Texas Business Tax — Franchise Tax, Sales Tax & Property Tax Guide

Texas Franchise Tax: A Detailed Implementation Guide

The Texas Franchise Tax, also known as the Margin Tax, is a privilege tax imposed on entities that do business in Texas or that are chartered by the state. It is not a tax on income. For reports originally due on or after January 1, 2026, the no tax due threshold is $2,650,000 [1]. Entities with annualized total revenue at or below this amount owe no franchise tax but are still required to file a Public Information Report (PIR) or an Ownership Information Report (OIR) [1].

Margin Calculation Methods:

Taxable margin can be calculated using one of four methods [1]:

1. Total Revenue less Cost of Goods Sold (COGS): This method allows for the deduction of COGS, as defined by Texas Tax Code Section 171.1012 and Rule 3.588. It is generally applicable to entities that sell real or tangible personal property in the ordinary course of business [1].
2. Total Revenue less Compensation: This method allows for the deduction of compensation paid, with a limit of $480,000 per person for reports originally due on or after January 1, 2026 [1].
3. Total Revenue multiplied by 70%: This simplified method is available to entities that do not elect to use the COGS or compensation deductions [1].
4. EZ Computation: Available to entities with annualized total revenue of $20 million or less. This method calculates margin as 0.331% of total revenue [1].

Tax Rates:

For reports originally due on or after January 1, 2026, the franchise tax rates are [1]:

• 0.331% for entities primarily engaged in retail or wholesale trade (NAICS codes 42 or 44-45) that do not elect to subtract COGS.
• 0.75% for all other taxable entities.

Filing Procedures and Deadlines

Annual Reports:

Franchise tax reports are due on May 15 each year. If May 15 falls on a Saturday, Sunday, or legal holiday, the next business day becomes the due date [1].

Electronic Filing and Payment:

Electronic filing and payment are highly encouraged and available 24 hours a day via Webfile. Webfile assists with mathematical computations and includes built-in edits to prevent common errors [1]. Entities owing $10,000 or more during the preceding fiscal year are required to electronically pay their franchise tax [1]. Electronic payment options include credit card, electronic check (Web EFT), or TEXNET [1].

Extensions:

An extension of time to file a franchise tax report may be tentatively granted upon timely submission of a valid online extension payment or request [1]. The request must be received or postmarked on or before the original due date [1].

Combined Reporting:

Combined groups, consisting of entities with common ownership and unitary business operations, are required to file a combined report [1]. Special rules apply to the calculation of total revenue, COGS, and compensation for combined groups, including intercompany eliminations and a single $1 million deduction for the entire group [1].

Client Conversation Script: Texas Franchise Tax

Practitioner: "Good morning/afternoon, [Client Name]. Thanks for coming in. Today, I want to discuss your Texas business tax obligations, specifically the Texas Franchise Tax, also known as the Margin Tax."

Client: "Okay, I thought Texas didn't have an income tax. Is this something new?"

Practitioner: "That's a common misconception, and you're right that Texas doesn't have a personal or corporate income tax in the traditional sense. However, it does impose a franchise tax on most businesses operating here. It's not based on net income, but rather on your 'margin,' which is essentially your revenue minus certain deductions like cost of goods sold or compensation."

Client: "So, how does it work for my business?"

Practitioner: "For 2026, there have been some updates. The good news is, if your business's total revenue is $2,650,000 or less, you won't owe any franchise tax. However, even if you're below that threshold, you'll still need to file an informational report with the state, either a Public Information Report or an Ownership Information Report. It's crucial to file these to maintain good standing with the state."

Client: "What if my revenue is higher than that?"

Practitioner: "If your annualized total revenue exceeds $2,650,000, we'll need to calculate your taxable margin. There are a few ways to do this: we can subtract your cost of goods sold, or your compensation expenses, or simply take 70% of your total revenue. There's also an 'EZ Computation' option if your revenue is $20 million or less, which uses a fixed rate on your total revenue. We'll analyze your specific financials to determine which method results in the lowest tax liability for you."

Client: "And what are the rates?"

Practitioner: "The rates for 2026 are generally 0.75% of your taxable margin. If your business is primarily in retail or wholesale trade and you don't subtract cost of goods sold, there's a lower rate of 0.331%. We'll ensure we apply the correct rate based on your business activities."

Client: "When is this all due?"

Practitioner: "The annual report is typically due on May 15th. If that falls on a weekend or holiday, it shifts to the next business day. We can also file for an extension if needed, but it's important to do so timely. We'll handle all the filing for you electronically to ensure accuracy and timely submission."

Client: "Are there any common mistakes I should be aware of?"

