Small Business Owners Beware!
by Darrell Holmes
For my industry, I am involved with organizations that provide consultation and support for the members of those various organizations. During a lunch meeting today, I was made aware of a franchise tax that was recently signed into law for the state of Texas. The intentions of the tax are well-placed. Essentially it would alleviate some of the financial burden carried by homeowners through property taxes without sacrificing funding to education. Believe me that as a homeowner I’m all for being relieved of some of the taxes I pay with my area having some of the largest homeowner taxes in the country. However, the committee that organized the wording of the new tax is putting a strange hold on small business owners who operate service-based corporations.
Here’s the meat of the matter: any partnership minus those entirely directly owned by natural persons, LLC, business trust, professional association, business association or joint venture is subject to this tax. The tax rate is 0.5% for entities primarily engaged in retail and wholesale trades(that is, over 51% of their business must fall into this category). The rate is 1% for all other taxable entities. Here’s kicker #1: retail and wholesale trades do NOT include service companies. So, if you own a tax service you provide a service and are therefore subject to the 1% franchise tax. The new revised taxable base is your margin(gross), and is equal to the lesser of 1) total revenue minus cost of goods sold, 2) total revenue minus compensation(including benefits), or 3) total revenue times 70%. Total revenue is determined based on federal income tax reporting. Here’s kicker #2: cost of goods sold will no longer include leased vehicles, any types of fuel, tools/equipment used, etc. for service-based organizations. So, whatever materials or goods you use to produce your service can not be used towards your reducing your overall taxable margin. If you, as a contractor, sub out another contractor and give him a 1099 form for his work you can not consider his service as COGS. All of this is directly opposite of how COGS are filed for federal taxes.
There is a discount scale for entities who have annual margin bases below $1M, but for a whole ton of service-based organizations they have no hope of being under that magic marker line. Also, this tax will be eligible for your 2007 filings in 2008 so even if you had hopes of adjusting anything you got no shot.
I’m no where near an accountant so I don’t know or can explain every intricacy of this new tax, but I do believe a franchise tax can be a good thing. I also know that retail and product-based industries carry a heavy financial burden with little to no margin that’s not quite as severe as it is in service-based industries. Still, I don’t want to pay more for the guy to come clean my carpets or for the guy who does my taxes. It doesn’t make sense for me to pay less in my taxes just to get killed in the markup at the oil change place. Besides, the franchise tax is on the books and WILL happen; the reduction in property taxes is just being proposed and hasn’t been signed into law.
The hope is that the law will be modified over the next 10 to 24 months so that the service industries wont get killed. You can help by contacting your state representatives.
Comments
3 Comments on Small Business Owners Beware!
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theo.johnson on
Sun, 16th Sep 2007 11:51 pm
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Villager on
Mon, 17th Sep 2007 4:31 am
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darrell.holmes on
Mon, 17th Sep 2007 8:31 am
Nice post. I’m going to have to look into this. I’m a contractor, so I’m sure I’ll have to deal with this at some point. Thanks.
Good looking out Theo!
peace, Villager
Thanks Theo. A couple of things of note are 1) if you’re a sole proprietor you’re not affected; 2) hopefully much of this will change in the coming years or sooner.
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