SECTION 3.589. Margin: Compensation

(a) Effective date. The provisions of this section apply to franchise tax reports originally due on or after January 1, 2008, except as otherwise noted.

(b) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

(1) Client--

(A) any person who enters into a professional employer services agreement with a license holder; or

(B) any person who enters into an agreement with a temporary employment service, as defined under Labor Code, §93.001(2) (Definitions), for the purpose of having individuals supplement their workforce.

(2) Covered employee--An individual having a co-employment relationship with a professional employer organization and a client.

(3) Management company--A corporation, limited liability company or other limited liability entity that conducts all or part of the active trade or business of another entity (the managed entity) in exchange for a management fee and reimbursement of specified costs incurred in the conduct of the active trade or business of the managed entity, including wages and cash compensation as determined under Tax Code, §171.1013(a) and (b) (Determination of Compensation). To qualify as a management company:

(A) the entity must perform active and substantial management and operational functions, control and direct the daily operations, and provide services such as accounting, general administration, legal, financial or similar services; or

(B) if the entity does not conduct all of the active trade or business of an entity, the entity must conduct all operations, as provided in subparagraph (A) of this paragraph, for a distinct revenue-producing component of the entity.

(4) Natural person--A human being or the estate of a human being. The term does not include a purely legal entity given recognition as the possessor of rights, privileges, or responsibilities, such as a corporation, limited liability company, partnership, or trust.

(5) Net distributive income--The net amount of income, gain, deduction, or loss relating to a pass-through entity or disregarded entity reportable to the owners for the tax year of the entity.

(6) Professional employer organization--A business entity that offers professional employer services or a temporary employment service.

(7) Small employer--A person who employed an average of at least two employees but not more than 50 employees on business days during the preceding calendar year, as defined under Insurance Code, §1501.002 (Definitions). For purposes of this definition, a partnership is the employer of a partner.

(8) Undocumented worker--A person who is not lawfully entitled to be present and employed in the United States.

(9) Wages and cash compensation--

(A) the amount entered in the Medicare wages and tips box of Internal Revenue Service Form W-2 or any subsequent form with a different number or designation that substantially provides the same information for the period on which the tax is based;

(B) any wages and cash compensation paid to employees in a foreign country and reported on forms issued by the foreign company that are substantially equivalent to the Internal Revenue Service Form W-2;

(C) the amount of net distributive income (not to include net distributive income that has been subtracted from total revenue), regardless of whether cash or property pertaining to such income is actually distributed and regardless of whether it is a positive or negative amount, from one of the following entities to partners or owners during the accounting period but only if the person receiving the amount is a natural person:

(i) taxable entities treated as partnerships for federal income tax purposes;

(ii) limited liability companies and corporations treated as S corporations for federal income tax purposes; and

(iii) limited liability companies treated as sole proprietorships for federal income tax purposes;

(D) stock awards and stock options deducted for federal income tax purposes, to the extent not included in subparagraph (A) of this paragraph.

(c) Compensation. Subject to Tax Code, §171.1014 (Combined Reporting; Affiliated Group Engaged in Unitary Business), a taxable entity that elects to subtract compensation (see subsection (i) of this section) for the purpose of computing its taxable margin under Tax Code, §171.101 (Determination of Taxable Margin), may subtract an amount equal to:

(1) subject to subsection (d) of this section, all wages and cash compensation paid by a taxable entity to its officers, directors, owners, partners, and employees up to the following thresholds for any one person per 12-month period on which the tax is based:

(A) for reports originally due on or after January 1, 2008, but before January 1, 2010, the taxable entity cannot subtract more than $300,000;

(B) for reports originally due on or after January 1, 2010, but before January 1, 2012, the taxable entity cannot subtract more than $320,000;

(C) for reports originally due on or after January 1, 2012, but before January 1, 2014, the taxable entity cannot subtract more than $330,000;

(D) for reports originally due on or after January 1, 2014, but before January 1, 2016, the taxable entity cannot subtract more than $350,000;

(E) for reports originally due on or after January 1, 2016, but before January 1, 2018, the taxable entity cannot subtract more than $360,000;

(F) for reports originally due on or after January 1, 2018, but before January 1, 2020, the taxable entity cannot subtract more than $370,000;

(G) for reports originally due on or after January 1, 2020, but before January 1, 2022, the taxable entity cannot subtract more than $390,000;

(H) for reports originally due on or after January 1, 2022, but before January 1, 2024, the taxable entity cannot subtract more than $400,000; and

(2) subject to subsection (e) of this section, the cost of all benefits the taxable entity provides to its officers, directors, owners, partners, and employees.

