Does a federally tax-exempt nonprofit have to file and pay Texas franchise tax, and does its unrelated business income get taxed?

Plain-English summary

The Texas Comptroller explained how the franchise tax applies to a federally tax-exempt nonprofit that has some unrelated business income. Texas has no personal or corporate income tax, but it does levy a franchise tax on "each corporation that does business in this state or that is chartered or authorized to do business" here (Tex. Tax Code § 171.001). The Comptroller confirmed that "corporation" includes nonprofit corporations (along with S corporations, close corporations, professional corporations, LLCs, banking corporations, and savings-and-loan associations). Partnerships and sole proprietorships were not subject to this tax.

Being exempt from federal income tax does not automatically exempt a nonprofit from Texas franchise tax. A nonprofit corporation doing business in Texas must apply for a Texas exemption under § 171.051 and Franchise Tax Rule 3.541, and it is "required to file and pay franchise tax until an exemption is granted by the comptroller."

Finally, the Comptroller noted that if the nonprofit has unrelated business income that is part of its federal taxable income, that income "would be included in the calculation of the earned surplus component of the franchise tax."

Important currency note: This 1999 letter describes the franchise tax as it existed before 2008, when the tax had a "taxable capital" and an "earned surplus" component. The Legislature replaced that structure with the current margin-based franchise tax effective January 1, 2008, and STAR marks this document partially superseded. Use it for the general principle — nonprofits must obtain a Texas exemption, they are not automatically exempt — and confirm the current mechanics with the Comptroller.

What this means for you

Nonprofit and tax-exempt organizations

Do not assume that an IRS 501(c) determination covers you in Texas. If your nonprofit is incorporated and doing business in Texas, you generally must separately apply to the Comptroller for a Texas franchise-tax exemption, and you owe the tax until that exemption is granted. Build the Texas application into your start-up checklist so you are not accruing tax while you wait.

Accountants and tax professionals

The two takeaways that survive the 2008 overhaul are structural: (1) Texas franchise tax reaches nonprofit corporations, and exemption is by application, not automatic; and (2) unrelated business income that flows into federal taxable income was picked up by the earned-surplus base. Verify the current filing and exemption procedure, because the base and components changed under the margin tax.

Common questions

Q: Is a federally tax-exempt nonprofit automatically exempt from Texas franchise tax?
A: No. A nonprofit corporation doing business in Texas must apply to the Comptroller for a Texas exemption under § 171.051 and Rule 3.541, and must file and pay franchise tax until the exemption is granted.

Q: Does unrelated business income get taxed?
A: Under the pre-2008 tax addressed here, to the extent the unrelated business income was part of the organization's federal taxable income, it was included in the earned-surplus component of the franchise tax.

Q: Can I rely on this letter?
A: Not as your own ruling. STAR letters can support a detrimental-reliance claim only for the taxpayer they were issued to, and this one predates the 2008 restructuring of the franchise tax, so confirm current procedure with the Comptroller.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.001 (franchise tax imposed on corporations doing business in Texas)
• Tex. Tax Code § 171.051 (application for exemption from franchise tax)
• Franchise Tax Rule 3.541 (exemptions — application process)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9910268L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/15/14
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.

October 14, 1999

To: **

Dear **:

Thank you for your e-mail regarding federally exempt organizations with
unrelated taxable business income.

You asked specifically what type of returns these organizations should file for
Texas franchise tax reporting purposes.

As you know, Texas does not have an income tax. It does have a franchise tax
that is imposed on "each corporation that does business in this state or that
is chartered or authorized to do business in this state." See Sec. 171.001 of
the Texas Tax Code (TTC). Corporations are defined to include Non-Profit
corporations, S Corporations, Close Corporations, Professional Corporations,
Limited Liability Companies, Banking Corporations and Savings & Loan
Associations. Partnerships and sole proprietorships are not subject to the tax.

If the tax-exempt organization is a non-profit corporation that is doing
business in Texas, it will be subject to the Texas franchise tax. However,
Section 171.051 of the TTC states that a "corporation may apply for exemption
under this subchapter by filing with the comptroller...evidence of the
corporation's qualifications for the exemption." Franchise Tax Rule 3.541
(Exemptions) sets out guidelines for the application process.

The non-profit corporation is required to file and pay franchise tax until an
exemption is granted by the comptroller.

In addition, to the extent that the unrelated business income of the tax-exempt
entity is part of taxable income for federal income tax reporting purposes, the
income would be included in the calculation of the earned surplus component of
the franchise tax.

The statute and rule cited above can be viewed via the Comptroller's Window on
State Government at . Click on the heading "Texas
Taxes", then "the Franchise Tax." On "the Franchise Tax" page, you'll see a
link to " Franchise Tax Rules from the Texas Administrative Code at the Texas
Secretary of State" and a link to "Chapter 171 of the Tax Code."

For the rules, click on the "Texas Administrative Code" link and you'll be
connected to the Texas Secretary of State's website. At the top of that page,
you'll see the "Texas Administrative Code Viewer." Click on this, then enter
the rule number and the rule title or heading.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 3-4612.

Sincerely,

Janet Spies
Tax Policy Division