Practitioner: "Yes, some common pitfalls include misclassifying your entity, failing to file the required informational reports even if no tax is due, or incorrectly calculating your margin. The state also looks for significant changes in reported margin or unusually high deductions. We'll work closely to ensure your reporting is accurate and consistent to minimize any audit risk."

Client: "That sounds complicated. I'm glad I have you to help."

Practitioner: "That's what we're here for. My goal is to ensure you're fully compliant with Texas tax laws while optimizing your tax position. We'll review everything thoroughly and make sure you're taking advantage of all available deductions and credits. Do you have any initial questions about this, or anything else we should discuss today?"

State Applicability and State-Specific Considerations

While the Texas Franchise Tax is a significant business tax, other state-specific taxes and considerations are crucial for practitioners advising clients in Texas.

Texas Sales and Use Tax:

Texas imposes a 6.25% state sales and use tax on all retail sales, leases, and rentals of most goods, as well as taxable services [2]. Local taxing jurisdictions (cities, counties, special purpose districts) can impose an additional local sales tax, with the total combined rate capped at 8.25% [2].

Sales Tax Nexus:

Businesses, including remote sellers, have Texas sales tax collection and reporting obligations if they establish economic nexus in the state. Economic nexus is generally triggered when a seller's total sales in Texas exceed $500,000 in a 12-month period [3]. Physical presence, such as having an office, employees, or inventory in Texas, also establishes nexus [3].

Taxable Services:

Unlike many states, Texas taxes a broad range of services. Practitioners must be aware of what constitutes a taxable service in Texas, as this can significantly impact compliance for service-based businesses [2]. Examples include: data processing services, information services, real property repair and remodeling, and certain amusement services.

Texas Property Tax:

Texas property taxes are among the highest in the United States, as they are the primary funding source for local government services, including public schools [4]. Property taxes are locally assessed and collected by appraisal districts and taxing units.

Valuation and Appraisal:

Property is appraised at its market value as of January 1 each year [4]. Property owners receive an appraisal notice and have the right to protest the valuation if they believe it is incorrect. The deadline to protest is typically May 15 or 30 days after the appraisal notice is mailed, whichever is later [5].

Exemptions:

Various property tax exemptions are available, with the most significant being the residence homestead exemption. For 2026, the state increased the homestead exemption to $140,000 for school district taxes, with an additional $60,000 for qualifying homeowners [6]. Other exemptions include those for seniors (over 65), disabled individuals, disabled veterans, and certain agricultural lands [4].

Business Personal Property Tax:

Businesses in Texas are subject to personal property tax on assets used to produce income, such as inventory, furniture, fixtures, and equipment [4]. This often comes as a surprise to businesses relocating from states that do not impose such a tax. Accurate reporting of business personal property is crucial to avoid penalties.

Deep Dive: Cost of Goods Sold (COGS) Deduction

For many Texas businesses, particularly those in manufacturing, retail, and wholesale, the Cost of Goods Sold (COGS) deduction is the most advantageous method for calculating the taxable margin. However, the Texas definition of COGS under Tax Code Section 171.1012 is highly specific and often differs significantly from the federal COGS calculation. Practitioners must carefully analyze a client's expenses to ensure all allowable costs are included and unallowable costs are excluded.

Direct Costs Allowed

The Texas Tax Code explicitly allows the deduction of direct costs associated with acquiring or producing goods. These include [1]:

• Direct Labor: Compensation paid to employees directly involved in the manufacturing or acquisition process. This includes wages, salaries, and certain benefits.
• Direct Materials: The cost of raw materials, parts, and components that become an integral part of the finished product.
• Handling and Storage: Costs related to the handling, storage, and transportation of goods prior to their sale.
• Utilities: The cost of electricity, water, and gas directly consumed in the manufacturing process.

Indirect Costs Allowed

In addition to direct costs, certain indirect costs may also be included in the COGS calculation, provided they are allocable to the acquisition or production of goods [1]:

• Depreciation and Amortization: Depreciation of equipment and facilities used directly in the manufacturing process. Note that for 2026, the federal bonus depreciation rate is 60%, but Texas does not conform to federal bonus depreciation for franchise tax purposes. Practitioners must calculate depreciation using standard MACRS or straight-line methods as applicable under Texas law.
• Rent and Lease Payments: Rent paid for facilities or equipment used in the production process.
• Insurance: Premiums for insurance on the manufacturing facility or equipment.
• Taxes: Certain taxes paid on the manufacturing facility or equipment, excluding income or franchise taxes.

Costs Specifically Excluded

It is equally important to understand which costs are explicitly excluded from the Texas COGS calculation. Including these costs can lead to audit adjustments and penalties [1]:

• Selling Costs: Expenses related to marketing, advertising, and selling the product, including sales commissions.
• Distribution Costs: Outbound transportation and freight costs incurred after the product is ready for sale.
• General and Administrative (G&A) Expenses: Overhead costs such as executive salaries, legal fees, accounting fees, and office supplies.
• Research and Development (R&D): While Texas offers an R&D credit, the costs themselves are generally not includable in COGS unless they are directly related to the production process.

