The Texas Franchise Tax: What Business Owners Often Miss

Texas is well known for having no state income tax, which is a meaningful advantage for high earners and business owners. But many businesses overlook the Texas franchise tax — officially called the "margin tax" — which applies to most entities doing business in Texas.

The franchise tax is not based on profit in the traditional sense. It is based on a measure called "taxable margin," which is essentially your Texas revenues minus one of several allowable deductions. The result is then multiplied by the applicable tax rate.

Texas gives businesses four ways to calculate taxable margin, and you use the one that produces the lowest tax:

1. 70% of total revenue 2. Revenue minus cost of goods sold (COGS) 3. Revenue minus compensation paid to employees 4. Revenue minus $1 million

For most service businesses, the compensation deduction is the most valuable. For product-based businesses, COGS often wins. The 70% cap is frequently the fallback.

The tax rate for most businesses is 0.75% of taxable margin. Retail and wholesale businesses pay 0.375%. Businesses with total revenues under $2.47 million (2024 threshold) owe $0 — they file a "No Tax Due" report but pay nothing.

1. Not filing when required. Any entity legally formed in Texas, or doing business in Texas, must file — even if no tax is owed. The penalty for failure to file starts at 5% of the tax due and increases.

2. Miscategorizing compensation. The compensation deduction includes wages, salaries, bonuses, and certain employee benefits — but not payments to independent contractors. Getting this wrong can mean leaving money on the table or understating your deduction.

3. Ignoring the combined group rules. If your business is part of a group of affiliated entities under 70% common ownership, Texas may require a combined group filing. This catches many multi-entity businesses by surprise.

4. Missing the May 15 deadline. The Texas franchise tax report is due May 15 each year (with extensions available). The IRS April 15 federal deadline is a different filing entirely.

The Texas franchise tax rewards thoughtful structure. A few strategies worth discussing with your advisor:

Optimize your entity structure. Sole proprietors and general partnerships are exempt from the franchise tax. Certain holding companies structured around real property may also qualify for exemptions. This does not mean you should restructure entirely to avoid the tax, but it is worth modeling.

Maximize the compensation deduction. If your business relies heavily on employee labor, ensure you are capturing all eligible compensation — including employer-paid health insurance, retirement contributions, and certain other benefits.

Coordinate timing. The franchise tax is based on the prior year's revenue, which means decisions made now affect next year's liability. Year-end planning can shift the picture meaningfully.