If a Texas corporation converts into a limited partnership, does it still owe Texas franchise tax, and does a federal check-the-box election matter?

Plain-English summary

A Texas S corporation planned to convert into a Texas limited partnership by filing articles of conversion (under Tex. Bus. Corp. Act art. 5.18 and Tex. Revised Limited Partnership Act § 2.15) and to elect, federally, to be taxed as a corporation under the "check-the-box" rules. It asked how the conversion affects Texas franchise tax.

The Comptroller confirmed several points:

• Before conversion: the corporation remains liable for franchise tax up to the conversion. Either the tax must be paid before the conversion, or the articles of conversion must state that the resulting partnership will be liable for the converting corporation's franchise taxes.
• Final report: a final franchise tax report is due within 60 days after the effective date of the conversion.
• After conversion: the new partnership is not subject to the franchise tax. The federal "check-the-box" election (IRS Form 8832) has no effect on the partnership's franchise-tax status, because Texas looks to the legal formation of the entity, not its federal tax election.
• Corporate partners: a foreign corporation acting as general partner of a limited partnership doing business in Texas is subject to franchise tax; a Texas corporation acting as general partner or limited partner is also subject; but a foreign corporation whose only Texas contact is as a limited partner is not (Tex. Tax Code § 171.001(a); Rule 3.546(c)(12)).

Important currency note: This 1999 letter reflects the franchise tax before the 2008 overhaul. The premise that the converted partnership escapes the tax 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current margin-based franchise tax, partnerships are generally taxable entities, and STAR marks this document partially superseded on the taxation of partnerships.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 "partnership pays nothing after conversion" outcome as historical.

What this means for you

Businesses converting entity type

Two things survive the 2008 change and still matter on any conversion: (1) you must square up the old entity's franchise tax — pay it or shift the liability in the conversion documents — and (2) a final report is due (here, within 60 days). What did not survive is the idea that converting to a partnership ends franchise-tax exposure; a limited partnership is now generally a taxable entity itself.

Anyone relying on federal "check-the-box"

Texas did not, and generally does not, let a federal entity-classification election drive its franchise-tax treatment — it looks to how the entity is legally organized. Don't assume a federal election changes your Texas result.

Accountants and tax professionals

The general-partner nexus grid (foreign GP = taxable; Texas GP or LP = taxable; foreign LP-only = not taxable) is a useful pre-2008 reference, but confirm current treatment under the margin tax, which made partnerships taxable and reworked nexus and reporting.

Common questions

Q: When a corporation converts to a limited partnership, is the old franchise tax wiped out?
A: No. The corporation stays liable through the conversion; the tax must be paid before conversion or the articles of conversion must make the new partnership responsible, and a final report is due within 60 days.

Q: Does a federal check-the-box election to be taxed as a corporation change the Texas result?
A: No. The Comptroller said the election has no effect on the partnership's franchise-tax status because Texas looks to the entity's legal formation.

Q: Was the resulting partnership taxable?
A: Not under this pre-2008 letter. That changed in 2008, when partnerships became generally taxable entities.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.001(a) (franchise tax imposed on corporations doing business in Texas)
• Franchise Tax Rule 3.546(c)(12) (corporate general/limited partner nexus)
• Tex. Bus. Corp. Act art. 5.18; Tex. Revised Limited Partnership Act § 2.15 (articles of conversion — conversion mechanism)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9908261L

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
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.

August 25, 1999

RE: Conversion of Texas Corporation to a Texas Limited Partnership

Dear **:

Thank you for your letter concerning the conversion of a Texas corporation to a
Texas limited partnership.

You stated in your letter that your client is an existing Texas corporation
that has elected "S" status under Internal Revenue Code (IRC). The company
intends to convert from a corporation to a Texas Limited Partnership. It will
file Articles of Conversion in compliance with the requirements established in
Article 5.18 of the Texas Business Corporation Act and Section 2.15 of the
Texas Revised Limited Partnership Act. For federal income tax purposes, the
client plans to elect to be treated as a corporation under the Treasury
Regulations' "check-the-box" rules.

You correctly stated in your letter that the corporation would be liable for
the Texas franchise tax up until the time of conversion and that all of the
franchise taxes must be paid by the corporation prior to conversion or that the
Articles of Conversion must state that the converted entity (the partnership)
will be liable for the franchise taxes owed by the converting entity (the
corporation). A final franchise tax report will be due within 60 days after
the effective date of the conversion.

After the conversion, the newly formed partnership will not be subject to the
Texas franchise tax. The "check the box" regulation under the IRC (election
made on IRS Form 8832) will not have any affect on the franchise tax liability
of the partnership. We consider the legal formation of an entity in
determining its responsibility for Texas franchise tax.

I must also note that a foreign corporation, acting as the general partner in
the limited partnership, will be subject to the Texas franchise tax if the
limited partnership is doing business in Texas. A Texas corporation acting as
the general partner or as a limited partner will also be subject to the
franchise tax. A foreign corporation, whose only contact with Texas is as a
limited partner in a limited partnership doing business in Texas, is not
subject to Texas franchise tax. See Texas Tax Code section 171.001(a) and Rule
3.546(c)(12).

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