Special Rules for Specific Industries

The Texas Comptroller provides specific guidance for certain industries regarding the COGS deduction [1]:

• Construction: Contractors can generally include the cost of materials, labor, and subcontracted work in their COGS. However, the treatment of certain indirect costs may vary depending on the type of contract.
• Software Development: The cost of developing software for sale or license may be included in COGS, but the rules are complex and require careful analysis of the development process.
• Agriculture: Farmers and ranchers have specific rules for calculating COGS, including the treatment of livestock and crop production costs.

Deep Dive: Compensation Deduction

For service-based businesses or those with high labor costs relative to revenue, the compensation deduction method often yields the lowest franchise tax liability. The Texas Tax Code defines compensation broadly, but there are strict limits and exclusions that practitioners must navigate.

What is Included in Compensation?

The compensation deduction generally includes [1]:

• Wages and Salaries: W-2 wages and salaries paid to officers, directors, owners, partners, and employees.
• Benefits: The cost of providing benefits, such as health insurance, retirement plan contributions, and workers' compensation, to the extent deductible for federal income tax purposes. For 2026, the 401(k) contribution limit is $23,500, and the IRA contribution limit is $7,000. These employer contributions are generally includable in the compensation deduction.
• Net Distributive Income: For partnerships and LLCs treated as partnerships, the net distributive income allocated to natural persons.

The Compensation Limit

A critical component of the compensation deduction is the per-person limit. For reports originally due on or after January 1, 2026, the maximum compensation deduction per person is $480,000 [1]. This limit applies to both W-2 wages and net distributive income. If an individual's total compensation exceeds this amount, the excess cannot be deducted.

What is Excluded from Compensation?

Certain payments are explicitly excluded from the compensation deduction [1]:

• Independent Contractors: Payments made to 1099 independent contractors are not considered compensation for franchise tax purposes. This is a common area of confusion and a frequent audit adjustment.
• Employer Payroll Taxes: The employer's share of payroll taxes, such as Social Security and Medicare taxes, is not includable in the compensation deduction. Note that for 2026, the Social Security wage base is $176,100.

Apportionment: Calculating the Texas Percentage

For businesses that operate both within and outside of Texas, calculating the franchise tax requires apportioning the taxable margin to determine the portion attributable to Texas activities. This is done using a single-sales factor apportionment formula.

The Apportionment Formula

The apportionment factor is calculated as follows [1]:

Texas Gross Receipts / Everywhere Gross Receipts = Apportionment Factor

The taxable margin is then multiplied by this apportionment factor to determine the apportioned margin, which is subject to the franchise tax rate.

Determining Texas Gross Receipts

The rules for sourcing receipts to Texas depend on the type of transaction [1]:

• Sales of Tangible Personal Property: Receipts from the sale of tangible personal property are sourced to Texas if the property is delivered or shipped to a purchaser within the state, regardless of the FOB point or other conditions of the sale.
• Sales of Services: Receipts from the performance of a service are sourced to Texas if the service is performed in the state. If a service is performed both inside and outside of Texas, the receipts must be apportioned based on the fair value of the services rendered in Texas.
• Intangible Property: Receipts from the use of intangible property, such as patents, copyrights, or trademarks, are sourced to Texas to the extent the property is used in the state.

The "Throwback" Rule

Texas does not have a general "throwback" rule for sales of tangible personal property. This means that if a Texas-based business sells goods to a purchaser in a state where the business does not have nexus, those sales are not "thrown back" to Texas and included in the Texas gross receipts numerator. This can be a significant advantage for Texas businesses with out-of-state sales.

Combined Reporting: Navigating Unitary Business Groups

Texas requires mandatory combined reporting for affiliated groups engaged in a unitary business. This means that multiple legal entities must file a single franchise tax report and calculate their tax liability on a combined basis.

Defining an Affiliated Group

An affiliated group exists when one or more entities own a controlling interest (more than 50%) in another entity or entities [1]. The ownership can be direct or indirect.

The Unitary Business Principle

Even if entities are part of an affiliated group, they are only required to file a combined report if they are engaged in a unitary business. A unitary business is characterized by centralized management, functional integration, and economies of scale [1]. Factors indicating a unitary business include:

• Shared executive officers or board members.
• Centralized accounting, legal, or human resources functions.
• Intercompany sales or transfers of goods or services.
• Shared use of intellectual property or trademarks.

