Is the 'assets minus debts minus stated capital' formula used to compute earned surplus, and do already-paid expenses count as debts?

Plain-English summary

A taxpayer filling out the short (no tax due) form was confused about taxable earned surplus everywhere and asked whether to use the "assets - debts - stated capital" formula and whether already-paid expenses count as debts.

• Two different components. The franchise tax has taxable capital (which includes the corporation's surplus and stated capital) and earned surplus (based on federal taxable income with modifications), each apportioned and taxed - 0.25% and 4.5% - with the corporation paying the greater. No tax is due if the computed tax is under $100 or gross receipts everywhere are under $150,000 for both components, but a report must still be filed.
• The formula is for taxable capital, not earned surplus. "Assets minus debts minus stated capital" produces surplus, which is used in computing taxable capital - not earned surplus (Sec. 171.109(a)(1) & (2)). So the taxpayer was applying the wrong formula to earned surplus.
• Paid expenses aren't debts. A debt (Sec. 171.109(a)(3)) is a legally enforceable obligation for a certain amount payable within an ascertainable time or on demand - generally the liabilities, payables, and accruals on the balance sheet. Expenses that have actually been paid are generally not part of a liability.

Currency note: This 2000 letter applies the pre-2008 franchise tax's two components (replaced by the margin tax effective January 1, 2008 under House Bills 3 and 3928). The margin tax computes a single base differently; treat as historical and confirm current law.

What this means for you

Small corporations filling out the franchise-tax forms

The common mistake here is worth flagging: the net-worth-style formula (assets - debts - stated capital) belongs to the taxable-capital side and yields surplus; earned surplus instead starts from federal taxable income. And you can't treat money you've already spent as a debt - only genuine outstanding obligations reduce the base.

Tax professionals

Useful as a plain restatement of the two-component structure and the debt definition. Note the pinpoint: paid expenses are not liabilities/debts, so they don't reduce surplus. All pre-2008; the margin tax abandons this structure, so re-verify.

Common questions

Q: Do I use "assets minus debts minus stated capital" to compute earned surplus?
A: No. That formula produces surplus for the taxable-capital component. Earned surplus is based on federal taxable income with modifications.

Q: Are expenses I've already paid counted as debts?
A: Generally no. A debt is an outstanding legally enforceable obligation; expenses actually paid are generally not part of a liability.

Q: If I owe no tax, do I still file?
A: Yes. Even at under $100 tax or under $150,000 gross receipts, a franchise tax report or information report must be filed.

Citations and references

Statutes:

• Texas Tax Code Sec. 171.109(a)(1) - definition of surplus (used for taxable capital)
• Texas Tax Code Sec. 171.109(a)(2) - definition of net assets
• Texas Tax Code Sec. 171.109(a)(3) - definition of debt

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200004112L

Original ruling text

April 3, 2000

To: **

Dear **:

Thank you for your e-mail regarding the completion of the short (no tax due)
form for Texas franchise tax.

You stated in your e-mail that you are having problems determining the taxable
earned surplus everywhere. You asked "Do I compute the amount using the ASSETS

• DEBTS - STATED CAPITAL formula? If so, are expenses (i.e., amounts already
  paid out) considered debts?"

The franchise tax consists of two components: Taxable Capital and Earned
Surplus. The taxable capital component includes the surplus and stated capital
of the corporation. The earned surplus component includes federal taxable
income with modifications. Both components are apportioned and multiplied by
the appropriate tax rates (.25% for taxable capital and 4.5% for earned
surplus). A corporation will pay the greater of the two taxes. If the
calculated tax due is less than $100, no tax is due, but a franchise tax report
must be filed.

In addition, those corporations, who had less than $150,000 in gross receipts,
everywhere, for a particular report for both taxable capital and earned surplus
purposes, will owe no franchise tax, but still must file an information report.

The "assets minus debts minus stated capital" formula will result in surplus
which is used in computing taxable capital; not earned surplus. Texas Tax Code
(TTC) Section 171.109(a)(1) & (2). A debt is defined in TTC Section
171.109(a)(3) as a "legally enforceable obligation measured in a certain amount
of money which must be performed or paid within an ascertainable period of time
or on demand." This definition generally describes liabilities, payables,
accruals, etc. that might appear in a corporation's balance sheet. Expenses
that have actually been paid would generally not be part of a liability.

The statutory cites mentioned above may be viewed via the Comptroller's Window
on State Government at . Click on the heading "Texas
Taxes" and you'll find a heading for "the Franchise Tax." Once you are on "the
Franchise Tax" page, you'll find a link to "Chapter 171."

This response is based on current law and the facts presented. If there are
different or additional facts, the response may change.

If you have any questions about this or any other franchise tax matter, you may
call me at 1-800-531-5441, extension 3-4612, or e-mail me at the address below.

Sincerely,

Janet Spies
[email protected]
Comptroller of Public Accounts