Georgia Rules: Texas Franchise Tax is an Income Tax

The Georgia Tax Tribunal ruled that the Texas Franchise Tax is an income tax for the purposes of the adjustment to federal adjusted gross income permitted to resident owners of pass-through entities.

In one of its more significant decisions since becoming active on Jan. 1, 2013, the Georgia Tax Tribunal (the “Tribunal”) ruled that the Texas Franchise Tax (the “TFT”) is a tax “on or measured by income” for purposes of the adjustment to federal adjusted gross income (“FAGI”) permitted to resident owners of pass-through entities. [1]

In this case, the taxpayer owned an interest in an LLC that did business in Texas. The LLC filed the entity-level TFT report and paid the TFT, which is based on the LLC’s margin that is apportioned to Texas. An LLC’s margin (prior to apportionment) equals the lesser of (i) total revenue minus cost of goods sold, (ii) total revenue minus compensation, or (iii) 70 percent of total revenue. [2] The taxpayer reported his FAGI (which included his share of the LLC’s income) on his Georgia resident individual tax return and then reduced FAGI based on the amount of income that was subject to the TFT in accordance with the Georgia statute that permits an adjustment to FAGI “for the entity’s income taxed in another state which imposes on the entity a tax on or measured by income.” [3] The Georgia Department of Revenue (the “Department”) denied the adjustment based on its view that the adjustment is allowed only if the tax paid by the entity is on or measured by net income.

In ruling for the taxpayer, the Tribunal rejected the Department’s interpretation of the statute based on the statute’s plain language, and refused to read the term “net” into the language. The Tribunal’s conclusion that the TFT is a tax “on or measured by income” was based on its analysis that the terms “income” and “gross income” are synonymous (and include all sources of income without regard to deductions or expenses) and that the TFT’s total revenue calculation includes basically all items of income that make up gross income under the Internal Revenue Code. Specifically, the Tribunal stated that the TFT “is thus on or measured by ‘income,’ whether the focus is on the ‘total revenue’ base or the ‘taxable margin’ base.” This language is significant since it raises the possibility that other state taxes measured by revenue (and without any deductions) may be eligible for the adjustment.

Resident individual taxpayers should review current and prior returns that are still within the three-year statute of limitations period and determine if they are eligible for refunds. Unfortunately, the Tribunal’s opinion did not address exactly how one computes that allowable adjustment under the statute. It is anticipated that the Department will issue a regulation to address this, although it is not clear when.

Contact Jeff Glickman, partner-in-charge of HA&W’s State and Local Tax practice, at jeff.glickman@aprio.com for more information.

[1] H. Alan Rosenberg v. Douglas J. Macginnittie, Commissioner, Georgia Department of Revenue, No. 1414626 (GA Tax Tribunal, Nov. 25, 2014).
[2] Effective Jan. 1, 2014, a fourth alternative to compute margin is available which equals total revenue minus $1 million. This case concerned tax years prior to 2014.
[3] Ga. Code Ann. § 48-7-27(d)(1)(C). This provision applies to owners of entities that are taxed as partnerships or disregarded for federal income tax purposes. A similar adjustment is permitted to resident shareholders of S-corporations under Ga. Code Ann. § 48-7-27(d)(1)(B).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.

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