Texas does not have a state personal or corporate income tax. Instead, it imposes a franchise tax (also called the margin tax) on most businesses operating in the state. Understanding how the Texas franchise tax compares to income taxes in other states is important for Texas business owners and for businesses considering relocating to Texas.
What Is the Texas Franchise Tax?
The franchise tax is a privilege tax imposed on entities doing business in Texas. It is based on a business's taxable margin, which is calculated using total revenue minus certain deductions. The tax is not an income tax because it is based on gross margin rather than net profit.
Franchise Tax Rates
- Standard rate: 0.75% of taxable margin
- Wholesale and retail rate: 0.375% of taxable margin
- No-tax-due threshold: Businesses with total revenue below a defined threshold (adjusted periodically by the Comptroller) owe no franchise tax
- EZ computation: Businesses with revenue under the EZ threshold can use a simplified computation at a reduced rate
How It Differs from Income Tax
Tax Base
- Income tax (other states): Based on net profit after all deductions and expenses
- Texas franchise tax: Based on gross revenue minus limited deductions (cost of goods sold, compensation, or 30% standard deduction)
Profitability Impact
- Income tax: No profit means no tax (generally)
- Franchise tax: A business can owe franchise tax even if it is not profitable, because the tax is based on revenue and margin, not net income
Personal Impact
- States with income tax: Business owners pay state income tax on wages, dividends, and distributions
- Texas: No personal income tax, which reduces the combined tax burden for business owners who also live in Texas
Calculating Taxable Margin
Texas businesses calculate taxable margin by choosing the lowest of the following methods:
- Total revenue minus cost of goods sold
- Total revenue minus compensation
- 70% of total revenue (equivalent to a 30% standard deduction)
- Total revenue times $1 million (effectively a minimum threshold)
Who Is Exempt from the Franchise Tax
- Sole proprietorships (unless organized as an LLC or LP)
- General partnerships owned entirely by natural persons
- Businesses with total revenue below the no-tax-due threshold
- Certain passive investment entities
Comparison to Other States
When comparing total business tax burden, Texas is generally favorable for profitable businesses because there is no additional state income tax layer on top of the franchise tax. However, businesses with high revenue but low margins may find the franchise tax more burdensome than an income tax would be, since the franchise tax can apply even when the business is not profitable.
Find Programs That May Fit Your Business
Understanding your tax obligations is essential for maximizing incentive programs. Many Texas incentives, including franchise tax deductions and exemptions, can reduce your overall tax burden.
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