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Ezel / Tax Rulings / TX
TX 200607697L Franchise Tax (PRIOR TO 01/01/2008) 2006-07-19

Is a non-profit's unrelated business income subject to Texas franchise tax?

Short answer: It depends on whether the non-profit has obtained a Texas franchise-tax exemption. A non-profit corporation doing business in Texas is subject to the franchise tax, and it must file and pay until the Comptroller grants an exemption. The organization applies for exemption under Tax Code Section 171.051 by filing evidence of its qualifications, following the process in Franchise Tax Rule 3.541. Once an exemption is granted, the non-profit's unrelated business income is not subject to Texas franchise tax.

Apply this to your situation

This page answers the general question as of 2006. Ezel answers yours, under current Texas tax law, with citations.

Currency note: this ruling is from 2006
Subsequent statutory amendments, regulation changes, court decisions, or later rulings may have changed the analysis. Treat this page as historical context, not current tax advice. Verify current law before relying on any specific rule, rate, or position mentioned here.
Disclaimer: This is an official Texas Comptroller of Public Accounts letter published on the State Tax Automated Research (STAR) system. Letters on STAR can be the basis of a detrimental reliance claim only for the taxpayer to whom the letter was directly issued (see 34 Tex. Admin. Code Rules 3.1 and 3.10); documents on STAR may no longer represent current policy even if not marked superseded. This letter applies the Texas franchise tax as it existed before January 1, 2008; the 2007 legislation (House Bill 3 and House Bill 3928) later restructured the tax into the current margin tax, so its rate, filing, and mechanics may have changed even though the exemption framework for qualifying non-profits continues. Taxpayer-identifying details are redacted. This summary is informational only and is not legal or tax advice. Consult a licensed Texas tax professional about your specific situation.
About this page: The plain-English summary, reader guidance, and Q&A below were written by Ezel based on the official state tax ruling. The original ruling (linked on this page) is the authoritative source for any reliance.

Plain-English summary

A taxpayer asked how Texas treats the unrelated business income (UBI) of a non-profit (specifically, a library) for franchise-tax purposes. The Comptroller advised:

  • A non-profit corporation doing business in Texas is subject to the Texas franchise tax — being a non-profit does not, by itself, make it exempt.
  • The corporation may apply for an exemption under Tax Code Section 171.051 by filing with the Comptroller evidence of its qualifications for the exemption; Franchise Tax Rule 3.541 (Exemptions) sets out the application process.
  • Until an exemption is granted, the non-profit must file and pay franchise tax.
  • Once an exemption is granted, the organization's unrelated business income is not subject to Texas franchise tax.

The Comptroller pointed to its publication 96-114, The Texas Franchise Tax on Corporations, for a summary of the components, rates, apportionment, reporting periods, and due dates, and cautioned that the response rested on the facts presented and current law.

Important currency note: This letter describes the pre-2008 franchise tax. The 2007 legislation (House Bills 3 and 3928) restructured the tax into the current margin tax effective January 1, 2008. The core point — a qualifying non-profit must obtain a Comptroller exemption, and once exempt its unrelated business income is not taxed — reflects the exemption framework, but confirm the current rules and application procedure before relying on it.

What this means for you

Non-profits with business-type revenue in Texas

Federal tax-exempt status is not automatic in Texas: a non-profit that does business here is on the hook for the franchise tax — including on unrelated business income — until it secures a state exemption from the Comptroller. File for the exemption; keep filing and paying in the meantime.

Accountants and advisors to exempt organizations

The gate is Tax Code Section 171.051 plus Rule 3.541: exemption is granted on application with proof of qualification, not by default. After the grant, UBI drops out of the Texas franchise tax. Re-verify the current margin-tax exemption process for your client.

Common questions

Q: Is a non-profit's unrelated business income taxed under the Texas franchise tax?
A: Only if the non-profit has not obtained a Texas franchise-tax exemption. A non-profit doing business in Texas is subject to the tax until the Comptroller grants an exemption; after that, its unrelated business income is not subject.

Q: How does a non-profit become exempt from the Texas franchise tax?
A: By applying under Tax Code Section 171.051 — filing evidence of its qualifications with the Comptroller, following Franchise Tax Rule 3.541.

Q: What happens before the exemption is granted?
A: The organization must file and pay franchise tax until the Comptroller grants the exemption.

Citations and references

Statutes and rules:

  • Tex. Tax Code Sec. 171.051 (a corporation applies for franchise-tax exemption by filing evidence of its qualifications with the Comptroller)
  • Franchise Tax Rule 3.541 (Exemptions; application process)
  • Comptroller Publication 96-114, The Texas Franchise Tax on Corporations

Source

Original ruling text

July 19, 2006

To: **

Dear **:

Thank you for your email regarding Texas franchise tax for a federally-exempt
entity.

The statute, rule, letters and publication 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 how Texas treats unrelated business income of a non-profit, a
library, for Texas franchise tax purposes.

If your tax-exempt organization is a non-profit corporation that is doing
business in Texas, it will be subject to the Texas franchise tax. However,
Section 171.051 of the TTC states that a "corporation may apply for exemption
under this subchapter by filing with the comptroller...evidence of the
corporation's qualifications for the exemption." Franchise Tax Rule 3.541
(Exemptions) sets out guidelines for the application process.

The non-profit entity is required to file and pay franchise tax until an
exemption is granted by the comptroller.

If the entity has been granted an exemption from Texas franchise tax, then the
unrelated business income will not be subject to Texas franchise tax.

This agency’s publication, The Texas Franchise Tax on Corporations (96-114),
provides a concise summary of the franchise tax. The publication briefly
addresses the components of the tax, the tax rates, the apportionment of
receipts, the applicable reporting periods, and the due dates of the reports.

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 contact me at
1.800.531.5441, extension 34629.

Sincerely,

Lowell Olsen Dunn
Tax Policy Division

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