When a single-member LLC doing business in Texas is owned by a multi-member LLC with no other Texas contact, which entity owes franchise tax?

Plain-English summary

A taxpayer described a single-member LLC (disregarded for federal purposes) that was owned 100% by a multi-member LLC. The single-member LLC does business in Texas; the multi-member LLC has no Texas activity except holding that interest. Who owes the (pre-2008) franchise tax? The Comptroller advised:

• Franchise tax follows legal formation, not federal treatment. Under Tax Code Section 171.001(a), the tax applies to each corporation and LLC doing business in Texas or organized in Texas (Rules 3.546 and 3.554 list qualifying activities). So the single-member LLC is subject if it does business in Texas, even though it is disregarded for federal income tax purposes.
• Separate-entity reporting. Texas is a separate-entity state: each LLC reports franchise tax solely on its own financial condition. Consolidated reporting is not allowed.
• A membership interest is not nexus. Merely holding a membership interest in an LLC doing business in Texas does not create nexus for a non-Texas LLC. So the multi-member LLC is not subject, if it is not organized in Texas and its only Texas contact is owning the interest.

Important currency note: This letter applies the pre-2008 franchise tax and its separate-entity reporting. The 2007 legislation (House Bills 3 and 3928) replaced it with the current margin tax, which requires combined reporting for affiliated groups engaged in a unitary business. The separate-entity conclusion here may not hold today — confirm current law.

What this means for you

Businesses using tiered LLCs with Texas operations

Before 2008, an LLC's federal disregarded status did not matter — if it did business in Texas, it filed and paid on its own, and a passive parent LLC holding only the interest stayed out. The margin tax's combined-reporting rules changed how affiliated LLCs report, so this separate-entity answer is historical.

Accountants and tax professionals

Two durable ideas survive the era: Texas taxes by legal entity form, not federal classification, and a bare ownership interest does not by itself create nexus. But re-verify combined-reporting obligations under the current margin tax.

Common questions

Q: Did the single-member LLC owe Texas franchise tax even though it was disregarded federally?
A: Yes. Texas bases responsibility on legal formation, so an LLC doing business in Texas is subject regardless of its federal disregarded status.

Q: Did the parent multi-member LLC owe the tax?
A: No. If it was not organized in Texas and its only Texas contact was owning the membership interest, merely holding that interest did not create nexus.

Q: Could the two LLCs file a consolidated report?
A: No. Under the pre-2008 tax, Texas was a separate-entity state and each LLC reported on its own financial condition.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.001(a) (franchise tax on each corporation and LLC doing business in or organized under the laws of Texas)
• Franchise Tax Rule 3.546 (Taxable Capital: Nexus)
• Franchise Tax Rule 3.554 (Earned Surplus: Nexus)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200606695L

Original ruling text

June 1, 2006

To: **

Dear **:

Thank you for your Tax Help inquiry concerning Texas franchise tax.

You state that a single member limited liability company, disregarded for
federal purposes, is owned 100% by a multi-member LLC. The single member LLC
engages in business in Texas. The multi-member has no business activity in
Texas other than to hold this single member LLC interest. You ask who is
subject to the tax.

The statute and rules I mention below, as well as other related information,
are available online at
http://www.window.state.tx.us/taxinfo/franchise/index.html.

Texas Tax Code Section 171.001(a) imposes a franchise tax on each corporation
and each limited liability company (LLC) that does business in this state or
that is organized under the laws of this state. Comptroller’s Rules 3.546,
Taxable Capital: Nexus, and 3.554, Earned Surplus: Nexus, list various
activities that constitute doing business in Texas.

The determination of responsibility for Texas franchise tax is based on the
legal formation of an entity. An entity’s treatment for federal income tax
purposes does not determine its responsibility for Texas franchise tax.
Therefore, if the single member LLC is doing business in Texas it is subject to
franchise tax even if it is treated as a disregarded entity for federal income
tax purposes. Additionally, as Texas is a separate entity state each LLC doing
business in Texas must report franchise tax based solely on its own financial
condition. Consolidated reporting is not allowed.

The mere holding of a membership interest in an LLC that is doing business in
Texas does not create nexus for a non-Texas LLC. If the multi-member LLC is
not organized in Texas and the only contact the LLC has with Texas is owning a
membership interest in an LLC, then the multi-member LLC will not be subject to
Texas franchise tax.

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 email address is
[email protected], or you may call toll-free at 1-800-531-5441,
extension 59952.

Sincerely,

Teresa Bostick
Tax Policy Division