Could a federal S corporation opt out of S-corporation treatment for the former Texas franchise tax?

Plain-English summary

A federal S corporation could not make a separate Texas election to opt out of S treatment.

Texas said S corporations were treated like other corporations for most former franchise-tax purposes, but identified two differences:

• An S corporation could elect, but was not required, to use the federal income-tax method when computing taxable capital under Rule 3.548.
• Its reportable federal taxable income for earned surplus was the amount the S corporation reported to the IRS as taxable to shareholders. Other corporations instead used federal taxable income after Schedule C special deductions and before net operating losses.

Rule 3.556 governed the S corporation's taxable earned-surplus computation.

What this means for you

S corporations reviewing historical elections

The federal S election carried into the Texas classification; there was no separate state election to reject it.

Tax professionals

Distinguish the optional taxable-capital accounting method from the mandatory earned-surplus income definition.

Common questions

Q: Could the corporation opt out of S treatment only for Texas?
A: No.

Q: Was the federal income-tax method required for taxable capital?
A: No. The S corporation could elect it.

Q: What income entered earned surplus?
A: The S corporation's income reported to the IRS as taxable to its shareholders.

Citations and references

• 34 Tex. Admin. Code Secs. 3.548 and 3.556

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9705674L

Original ruling text

May 16, 1997

Dear **:

In your letter of April 11, you stated that ABC (ABC) Video Corp. does not wish
to be taxed as an S corporation for state purposes.

You state that ABC has elected to be taxed as an S corporation.

There is no separate state election to be taxed as an S corporation for
franchise tax purposes. However, for most purposes, S corporations are treated
the same as other corporations in computing franchise tax. Two specific
differences in the treatment of S corporations and other corporations for
franchise tax include the following:

An S corporation may elect (but is not required) to use the federal income tax
method in computing taxable capital (see Rule 3.548 enclosed).

An S corporation's reportable federal taxable income is the income reportable
by the S corporation to the Internal Revenue Service as taxable to the
shareholders. Other corporations' reportable federal taxable income is the
federal taxable income after Schedule C special deductions and before net
operating losses. I have enclosed Rule 3.556 which describes the computation
of taxable earned surplus for an S corporation.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is
3-4662. You may write me at Tax Policy Division, Comptroller of Public
Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division