For Texas earned surplus, what are the IRC Section 179 expensing limit and the phase-out threshold?

Plain-English summary

A taxpayer asked about the IRC Section 179 expensing limits when computing earned surplus for the (pre-2008) Texas franchise tax - specifically the phase-out threshold for current-year fixed-asset additions.

• Earned surplus follows a frozen version of federal law. It is calculated under the Internal Revenue Code 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)). So the 1996 Section 179 limits apply, not later expanded federal amounts.
• $25,000 election cap. The amount of Section 179 property for which the election may be made is limited to a maximum of $25,000.
• $200,000 phase-out threshold. The cost of all Section 179 property cannot exceed $200,000 without phasing out the amount of the Section 179 deduction.

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

What this means for you

Businesses expensing equipment

Even if your federal return used a larger Section 179 deduction, Texas earned surplus held you to the 1996 numbers: a $25,000 cap and a dollar-for-dollar phase-out once your Section 179 property crossed $200,000.

Accountants and tax professionals

Because Sec. 171.001(b)(5) freezes earned surplus to the 1996 Code, add back federal Section 179 amounts above the $25,000 / $200,000 limits when computing earned surplus. (A companion letter allows the larger federal amounts only in the taxable-capital component under the FIT accounting method.)

Common questions

Q: What is the Section 179 limit for Texas earned surplus?
A: A $25,000 maximum election, phasing out once the cost of Section 179 property exceeds $200,000, under the 1996 Internal Revenue Code that earned surplus follows.

Q: Why not the larger federal amount?
A: Earned surplus conforms to the IRC as in effect for 1996 (Tax Code Sec. 171.001(b)(5)), so later federal increases to Section 179 do not apply to it.

Citations and references

Statutes:

• Tex. Tax Code Sec. 171.001(b)(5) (earned surplus conforms to the 1996 IRC)
• IRC Section 179 (election to expense certain property)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200403571L

Original ruling text

March 11, 2004

To: **

Dear **:

Thank you for your email regarding IRC Section 179 expense deductions for Texas
franchise tax purposes.

The statute I mention below, as well as other related information, can be found
at http://www.window.state.tx.us/taxinfo/franchise/index.html.

You have asked what the proper phase out amount of current year fixed asset
additions that are allowed before any reduction in otherwise allowable Section
179 deduction is.

Earned surplus for Texas franchise tax is calculated based upon the Internal
Revenue Code (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. See Texas Tax Code Sect. 171.001(b)(5).

The amount of Section 179 property for which you may make the election is
limited to a maximum of $25,000. The cost of all Section 179 property cannot
exceed $200,000 without phasing out the amount of Section 179 deduction taken.

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 online survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you need any additional information, please feel free to call me at
1.800.531.5441, extension 34629.

Sincerely,

Lowell Olsen Dunn
Tax Policy Division