For Texas franchise tax, can a company include wages paid to employees at its foreign offices in its compensation deduction if those wages are reported on a foreign government form instead of an IRS Form W-2?

Plain-English summary

A global law firm with employees in six foreign countries pays wages and cash compensation to staff at its international offices and reports that pay on foreign government forms — not on IRS Form W-2, since those employees aren't on U.S. payroll. It asked whether it could still include that foreign-office pay in its Texas franchise tax compensation deduction.

The Comptroller ruled yes, with a condition: Tax Code § 171.1013(a) defines "wages and cash compensation" by reference to what's reported on IRS Form W-2 "or any subsequent form with a different number or designation that substantially provides the same information." Reading that language in context, the Comptroller interpreted it to also reach a foreign government form that is substantially equivalent to Form W-2 — meaning it performs the same function and reports the wages/cash compensation paid to an individual employee. The deduction remains subject to the ordinary per-employee wage limitation in § 171.1013(c).

The key limit: the foreign form must report employee compensation, not independent-contractor payments. A form used to report payments to independent contractors is not "substantially equivalent" to a W-2, so those payments don't qualify for the deduction.

Revision note: the Comptroller originally issued this ruling October 12, 2015, allowing the deduction for wages reported on a substantially equivalent foreign form generally. On June 14, 2016, it reissued the ruling with the same core holding but added the express independent-contractor carve-out, tightening the rule to employee-only forms.

What this means for you

Companies with employees stationed abroad

If your foreign offices report employee pay on a local government form rather than a U.S. W-2, you can still include that pay in your Texas franchise tax compensation deduction — but only if the foreign form functions like a W-2 (reports wages/cash compensation for an actual employee) and only up to the per-employee wage limitation that applies to all compensation-deduction wages.

Companies that also use foreign independent contractors

Don't extend this ruling to contractor payments. The Comptroller drew a specific line: forms reporting payments to independent contractors are excluded even if a country's tax system otherwise treats the reporting form similarly to how the U.S. treats a W-2. Only employee compensation qualifies.

Multinational businesses relying on the October 2015 version of this ruling

Rely on the June 14, 2016 revised version instead — it's the current, controlling text and adds the independent-contractor exclusion that the October 2015 original didn't spell out.

Common questions

Q: Does a company have to use IRS Form W-2 to claim the Texas franchise tax compensation deduction for its employees?
A: No — per this ruling, a foreign government form substantially equivalent to Form W-2 (reporting wages/cash compensation paid to an employee) also qualifies.

Q: Can a company deduct payments to foreign independent contractors the same way?
A: No — per this ruling, forms used to report independent-contractor payments are not "substantially equivalent" to Form W-2 and don't qualify for the compensation deduction.

Q: Which version of this ruling controls — the October 2015 original or the June 2016 revision?
A: The June 14, 2016 revision controls; it restates the same core holding but adds the express exclusion for independent-contractor forms.

Citations and references

Statutes:

• Tex. Tax Code § 171.1013(a) (Compensation — "wages and cash compensation" defined by reference to Form W-2 or a substantially equivalent successor form)
• Tex. Tax Code § 171.1013(b)(1) (Compensation deduction — officers, directors, owners, partners, and employees)
• Tex. Tax Code § 171.1013(c) (Compensation deduction — subject to the wage limitation)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/201510539L

Original ruling text

June 14, 2016

Re: Private Letter Ruling Request #152100509
(revision to letter dated October 12, 2015)

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter
Rulings and General Information Letters. Detrimental reliance is provided in
accordance with Rule 3.10, the Taxpayer Bill of Rights.

You request guidance on whether wages and cash compensation paid to employees
assigned to international offices may be subtracted under Texas Tax Code Section
171.1013. [ENDNOTE 1] We issue this private letter ruling as the agency has not
previously addressed the precise facts presented by this inquiry and existing
authorities are not sufficiently clear to provide a definitive answer.

Ruling Request

***** (“Taxpayer”) asks whether the wages and compensation paid to
employees assigned to international offices and reported on a foreign government
form substantially equivalent to the IRS W-2 are included in the compensation deduction.

