How did Texas treat income from in-state and out-of-state municipal bonds under the 1998 franchise tax?

Plain-English summary

Municipal-bond revenue entered the former taxable-capital calculation, but federally exempt bond income stayed out of taxable earned surplus and its receipts factor.

For taxable capital, municipal-bond revenue entered surplus and gross receipts. For earned surplus, income excluded from federal taxable income because of its exempt status did not enter taxable earned surplus or receipts. The letter gave the same answer for Texas and out-of-state municipal bonds.

For 1998, the franchise tax was the greater of taxable capital at 0.25% per privilege year or earned surplus at 4.5%. Texas imposed no intangibles tax and had no graduated rate scale. The letter reported no 1997 or pending 1998 tax-code changes affecting municipal-bond holders.

What this means for you

Corporate municipal-bond holders

The two former tax bases did not treat tax-exempt bond income the same way: taxable capital followed surplus and receipts, while earned surplus followed federal taxable income with stated modifications.

Tax professionals

Do not apply the historical rates or conclusions to current periods without checking current law.

Common questions

Q: Did Texas distinguish in-state from out-of-state municipal bonds?
A: The letter applied the same response to both.

Q: Did Texas impose an intangibles tax?
A: No.

Q: Was there a graduated franchise-tax rate?
A: No.

Citations and references

• The ruling identifies no statute or rule by section number

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9801343L

Original ruling text

January 14, 1998

Dear **:

In your letter of December 15, you requested information regarding the state
tax treatment of municipal bond income for the 1998 tax year.

I have restated your questions below followed by a response:

1. What method does your state use to calculate an effective state tax rate?

Response

Although Texas has no income tax, the state does impose a franchise tax on
corporations, banks, savings and loan associations, and limited liability
companies. In general, the tax is the larger of the tax computed for the net
taxable capital component (based on a rate of .25% per year of privilege
period) and the net taxable earned surplus component (which has a rate of
4.5%). The computation of each component is as follows:

(a) The net taxable capital component is based on the stated capital plus
surplus and is apportioned using a single gross receipts factor. In general,
surplus is based on the net assets of the corporation without deduction for
estimated liabilities and asset writedowns. In addition, certain accounting
methods are required in computing surplus. Revenues from municipal bonds would
be included in surplus and in calculating the gross receipts factor. State and
local taxes paid are deductible. However, deferred federal and state income
taxes must be added-back in computing surplus.

(b) The net taxable earned surplus component is based on federal taxable
income less certain specified deductions for dividends. In addition, officer
and director compensation must be added-back unless the entity is exempt from
the add-back. If municipal bond income is not included in federal taxable
income because it is exempt, the income is not included in taxable earned
surplus and receipts. State and local income taxes (and any deductible federal
taxes) would be allowed as deductions to the extent they are allowed as
deductions in computing federal taxable income.

2. Does Texas tax municipal bond income on out-of-state municipal bonds?

Response

See response to No. 1.

3. Does Texas tax municipal bond income on in-state municipal bonds?

Response

See response to No. 1.

4. Are intangible taxes levied in Texas on in-state or out-of-state municipal
   bonds? If yes, is there an exempted amount?

Response

No intangibles tax is levied.

5. What is the current rate of taxation and include the graduated income
   scale, if applicable, for the 1998 tax year.

Response

See response to No. 1 regarding tax rates. There is no graduated rate scale.

6. Were there any changes to the tax code in 1997 or are changes pending for
   1998 that would affect holders of municipal bonds?

Response

No.

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