If a Texas partnership elects to be taxed as a corporation federally, is it subject to franchise tax, and can a corporate general partner deduct the partnership's losses?

Plain-English summary

A Texas limited partnership elected, under Treasury Regulation § 301.7701-3 (the federal "check-the-box" rule), to be treated as an association taxable as a corporation for federal income tax purposes. Its corporate general partner and the partnership were included as members of a federal consolidated return. The general partner asked the Comptroller three questions about franchise tax.

The Comptroller's answers:

1. Does Texas respect the partnership's legal form, making it non-taxable? Yes. "If the entity is formed as a partnership under Texas law, it will not be subject to franchise tax" — the federal election to be taxed as a corporation does not change that.
2. Does the corporate general partner's earned surplus include the partnership's losses? No. The corporate general partner must compute its earned surplus as though no consolidated federal return were filed. On a separate federal return the partnership's losses would not be in the general partner's federal taxable income, so those losses are not included in the general partner's earned surplus.
3. Would the answer to #2 change if the partnership or general partner did not file as part of the consolidated return? No — the answer is the same either way.

The unifying idea: Texas looked to the entity's legal form (a partnership is not a franchise-tax payer), and it required a corporate partner to compute earned surplus on a separate-entity basis, so a partnership's losses could not shelter the corporate partner's earned surplus.

Important currency note: This 1998 letter reflects the franchise tax before the 2008 overhaul. The premise that a partnership is not a franchise-tax payer is exactly what changed — under the current margin-based franchise tax, partnerships are generally taxable entities, and STAR marks this document partially superseded on the taxation of partnerships. Treat the entity-level conclusion as historical.

What this means for you

Corporate partners in partnerships

The durable concept is separate-entity computation: a corporate partner computed its Texas earned surplus as if it filed no consolidated federal return, so it could not pull a partnership's losses into its own base. Don't assume federal consolidation flows through to Texas. (The margin tax changed partnership taxability and added combined reporting, so confirm current treatment.)

Anyone relying on "check-the-box"

As in the Comptroller's other letters of this era, a federal election to be taxed as a corporation did not make a Texas partnership a franchise-tax payer — Texas followed legal form. That entity-level result is pre-2008.

Accountants and tax professionals

Two takeaways: (1) legal form controlled the partnership's franchise-tax status; and (2) the corporate partner's earned surplus was computed on a separate-return basis, excluding partnership losses. Both are pre-2008; re-verify under the margin tax.

Common questions

Q: If a Texas partnership elects to be taxed as a corporation federally, is it subject to franchise tax?
A: No. The Comptroller said an entity formed as a partnership under Texas law is not subject to franchise tax, regardless of its federal election. (This entity-level result predates the 2008 margin tax, under which partnerships are generally taxable.)

Q: Can a corporate general partner deduct the partnership's losses in its earned surplus?
A: No. The corporate general partner computes earned surplus as though no consolidated federal return were filed, so the partnership's losses are not included.

Q: Does filing (or not filing) a consolidated federal return change that?
A: No — the Comptroller said the answer is the same either way.

Citations and references

Authorities referenced:

• Treasury Regulation § 301.7701-3 (federal "check-the-box" entity-classification election)
• The Comptroller applied the franchise tax's separate-entity earned-surplus computation for a corporate partner rather than a specific cited Tax Code section.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9801360L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/10/14
Issue(s) that caused the document to be superseded — Taxation of partnerships
Reason(s): The Franchise Tax Code was amended by House Bill 3 and House Bill 3928,
Acts 2007, 80th Legislative Session, effective January 1, 2008 and affected Franchise
tax reports due on or after January 1, 2008. One of the many changes to this Tax Code
subjected partnerships (previously not required to file) to the franchise tax reporting
requirement.

January 28, 1998

Dear Mr. **:

In your letter of January 16, you requested a determination regarding the
franchise tax treatment of a Texas limited partnership which has elected under
Treasury Regulation Section 301.7701-3 to be treated as an association taxable
as a corporation for federal income tax purposes.

You state that your client is the general partner of the partnership. You also
state that the partnership is actively engaged in business in Texas. For
federal income tax purposes, the partnership and your client will be included
as members of a consolidated federal income tax return.

I have restated your questions followed by a response:

Issue 1:

If a limited partnership elects to be treated as a corporation for federal tax
purposes, will Texas respect the legal form of the entity, a partnership,
therefore rendering it a non-taxable entity for franchise tax purposes?

Response

If the entity is formed as a partnership under Texas law, it will not be
subject to franchise tax.

Issue 2:

If the partnership is taxed as a corporation for federal purposes, and both the
partnership and corporate general partner file as members of a federal
consolidated return, will the earned surplus calculation for the corporate
general partner include the partnership's losses?

Response

As you indicate, the corporate general partner must compute its earned surplus
as though no consolidated federal income tax return were filed. Because the
losses of the partnership would not be included in the federal taxable income
of the corporate general partner on a separate federal income tax return, the
partnership losses will not be included in the calculation of earned surplus
for the corporate general partner.

Issue 3:

Would the answer to Issue 2 be different if the partnership or the corporate
general partner does not file as a member of the federal consolidated return?

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