Relevant Facts

Taxpayer is a global law firm with 172 employees in international offices. Its
largest office is in CITY A, but it also has offices in COUNTRY A, COUNTRY B,
COUNTRY C, COUNTRY D, COUNTRY E, and COUNTRY F. Taxpayer paid wages and cash
compensation to employees assigned to international offices and files franchise
tax reports using the compensation deduction.

Analysis

Generally, a taxable entity electing to subtract compensation may subtract all wages and
compensation paid by the taxable entity to its officers, directors, owners, partners,
and employees, subject to the wage limitation. Tax Code Section 171.1013(b)(1) and (c).

Tax Code Section 171.1013(a) defines “wages and cash compensation” as “the amount
entered in the Medicare wages and tips box of Internal Revenue Service (IRS) Form W-2
or any subsequent form with a different number or designation that substantially provides
the same information.” Reading this provision in context with the entire statute, the
Comptroller interprets this provision to include wages and cash compensation paid to
employees in a foreign country and reported on forms issued by the foreign country
substantially equivalent to the IRS Form W-2. To be substantially equivalent to the IRS
Form W-2, the foreign country form must perform the same function as the IRS Form W-2
and provide information on the wages and cash compensation paid to an individual employee
of the company. Forms for compensation paid to independent contractors are not considered
to be substantially equivalent to the IRS Form W-2.

Ruling

Taxpayer may include in its compensation deduction, subject to the wage limitation
in Tax Code Section 171.1013(c), wages and compensation paid to employees assigned to
international offices and reported on a foreign government form substantially equivalent to the
IRS Form W-2 that provides information on the wages and compensation paid to an employee
and not an independent contractor.

If you have questions about this private letter ruling, please email us at
https://www.window.state.tx.us/taxhelp and reference Private Letter Ruling #152100509.

Sincerely,

Tax Policy Division

October 12, 2015

Re: Private Letter Ruling Request #152100509

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter
Rulings and General Information Letters. Detrimental reliance is provided in
accordance with Rule 3.10, the Taxpayer Bill of Rights.

You request guidance on whether wages and cash compensation paid to employees
assigned to international offices may be subtracted under Texas Tax Code
Section 171.1013. [ENDNOTE 1] We issue this private letter ruling as the agency
has not previously addressed the precise facts presented by this inquiry and
existing authorities are not sufficiently clear to provide a definitive answer.

Ruling Request

***** (“Taxpayer”) asks whether the wages and compensation paid to
employees assigned to international offices and reported on a foreign
government form substantially equivalent to the IRS W-2 are included in the
compensation deduction.

Relevant Facts

Taxpayer is a global law firm with 172 employees in international offices. Its
largest office is in CITY A, but it also has offices in COUNTRY A, COUNTRY B,
COUNTRY C, COUNTRY D, COUNTRY E, and COUNTRY F. Taxpayer paid wages and cash
compensation to employees assigned to international offices and files franchise
tax reports using the compensation deduction.

Analysis

Generally, a taxable entity electing to subtract compensation may subtract all
wages and compensation paid by the taxable entity to its officers, directors,
owners, partners, and employees, subject to the wage limitation. Tax Code
Section 171.1013(b)(1) and (c).

Tax Code Section 171.1013(a) defines “wages and cash compensation” as “the
amount entered in the Medicare wages and tips box of Internal Revenue Service
(IRS) Form W-2 or any subsequent form with a different number or designation
that substantially provides the same information.” Reading this provision in
context with the entire statute, the Comptroller interprets this provision to
include wages and cash compensation paid to employees in a foreign country and
reported on forms issued by the foreign country substantially equivalent to the
IRS Form W-2.

Ruling

Taxpayer may include in its compensation deduction, subject to the wage
limitation in Tax Code Section 171.1013(c), wages and compensation paid to
employees assigned to international offices and reported on a foreign
government form substantially equivalent to the IRS Form W-2.

If you have questions about this private letter ruling, please email us at
https://www.window.state.tx.us/taxhelp and reference Private Letter
Ruling #152100509.

Sincerely,

Tax Policy Division

ENDNOTES

1. References to Section are to Texas Tax Code Annotated (Vernon 1992).