(d) Compensation - excluded items. Compensation does not include:

(1) payments made that are reportable on Internal Revenue Form 1099 (or would have been reported if the amount had met the Internal Revenue Service minimum reporting requirement);

(2) any expense excluded from total revenue and any net distributive income subtracted from total revenue. See §3.587 of this title (relating to Margin: Total Revenue);

(3) an employer's share of payroll taxes;

(4) wages or cash compensation paid to an employee whose primary employment is directly associated with the operation of a facility that is located on property owned or leased by the federal government and managed or operated primarily to house members of the armed forces of the United States. See §3.587 of this title; and

(5) wages or cash compensation paid to undocumented workers.

(e) Benefits. A taxable entity is allowed to subtract the cost of all benefits to the extent deductible for federal income tax purposes that it provides to its officers, directors, owners, partners, and employees.

(1) The term "benefits" includes employer contributions made to:

(A) employees' health savings accounts;

(B) health care (for example, this would include contributions to the cost of health insurance);

(C) retirement; and

(D) workers' compensation.

(2) The term "benefits" does not include the following:

(A) amounts included in the definition of wages and cash compensation; and

(B) payroll taxes. (For example, "payroll taxes" would include payments to state and federal unemployment compensation funds and payments under the Federal Insurance Contributions Act, Chapter 21 of Subtitle C of the Internal Revenue Code, §§3101 - 3128, the Railroad Retirement Tax Act, Chapter 22 of Subtitle C of the Internal Revenue Code, §§3201 - 3233).

(3) The cost of benefits does not include the amount paid by an employee.

(f) Professional employer organizations. See §3.587 of this title.

(1) A professional employer organization cannot include as compensation the following payments for covered employees:

(A) wages and cash compensation;

(B) payroll taxes;

(C) employee benefits including workers' compensation; and

(D) payments made to independent contractors and reportable on Internal Revenue Service Form 1099 (or would have been reported if the amount had met the Internal Revenue Service minimum reporting requirement).

(2) A client can include as compensation the following amounts for covered employees:

(A) wages and cash compensation; and

(B) benefits.

(3) A client cannot include as compensation the following:

(A) an administrative fee;

(B) payments made to a professional employer organization as reimbursement for payments made to independent contractors assigned to the client and reportable on Internal Revenue Service Form 1099 (or would have been reported if the amount had met the Internal Revenue Service minimum reporting requirement); and

(C) other costs.

(4) A professional employer organization shall determine compensation only for the taxable entity's own employees who are not covered employees.

(g) Management company. See §3.587 of this title.

(1) A taxable entity that is a management company may not include as wages and cash compensation any amounts reimbursed by a managed entity.

(2) A taxable entity that is a managed entity may subtract wages and cash compensation that are reimbursed to the management company.

(3) A management company shall determine compensation for only those wages and compensation payments that are not reimbursed by a managed entity.

(h) Small employers. This subsection applies to a taxable entity that is a small employer and that has not provided health care benefits to any of its employees in the calendar year preceding the beginning date of its reporting period. Subject to Tax Code, §171.1014, a taxable entity to which this subsection applies that elects to subtract compensation for the purpose of computing its taxable margin under Tax Code, §171.101, may subtract the following health care benefits:

(1) amounts as provided under subsection (c) of this section;

(2) for the first 12-month period on which margin is based and in which the taxable entity provides health care benefits to all of its employees, an additional amount equal to 50% of the cost of health care benefits provided to its employees for that period; and

(3) for the second 12-month period on which margin is based and in which the taxable entity provides health care benefits to all of its employees, an additional amount equal to 25% of the cost of health care benefits provided to its employees for that period.

(4) The term "provide" does not include amounts paid by the employee, officer, director, etc.

(i) Election to subtract compensation. The election to subtract compensation is made by filing the franchise tax report using the compensation method or by amending any report filed within the statute of limitations. A taxable entity may file an amended report for the purpose of correcting a mathematical or other error in a report, or to change its method of computing margin.

(j) Expenses paid with qualifying loan or grant proceeds. A taxable entity may include in compensation any expense paid using the qualifying loan or grant proceeds, as defined under Tax Code, §171.10131 (Provisions Related to Certain Money Received for COVID-19 Relief), to the extent the expense is otherwise includable as compensation under this section, even if the taxable entity has excluded the qualifying loan or grant proceeds from its total revenue under §3.587 of this title.

Source Note: The provisions of this §3.589 adopted to be effective January 1, 2008, 32 TexReg 10038; amended to be effective January 1, 2009, 33 TexReg 10504; amended to be effective December 31, 2009, 34 TexReg 9471; amended to be effective April 19, 2022, 47 TexReg 2031; amended to be effective December 19, 2022, 47 TexReg 8278