by John R. Bruce, CPA, CHBC
The revised Texas Franchise Tax will affect many practices
and business entities that were previously
exempt from the existing Texas Franchise Tax.
As you may know, this new tax was signed into law on
May 18, 2006, and is designed to replace the existing Texas
Franchise Tax. The tax is calculated on a business entity’s
gross margin. The revised franchise tax will affect franchise
tax reports that are due to the state of Texas on or after
January 1, 2008. The first report for calendar year taxpayers
will be due on May 15, 2008, which includes all entities
not previously subject to the franchise tax.
Under the previous franchise tax, only corporations and
limited liability companies were taxable entities. The
revised franchise tax will extend the list of taxable entities
to include partnerships, professional associations, joint
ventures, business trusts, and limited liability partnerships.
Many medical practices operate as professional associations
which, until now, have been exempt from the Texas
Franchise Tax. Some advanced planning will ensure that May
15 will not sneak up on your practice. Some practices may
have a significant liability to pay on May 15. If you have not
already done so, now is the time to review your potential liability
and explore methods to minimize your liability.
Issues you might face are:
• Will receipts from Medicare Advantage (replacement)
Plans qualify for the revenue exclusion?
• What is a “reasonable” methodology to reduce wages
and benefits due to revenue exclusions?
• How should you calculate the “actual cost” of providing
uncompensated care?
The revised franchise tax is calculated based on the total
revenues of an entity less the greater of compensation, cost
of goods sold, or 30 percent of total revenues.
The resulting number is called the “Margin.”
One of the recent changes enacted established an alternative“EZ Calculation” that can be used by taxable entities
with gross receipts of less than $10 million. This calculation
taxes gross revenue at a rate of .575 percent. The
downside of electing to use the EZ Calculation is that it results in the loss of any credits or
deductions, and the tax is based solely
on revenues.
In addition to the EZ Calculation,
there is also a small business discount
that operates on a sliding scale
for entities with less than $900,000
in total revenues. These discounts
range from 20 percent to 100 percent,
based on the total revenues of
the business. Entities with $300,000
or less in gross receipts will receive
the benefit of a full 100 percent discount.
Furthermore, entities owing
less than $1,000 in tax are exempt
from paying any tax, but they still
must file the annual report.
For this article, a greater emphasis
will be placed on the compensation
deduction, as that is what is most
likely to be used by healthcare professionals.
The tax rate of 1 percent is
then applied to the Margin to arrive
at the amount of tax due. If the entity
is a wholesaler or retailer, the tax
rate is .5 percent.
There are revenue exclusions that
are specific to healthcare providers.
These exclusions include receipts from
Medicare, Medicaid, Tricare, CHIP, and
receipts received from state workers’
compensation programs. Healthcare
providers may also exclude the actual
costs incurred for any uncompensated
care they provide during the tax year.
Most healthcare providers will utilize
the compensation deduction.
The amount of deductible compensation
is subtracted from total revenues
to determine the taxable margin.
Deductible compensation
includes wages and cash compensation
paid to officers, directors, partners,
owners, and employees of the
taxable entity. Compensation can
also include the cost of benefits paid
to the business’s officers, directors,
partners, owners, and employees.
These deductible benefits include
amounts paid for: workers’ compensation,
health insurance, retirement
plan contributions (to the extent
they are deductible for federal tax
purposes), and employer contributions
to an employee’s Heath Savings
Account. Also included in compensation
is the net distributive income
from partnerships and entities that
are treated as S corporations for federal
tax purposes and stock awards
and options given to employees,
directors, and owners, if they
were deducted for federal income
tax purposes.
There is a limitation on the
amount of compensation that can be
deducted. This limitation states that
wages may not exceed $300,000 for
any one person. Therefore, if any
employee, officer, owner, director, or
partner is paid more than $300,000
in compensation for the taxable year,
only $300,000 will be deductible. In
addition, this $300,000 limitation
also applies to controlled groups,
which will be discussed later.
Another limitation to the compensation
method is that the compensation
deduction is limited if income
has been excluded from total revenues.
Specific guidelines as to the
extent of which compensation should
be limited in this situation have not
yet been defined, but a “reasonable
method” should be used to limit the
amount of compensation, perhaps by
limiting compensation by the same
percentage that exclusions were
deducted from total revenues. For
example, if 30 percent of a medical
practice’s revenue is received from
Medicare, then it might be a reasonable
method to reduce the compensation
deduction by 30 percent.
An additional aspect of the revised
franchise tax is the requirement for
combined reporting for entities that
meet certain requirements. Combined
reporting is essentially a twopart
test where entities must be
reported together if they are an affiliated
group and they are engaged in a
unitary business. An affiliated group
is a group of entities in which a controlling
interest of more than 50 percent
is owned, directly or indirectly,
by a common owner or by one or
more of the entities that are members
of the affiliated group. The entities
are engaged in a unitary business
if it is a single economic entity that is
made up of commonly controlled
entities that are inter-dependent in
their activities. When calculating the
taxable margin for a combined group, all inter-company revenues are eliminated in determining total revenues.
In addition to having to report together, the election of whether to use the compensation
deduction, cost of goods sold deduction or the alternative of 30 percent
of total revenue deduction must be made at a group level, rather than at the individual
entity level. Combined groups are also limited because they must share the
small business discount and the compensation limit of $300,000 per person at
the combined group level and not the individual entity level. Below are two examples.
The first example is a $5,000,000 revenue medical practice of which 30 percent
is Medicare. The second example is a $500,000 revenue medical practice of which there is no Medicare, Medicaid, Tricare, or CHIP revenue to exclude.
* Because wages and benefits are associated with the generation of Medicare
receipts, 30 percent of the wages and benefits have been excluded from this deduction.
There may be other “reasonable” methods for reducing these deductions other than
using the percentage of Medicare receipts.
Please keep in mind that these are straightforward examples and there are
many unanswered issues and questions which will have to be addressed on a
case by case basis.
John R. Bruce is a principal with The Hanke Group, P.C. and directs their healthcare
practice. John is also a Certified Healthcare Business Consultant (CHBC). You can
reach John at 210-341-9400 or john.bruce@thehankegroup.com.
