Family Limited Partnership Exception to the new Texas Margin Tax

Wednesday, April 4, 2007
Contributed by: D. Chris Harkins

To the delight of Texas School Finance Reformists and the simultaneous chagrin of many Texas business entities, Governor Rick Perry signed House Bill 3 on May 18, 2006. The new State law effectively discards the current Texas Franchise Tax and replaces it with a new Margin Tax. Texas business entities will pay the first Margin Taxes in 2008, based upon revenue earned in 2007.

The stated purpose of the sweeping change in revenue generation was to make those entities doing business in Texas and enjoying statutory liability protection pay for that benefit. While there are many differences between the current Franchise Tax and the upcoming Margin Tax, one of the biggest changes is that several entities that currently escape Franchise Tax will be taxed under the new Margin Tax. However, there are still a couple of Texas entities that enjoy liability protection and will nevertheless escape the Margin Tax. The next two sections will provide an overview of two such examples (at least under the current law).

The first Texas business entity that will not be subject to the new Margin Tax is the Texas Family Limited Partnership that receives only passive income. The new law defines passive income but basically it must:

  • be either a general partnership, limited partnership, or trust (other than a business trust);
  • have federal gross income consisting of at least 90% dividends, interest, foreign currency exchange gain, payments from notional principal contracts, option premiums, cash settlement or termination payments with respect to a financial instrument, income from an LLC, distributive shares of partnership income, gains from the sale of real property, exchange-traded commodities and securities, royalties, bonuses, or delay rentals (rent income is not passive); and
  • have a federal gross income consisting of 10% or less from active trade or business.

Oddly enough, there is additional language specifically pertaining to family limited partnerships requiring that at least 80% of partners be related, the entity must be organized by the Secretary of State or equivalent agency of a sister state, and that it be treated as a partnership for tax purposes. However, since meeting the first set of criteria statutorily qualifies an entity as passive (and thus exempt from the Margin Tax), it appears permissible for these final requirements to be ignored.

For more information concerning the upcoming Margin Tax, which entities will be taxed, and at what rates, please contact one of the Underwood Law Firm's knowledgeable business formation attorneys.

This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author's law firm or its individual partners.