How did Texas treat S corporations and their subsidiaries before addressing the 1996 Small Business Job Protection Act changes?

Plain-English summary

Texas had not yet analyzed the 1996 Act; under existing 1994-Code law, the S corporation and subsidiaries filed separately.

The Small Business Job Protection Act changes applied to federal tax years beginning after December 31, 1996 and would not affect annual Texas reports due before January 1, 1998. Texas still computed earned surplus using the 1994 Internal Revenue Code, and the agency anticipated that the 1997 Legislature might update that reference.

Under existing law, the Comptroller said:

• The S corporation and C-corporation subsidiaries filed separate franchise-tax returns and reported earned surplus separately.
• The S corporation received no Schedule C deduction.
• Its earned surplus included income reported to the IRS as taxable to shareholders.

These observations assumed the corporation qualified as an S corporation under the 1994 Code.

What this means for you

S-corporation groups researching transition years

This letter is a pre-conformity snapshot, not a final interpretation of the 1996 federal Act.

Tax professionals

Verify which Internal Revenue Code reference Texas actually adopted for the report year before applying these rules.

Common questions

Q: Had Texas determined the 1996 Act's effect?
A: No.

Q: Did the S corporation and subsidiaries file together?
A: No, they filed separately.

Q: Did the S corporation receive a Schedule C deduction?
A: No under the existing-law answer.

Citations and references

• Small Business Job Protection Act of 1996
• Historical Texas reference to the 1994 Internal Revenue Code

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9612847l

Original ruling text

December 13, 1996

To: **

Dear **:

Thank you for your recent e-mail about the franchise tax effects of the Small
Business Job Protection Act in regard to S corporations.

Current franchise tax law requires corporations to use the Internal Revenue
Code (IRC) in effect for the 1994 calendar year in computing earned surplus.
At this time, the agency has not explored the impact of the franchise tax
changes resulting from the Small Business Job Protection Act in regard to S
corporations.

We understand that this IRC change applies to federal tax years beginning after
December 31, 1996. Thus, the IRC change will not affect annual franchise tax
reports due prior to January 1, 1998, so we have some time to consider the
effects. Because the Texas Legislature will convene in January, 1997, we
anticipate that the legislature might update the IRC reference in the franchise
tax law.

Therefore, at this time we can answer your questions only on the basis of
existing franchise tax law [that is, based on the 1994 IRC]. We believe the
following would apply to your questions:

1. The S corporation and C corporation subsidiaries would file separate
   franchise tax returns and report their earned surplus separately.

2. The S corporation would receive no Schedule C deduction.

3. The earned surplus of the S corporation would include income reportable to
   the Internal Revenue Service as taxable to the shareholders.

These observations are based on the presumption that the corporation would
qualify as an S corporation based on the 1994 Internal Revenue Code which is
currently required by the franchise tax law.

If you have questions about this, my internet address is
[email protected], or you may call me toll free at 1-800-531-5441,
extension 3-4662.

Sincerely,

Bob Jeffcoat
Tax Policy Division
Comptroller of Public Accounts