Calculating the Combined Margin

When filing a combined report, the group must calculate its margin on a combined basis. This involves [1]:

1. Aggregating Revenue: Combining the total revenue of all members of the group.
2. Eliminating Intercompany Transactions: Removing revenue and expenses resulting from transactions between members of the group to prevent double counting.
3. Applying Deductions: The group must elect a single deduction method (COGS, compensation, or 70% of revenue) for the entire group. The group cannot mix and match methods among its members.
4. Apportionment: The group calculates a single apportionment factor based on the combined Texas gross receipts and combined everywhere gross receipts of all members.

Tax Credits and Incentives

Texas offers several tax credits and incentives that can reduce a business's franchise tax liability. Practitioners should proactively identify opportunities for their clients to claim these credits.

Research and Development (R&D) Credit

Texas provides an R&D credit for qualified research expenses incurred in the state. The credit is generally equal to 5% of the difference between the qualified research expenses for the current period and a base amount [1]. The credit can be applied against the franchise tax or the sales and use tax, but not both.

Historic Structure Rehabilitation Credit

A credit is available for the certified rehabilitation of certified historic structures in Texas. The credit is equal to 25% of the eligible costs and expenses incurred in the certified rehabilitation [1].

Clean Energy and Environmental Credits

Texas offers various incentives for investments in clean energy and environmental projects, such as the solar energy franchise tax exemption and the wind energy franchise tax exemption [1].

Interaction with Federal Tax Law

While the Texas Franchise Tax is a state-level tax, it interacts with federal tax law in several important ways. Practitioners must understand these interactions to provide comprehensive tax planning advice.

Federal Conformity

Texas generally conforms to the Internal Revenue Code (IRC) in effect for the tax year for which the report is filed, with certain exceptions. For example, as mentioned earlier, Texas does not conform to federal bonus depreciation rules. Practitioners must carefully review the Texas Tax Code to identify areas of non-conformity.

Deductibility of Franchise Tax

The Texas Franchise Tax is generally deductible as an ordinary and necessary business expense for federal income tax purposes under IRC Section 162. This deduction reduces the business's federal taxable income, providing a partial offset to the state tax liability.

Qualified Business Income (QBI) Deduction

For pass-through entities, the Texas Franchise Tax reduces the net business income used to calculate the federal Qualified Business Income (QBI) deduction under IRC Section 199A. For 2026, the QBI deduction is 23% (under the OBBBA). Practitioners must factor the franchise tax expense into their QBI calculations to ensure accurate federal tax projections.

Entity Selection and Restructuring Strategies

The choice of business entity can have a significant impact on a business's Texas Franchise Tax liability. Practitioners should evaluate entity structures to optimize their clients' tax positions.

Limited Liability Companies (LLCs)

LLCs are a popular choice for Texas businesses due to their flexibility and liability protection. For franchise tax purposes, LLCs are generally treated as taxable entities, regardless of whether they are taxed as partnerships, S corporations, or C corporations for federal purposes. However, single-member LLCs that are disregarded for federal tax purposes are also disregarded for Texas franchise tax purposes and are treated as part of the owner's return.

S Corporations

While Texas does not recognize the S corporation election for state income tax purposes (since there is no state income tax), S corporations are subject to the franchise tax. The compensation deduction method is often beneficial for S corporations, as they can deduct the W-2 wages paid to shareholder-employees, subject to the $480,000 per-person limit.

Limited Partnerships (LPs) and Family Limited Partnerships (FLPs)

LPs and FLPs are frequently used in Texas for asset protection and estate planning. These entities are subject to the franchise tax. However, passive entities, such as certain investment partnerships, may be exempt from the franchise tax if they meet specific criteria regarding the nature of their income (e.g., primarily interest, dividends, and capital gains).

References

[1] Texas Comptroller of Public Accounts. (2026). 2026 Texas Franchise Tax Report Information and Instructions (Form 05-915). Retrieved from https://comptroller.texas.gov/forms/05-915.pdf

[2] Texas Comptroller of Public Accounts. (2026). Sales and Use Tax. Retrieved from https://comptroller.texas.gov/taxes/sales/

[3] Galvix. (2026). Texas Sales Tax Nexus Guide for 2026. Retrieved from https://www.galvix.com/sales-tax-nexus/texas/

[4] Texas Comptroller of Public Accounts. (2026). Texas Property Tax Basics (Publication 96-1425). Retrieved from https://comptroller.texas.gov/taxes/property-tax/docs/96-1425.pdf

[5] Resolute Property Tax Solutions. (2026). Texas Property Tax Protest Deadline 2026. Retrieved from https://resolutepts.com/texas-property-tax-protest-deadline/

[6] Tax Policy Center. (2026). Eliminating School Property Taxes for Texas Homeowners Could Backfire Sooner Rather Than Later. Retrieved from https://taxpolicycenter.org/taxvox/eliminating-school-property-taxes-texas-homeowners-could-backfire-sooner-rather-later