute NDI for a partnership, from the partner’s IRS Form 1065 K-1, you
  • add items 1, 2, 3, 4, 5, 6a, 7, 8, 9a, 10 and 11; and
  • subtract from that result the sum of items 12, the item 13 amounts that represent deductions and item 21 (Foreign taxes paid or accrued).
• To compute NDI for each owner that is a natural person for an S corporation, from IRS Form 1120S K-1, you
  • add items 1, 2, 3, 4, 5a, 6, 7, 8a, 9 and 10;
  • subtract from that result the sum of items 11, the item 12 amounts that represent deductions, and Code F item 16 (Foreign taxes paid or accrued).

Yes. If an entity elects to subtract compensation in computing its margin, it must include all compensation as defined in Texas Tax Code Section 171.1013, Determination of Compensation. If NDI is a loss, then treat it as a negative number when computing the entity’s compensation deduction.

See also Rule 3.589 (b)(9), Margin: Compensation.

If an entity issues a W-2 and a K-1 to an individual, add the individual’s W-2 and K-1 amounts together and apply the 12-month period wage limitation allowed each individual when computing the entity’s compensation deduction.

See Texas Tax Code Section 171.1013, Determination of Compensation and Rule 3.589, Margin: Compensation.

No. If your entity’s accounting period is more or less than 12 months, you must pro-rate the compensation wage limitation over the length of the accounting period.

For example, if you are filing the 2016 report for the accounting period Jan. 1, 2015, to June 30, 2015, the compensation wage limitation is not $360,000 for a 12-month period; rather, it is limited to $180,000 for each person for the 6-month period. To calculate this pro-rated compensation wage limitation deduction amount, you

• add the number of payroll periods (i.e., weekly, monthly, etc.) in the accounting period;
• divide the number of payroll periods in the accounting period by total payroll periods in a 12-month accounting period; then
• multiply by the 12-month compensation wage limitation; and
• round the amount to the nearest whole dollar.

See Texas Tax Code Section 171.1013(c), Determination of Compensation.

Yes, but you treat benefit costs differently for franchise tax based on how you report them for federal tax purposes.

• When you do not deduct your benefit costs as guaranteed payments on IRS Form 1065, on Schedule K, line 13d and on Schedule K-1, line 13 – You can include your benefit costs in your compensation deduction of your partnership for franchise tax purposes without regard to the wage limitation.
• When you deduct your benefit costs on IRS Form 1065 as guaranteed payments – You can include your benefit costs in your compensation deduction of your partnership for franchise tax purposes without regard to the wage limitation if and only if you adjust the amount you deduct as a guaranteed payment as may be necessary to prevent a double deduction of benefit costs.

See Texas Tax Code Section 171.1013, Determination of Compensation and Rule 3.589, Margin: Compensation.