Businesses operating in multiple states don’t pay Texas franchise tax on their entire taxable margin. Instead, they apportion their margin between Texas and other states based on where their gross receipts are sourced. Getting apportionment right can significantly affect your tax bill, and getting it wrong invites audit adjustments.
Texas uses a single-factor apportionment formula based on gross receipts. Your Texas apportionment percentage equals your Texas gross receipts divided by your total gross receipts from everywhere. If 60% of your gross receipts come from Texas, you pay franchise tax on 60% of your taxable margin.
The critical question is where receipts are “sourced.” Texas applies market-based sourcing, which generally means receipts are sourced to where the customer receives the benefit of what you’re selling. This seems intuitive for goods shipped to customers in Texas, but gets complicated for services, licenses, and intangible transactions.
For services, Texas sources receipts based on where the service is performed, but with a twist. If the service is performed in multiple locations, you allocate based on the portion performed in each state. If you can’t determine where a service is performed, receipts go to the customer’s location. Documentation of where your people actually perform work matters for defending your apportionment.
Receipts from selling tangible personal property are generally sourced to where the goods are delivered. If you ship products to Texas customers, those receipts are Texas receipts. Drop shipments and back-to-back sales create complexity because the goods may move through multiple locations.
Licensing fees, royalties, and other receipts from intangibles require analysis of where the intangible is used. A software license used by a customer at their Texas headquarters generates Texas receipts. But licenses used enterprise-wide by customers with operations in multiple states may need allocation.
Auditors focus on apportionment because the stakes are high. Shifting even a few percentage points in the apportionment formula can change your tax liability by thousands of dollars. Common audit adjustments include recharacterizing receipts from out-of-state to Texas, challenging how you allocated service receipts, and questioning exclusions from the apportionment base.
Documentation supports your apportionment position. Keep records showing where customers are located, where services are performed, and where goods are delivered. If you use estimates or allocation methodologies, document the basis for your approach.
Apportionment disputes require careful analysis of the facts and the law. If the Comptroller is challenging your apportionment, contact us to discuss your options.
