Articles

Texas Franchise Tax - The Revamped Version

Kathleen Quiroz and Jerry B. Cohen

M.D. News San Antonio (January 2009)

For many physician practices, 2007 was a confusing and potentially costly year as a result of the implementation of the revised Texas Franchise Tax, commonly known as the Margin Tax. Like most Texas businesses, physician practices and other healthcare providers recently have filed their first state franchise tax return under the new Margin Tax, and we are now able to survey the impact of this new tax.

Closing the “Loophole”
In prior years, physician practices and other healthcare organizations that were organized as professional associations or limited partnerships were not subject to the Franchise Tax. The Texas legislature, seeking to close this perceived “loophole” whereby some businesses were subject to tax and others were not simply based upon their form of legal organization, revamped the Franchise Tax with the new Margin Tax. Among other things, these changes made the Franchise Tax applicable to nearly all business entities organized or transacting business in Texas. Therefore, as of January 1, 2007, physician practices organized as professional associations became subject to the Franchise Tax for the first time.

As a general rule, any form of legal entity that provides its owners with a statutory liability shield now will be subject to the Franchise Tax. In fact, the only business organizations that remain free of the Franchise Tax are sole proprietorships, general partnerships directly owned by individual natural persons, tax exempt organizations, and certain trusts and estates of natural persons.

Calculating the Margin
At its most basic level, the Margin Tax is a tax on the difference, or margin, between a business’ revenue (adjusted for certain statutory exclusions) minus an amount calculated by one of three alternative statutory deductions or reductions. The three alternative deductions or reductions against revenue permitted by the Margin Tax are (i) a deduction for cost of goods sold, (ii) a deduction for the cost of employee compensation and benefits, or (iii) a simple multiplication of adjusted revenue by 70 percent. An entity’s taxable “margin” is the difference between its adjusted revenue and whichever of the three alternative deductions or reductions results in the lowest margin. Since physician practices typically have little if any costs of goods sold, most practices and other healthcare providers rely upon the compensation deduction or the 70% of revenue calculation.

Limits on the Compensation Deduction
Unlike the federal income tax system, where only “unreasonable” compensation cannot be deducted, the Margin Tax caps the compensation portion of the compensation and benefits deduction at a fixed $300,000 per individual. This $300,000 cap includes any cash compensation, including both W-2 income and distributive income from partnerships, limited liability companies, and S Corporations. Therefore, physician practices with highly compensated physicians or other employees may not be able to deduct the full amount of the compensation paid to such individuals. However, there is no similar cap on the benefits component of this deduction and, therefore, the full cost of employee benefits provided by a physician practice or other healthcare organization should be deductible.

Adjusting Revenue
Physician practices and other healthcare providers have been provided with certain advantages in the new Margin Tax provisions of the Franchise Tax. Primarily, when calculating the “revenue” of the organization, healthcare providers and healthcare institutions may exclude all revenues received from Medicare, Medicaid, CHIP, workers’ compensation and TRICARE as well as the actual costs for providing uncompensated care. Further, for beneficiaries enrolled in Medicare Part C or similar replacement products, revenues received for services provided to these beneficiaries from the private payers providing the Medicare and other replacement products can be excluded from revenue as well. Finally, co-payments and deductibles received pursuant to one of the above government healthcare programs, or pursuant to supplemental insurance for enrollees in one of the above programs, also may be excluded from revenue.

The amount of revenues excluded depends upon whether the organization is a “Healthcare Provider” or a “Healthcare Institution” under the Margin Tax. Healthcare Providers, including physician practices, may exclude 100 percent of the revenues received from the above sources. Healthcare Institutions, including hospitals and other facilities, may exclude 50 percent of the revenues received from the above sources.

The (Almost) Final Calculation
Therefore, to calculate the taxable margin of a typical physician practice or healthcare provider, the organization will (1) start with a determination of its total revenue, (2) exclude either 50 percent or 100 percent, as appropriate, of the revenues received from the government payers and replacement products as noted above, and (3) then either deduct the appropriate compensation and benefit amounts, or multiply the remainder by 70 percent. Again, the organization’s taxable margin will be the result of whichever of the deduction or reduction calculations generates the smaller margin.

Tax Rate and Small Business Exceptions
In general, the Margin Tax rate is 1 percent of an entity’s taxable margin. However, there are several exemptions and rate reductions for small businesses that should be of assistance to many smaller physician practices and other small businesses in the healthcare industry. First, no tax at all is owed by any physician practice or other business whose total revenue, net of the exclusions described above, is $300,000 or less. Similarly, no tax at all is owed by any entity whose calculated Margin Tax due is $1,000 or less. For physician practices and other businesses with total revenues, again net of exclusions, of $900,000 or less, certain tax rate reductions ranging from 20 percent to 80 percent of standard rate may be available. Finally, physician practices and other businesses with $10,000,000 or less in total revenues, again net of exclusions, may elect the “E-Z computation,” under which a reduced tax rate of 0.575 percent is imposed against total gross revenues.

Tiered Structures
One final issue that concerned many in the healthcare industry was the impact of the Margin Tax on tiered structures. A common example of a tiered structure for physician practices is a general partnership in which all of the partners are professional associations each owned by an individual physician. For some time, practitioners were concerned that the margin tax would apply to the organization’s revenue at the lower (general partnership) level and then again when paid or distributed to the upper (professional association) level. In such a situation, it was possible that the same dollar of revenue would be taxed twice. Fortunately, the Margin Tax statute was clarified to provide that revenue received as distributive income from a taxable partnership (such as a general partnership owned by professional associations) or subchapter S corporation would be excluded from the taxable margin of the upper tier, or recipient, entity.

The Dust Settles
Just over one year into this new tax regime, it is clear that, for many entities in the healthcare industry, the Margin Tax presents a challenging new reality. However, for physician practices and other healthcare organizations that receive significant revenues from government payers, and for those smaller practices or businesses that find themselves excluded from taxation, this new reality may not be as painful as once feared.

_________________________________________________________________________

Jerry B. Cohen and Kathleen Quiroz are Shareholders with Oppenheimer, Blend, Harrison and Tate, Inc. - a top ranked Health Care law firm in San Antonio and Kerrville. Collectively, they have served Corporate and Health Care clients for 38 years and have been recognized by their peers in the legal industry as leading attorneys at both the local and national level. You can reach the Health Care Practice of Oppenheimer, Blend, Harrison and Tate, Inc. at 210.224.2000.

Copyright 2010, Oppenheimer, Blend, Harrison and Tate, Inc.