Business Income Tax in Texas State

In most states in the US, business income tax is derived from the transactions of the business. The US tax policy indicates that businesses in the US should be taxed dependant on the business’s legal form. For instance, corporations are subject to corporation tax. Moreover, income from pass-through entities is subject to a state’s tax on personal income. Such entities include limited liability companies (LLCs), S corporations, partnerships, and sole proprietorships.

In many states, tax rates for both corporate income and personal income widely vary. Corporate rates generally range between 4 to 10% while personal rates can range from 0 to 9 % or more in some states.  Below we briefly look at additional details for five of the most common forms of business in Texas. These are corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.

Corporations

Most notably, corporations in Texas are only subject to the franchise tax. For instance, let us take a corporation that had annualized total revenue of $500,000. The amount would be less than the no-tax-due threshold that is $1,130,000 for the financial year 2018/2019. This corporation would not owe the state any franchise tax. It is worth noting that the no-tax-due threshold is revised in every two years. This makes it necessary to business owners to update themselves on the new rates.

S Corporations

An S corporation is created by forming a traditional corporation first. What follows is a special form filed with the IRS to elect S corporation status. Unlike a traditional corporation, an S corporation does not pay federal income tax. In addition, most states also do not subject S corporations to a separate income tax. Instead, the state taxes each individual shareholder on the fraction of the corporation’s annual net income he or she receives.

In other words, S corporations in most states are pass-through entities. Even though Texas State recognizes the federal S election, S corporations are subject to the state’s franchise tax. Nevertheless, an individual shareholder does not owe state tax on whatever fraction of the corporation’s net income he or she ultimately receives.

For instance, given that an S corporation had annualized total revenue of $1,000,000. This amount is still below the no-tax-due threshold of $1,130,000. Therefore, the S corporation will not owe franchise tax. Moreover, individual shareholders will not owe tax on their ultimate share of the corporation’s net income.

Limited Liability Companies (LLCs)

Most states treat standard LLCs like pass-through entities that are not required to pay either federal or state income tax. The individual members share the net income from the business and then pay federal and state taxes on their respective amounts. However, LLCs are subject to the franchise tax in Texas. Notably, individual members do not owe state tax on whatever portion of the company’s net income they receive.

For federal tax purposes, LLCs fall under the categories of either partnerships or disregarded entities.  On the other hand, it is possible to elect to have your LLC classified as a corporation. Consequently, the LLC would be subject to federal corporate income tax. Nonetheless, this change in classification would not affect the LLC’s franchise tax obligations.

Partnerships

Partnerships are mainly in the form of general partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs), among others. It is prudent to remember that most partnerships in Texas are subject to the franchise tax. The only exception from franchise tax is a general partnership directly and solely owned by natural persons. In spite of the type of partnership, individual partners owe no state tax on the share of partnership income they receive.

Sole Proprietorships

Since you are the only beneficiary of the net income from your business, you will pay federal income tax on that income. The good news is that Texas has no personal income tax apart from interest and dividends. This implies that you will not owe tax to the state on your business’s income.

It would be best to note that the primary focus here is on businesses operating solely in Texas. If you are doing business in multiple states, acquit yourself with the tax policy in those states. Additionally, you may be obligated to pay taxes that you do not pay in others. Besides, a business is subject to Texas taxes if it was formed or is located in another state but generates revenue in Texas.

The rules for taxation of multistate businesses are complicated.  This includes what constitutes nexus with a state for the purpose of various taxes. If you operate such a business, it would be best to consult with a tax professional. At Mount Bonnell Advisors, we have tax experts who will accord you their unwavering attention and help you with your tax issues. Get in touch with us.

More from Mount Bonnell Advisors:

Layman's Guide to Texas Franchise Tax
Business Income Tax in Texas State