How did Texas address possible double taxation of related S corporations and LLCs under the former earned-surplus tax?

Plain-English summary

The letter gave related-entity rules for LLCs and dividends, but it did not decide the stated QSSS issue.

The requester described an S corporation owning 90% of another S corporation and asked about the same income being taxed at both levels under the former earned-surplus component.

For an LLC treated as a federal partnership, Texas said the corporate or LLC investor should exclude the LLC's federal taxable income and gross receipts to the extent the LLC itself would report them. The letter pointed to Rule 3.562(h)(2).

For dividends from other corporations, the letter identified the Schedule C special deduction in Section 171.110(d).

The Comptroller was still considering how to treat Qualified Subchapter S Subsidiaries and their parent corporations and gave no specific guidance on that question.

What this means for you

Related entities reviewing historical franchise tax

Do not treat this letter as a blanket rule that all parent-subsidiary income was excluded. The answer depended on the entity form and the particular statutory adjustment.

Tax professionals

Separate the LLC partnership-treatment rule, the corporate-dividend deduction, and the unresolved QSSS question.

Common questions

Q: Did Texas decide the QSSS parent-and-subsidiary issue?
A: No.

Q: What did the letter say about an LLC treated as a partnership?
A: The investor excluded income and receipts already reportable by the LLC to the extent described in Rule 3.562.

Q: What relief applied to corporate dividends?
A: The letter cited the Schedule C special deduction in Section 171.110(d).

Citations and references

• Texas Tax Code Secs. 171.001(b)(3) and 171.110(d)
• 34 Tex. Admin. Code Sec. 3.562(h)(2)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9709200L

Original ruling text

September 10, 1997

Dear **:

Thank you for your letter concerning the possibility of double taxation of
related entities.

In the example in your letter, "Company P" is an S-Corporation and it owns 90%
of a subsidiary, "Company S," which is also an S-Corporation. "Company S" earns
$100,000 during 1997 and will report and pay tax of $4,500 on its 1998 annual
franchise tax report. You then stated that "Company P" would pick up its share
of "Company S's" income on its 1998 income and franchise tax return ($100,000 x
90% = $90,000) and because of this, $90,000 would be taxed twice. Once on the
subsidiary's franchise tax report and again on the parent's franchise tax
report. You went on to state that this issue would also arise if the entities
were Limited Liability Companies(LLCs), or if there were several layers of
corporations, partnerships, and LLCs.

I presume that your question relates to the earned surplus component of the
franchise tax. Texas Tax Code (TTC) Sec. 171.001(b)(3) defines "corporation" to
include a limited liability company (LLC). Because the term "corporation" is
not otherwise defined under Rule 3.562, an LLC is considered a "corporate
member" of a limited liability company. For the earned surplus component, the
federal taxable income and gross receipts of an LLC, treated as a partnership
for federal income tax purposes, should be excluded from the investor
corporation's federal taxable income and gross receipts to the extent that they
would have been reported by the LLC. I have enclosed a copy of Rule 3.562 for
your review. Subsection (h)(2) of the rule relates to corporate and LLC members
of LLCs.

As for other related entities, there is an exclusion provided in Sec.
171.110(d) of the TTC for Schedule C special deductions for dividends received
from other corporations.

We are currently considering the treatment of Qualified Subchapter S
Subsidiaries and their parent corporations. No specific guidance can be given
at this time.

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

If you have any questions about this or any other franchise tax matter, please
call me at 1-800-531-5441, extension 34612. My direct number is (512) 463-4612.
You may write me at Tax Policy Division, Comptroller of Public Accounts,
Austin, Texas 78774.

Sincerely,

Janet Spies
Tax Policy Division