tax update

Margin Tax Update

We would like to update you on the Texas Comptroller’s pending margin tax desk audit program and to highlight some issues to be aware of in filing May 15 margin tax extension requests.

I. Desk Audit Program

The Comptroller will be conducting desk audits (correspondence audits) of certain margin tax reports filed in 2008. These desk audits will cover three types of reports:

• Reports that used the 0.5% tax rate, where the taxpayer has earlier reported (e.g., to the SEC) a standard industrial classification (SIC) code other than a retail or wholesale code, or where the taxpayer’s website suggests it is not a retailer or wholesaler;
• No Tax Due Reports filed by entities that reported total gross receipts of $300,000 or more on 2007 franchise tax reports; and
• Reports that used a SIC code for a service industry, but computed margin using the cost of goods sold deduction.

It is our understanding that the Comptroller's Office will target only single-entity filers, not combined groups. The program will not target passive entities, because they would not have filed 2007 franchise tax reports. Contact by the Comptroller’s Office under the program will disqualify taxpayers from entering into a voluntary compliance agreement only with respect to issues covered by the program, but not for any other issues.

The Comptroller’s initial focus will be on 0.5% rate taxpayers. For reports found to be suspect, the Comptroller will send an official letter identifying any perceived filing errors. Within 30 days of receiving that letter, a taxpayer will need to either substantiate its reporting position or agree to the Comptroller's findings. If the taxpayer substantiates its reporting position to the Comptroller’s satisfaction, no further action will be taken. If the taxpayer agrees to the Comptroller’s findings, the Comptroller will automatically amend the relevant tax report and waive all underpayment penalties. If the taxpayer either fails to respond to the letter or fails to substantiate its reporting position, the Comptroller will issue a deficiency determination.

Where the taxpayer does not fit neatly into a 4 digit SIC code, or where the taxpayer may be treated as a utility for certain regulatory purposes, a desk audit is likely and substantiating a 0.5% reporting position must be done carefully. A taxpayer in this position should consider beginning to substantiate a reporting position prior to receiving a desk audit notice, to insure time to prepare a thorough response within the 30 day turnaround. We have experience in substantiating 0.5% rate reporting positions and can assist with this process.

II. