Can off-the-shelf software expensed under the 2003 federal Section 179 amendment be deducted for Texas earned surplus?

Plain-English summary

The Jobs & Growth Tax Relief Reconciliation Act of 2003 expanded IRC Section 179 property to include off-the-shelf computer software. A taxpayer asked whether software expensed federally in 2003 under that amendment could be deducted in computing earned surplus for the (pre-2008) Texas franchise tax, which has two components - net taxable capital and net taxable earned surplus.

• Not in earned surplus. Earned surplus is computed under the IRC of 1986 as in effect for the tax year beginning January 1, 1996 and before January 1, 1997 (Tax Code Sec. 171.001(b)(5)). Because that frozen Code predates the 2003 Act, the expanded Section 179 definition is not allowed in the earned-surplus component.
• Yes in taxable capital under the FIT method. If a corporation qualifies and elects to report taxable capital using the federal income tax (FIT) accounting method, the expanded Section 179 definition is allowed in the taxable-capital component - as long as the same method was used on the corporation's most recent federal return.
• Who can elect FIT. A close corporation (35 or fewer shareholders) or a Subchapter S corporation may elect the FIT accounting method (Tax Code Sec. 171.113, with the limits in subsection (b); Rule 3.547(e)(2); Sec. 171.113(c)). Separately, an entity whose taxable capital is under $1 million may report its surplus using the FIT method from its most recent federal return (Secs. 171.109(c) and 171.112(c); Rule 3.547(e)(2)).

Currency note: This is the pre-2008, two-component franchise tax, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Businesses buying software

You could not use the new federal software-expensing break to shrink earned surplus. The only path to the larger deduction was through the taxable-capital component, and only if you qualified for and elected the FIT accounting method consistently with your federal return.

Accountants and tax professionals

Split the analysis by component: earned surplus is locked to the 1996 Code (no expanded Section 179), while taxable capital can pick up the expanded federal treatment for FIT-electing close/S corporations or sub-$1 million entities. Confirm the FIT election matches the most recent federal method.

Common questions

Q: Can I deduct off-the-shelf software under Section 179 for Texas earned surplus?
A: No. Earned surplus follows the 1996 Code, which predates the 2003 expansion, so the software expensing is not allowed there.

Q: Is there any way to get the expanded deduction?
A: Yes, in the taxable-capital component if you qualify for and elect the FIT accounting method (available to close/S corporations and entities with taxable capital under $1 million), matching your most recent federal method.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.001(b)(5) (earned surplus conforms to the 1996 IRC)
• Tex. Tax Code Sec. 171.113 (FIT accounting method; close and S corporations)
• Tex. Tax Code Secs. 171.109(c), 171.112(c) (FIT method for entities under $1 million taxable capital)
• 34 Tex. Admin. Code Sec. 3.547(e)(2) (accounting method from the most recent federal return)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200402373L

Original ruling text

February 3, 2004

To: **

Dear **:

Thank you for your inquiry concerning the calculation of earned surplus for
Texas franchise tax.

You state that the Jobs & Growth Tax Relief Reconciliation Act of 2003 amended
the definition of Internal Revenue Code (IRC) Section 179 property. The Act
expands the definition of Section 179 property to include "off-the shelf
computer software". You ask if off-the-shelf software expensed for federal
income tax purposes in tax year 2003 under this amended provision of IRC
Section 179 will be allowed as a deduction in the calculation of federal
taxable income for earned surplus.

Texas franchise tax has two components, net taxable capital and net taxable
earned surplus. Earned surplus for Texas franchise tax is calculated based
upon the IRC of 1986 in effect for the tax year beginning January 1, 1996 and
before January 1, 1997, and any regulations adopted under that code applicable
to that period. Texas Tax Code Section 171.001(b)(5). Consequently, the
expanded definition of Section 179 property under the new provisions of the
Jobs & Growth Tax Relief Reconciliation Act of 2003 is not allowed in
calculating the earned surplus component of the Texas franchise tax.

If a corporation qualifies and elects to report taxable capital using the
federal income tax (FIT) method, the expanded definition of Section 179
property will be allowed in calculating the taxable capital component as long
as the same method was used in the corporation's most recent federal income tax
return.

A close corporation that has not more than 35 shareholders and a Subchapter S
corporation may elect to compute taxable capital using the FIT accounting
method. Under the FIT accounting method, a corporation computes its surplus,
assets, debts, and gross receipts according to the method it uses to report its
federal taxable income tax instead of as provided by Tax Code Sections
171.109(b) and (g) and 171.112(b). See Tax Code Section 171.113 and the
limitations noted in subsection (b). Pursuant to Rule 3.547(e)(2), such a
corporation uses the accounting method used in its most recent federal income
tax return originally due on or before the date on which the entity's franchise
tax report is originally due. Tax Code Section 171.113(c).

Additionally, an entity whose taxable capital is less than one million dollars
may report its surplus according to the FIT accounting method used in its most
recent federal income tax return originally due on or before the date on which
the entity's franchise tax report is originally due. Tax Code Sections
171.109(c) and 171.112(c); Rule 3.547(e)(2).

The statutes and rule mentioned, as well as other related information, are
available online at http://www.window.state.tx.us/taxinfo/franchise/index.html.

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

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our on-line survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 59952.

Sincerely,

Teresa Bostick
Tax Policy Division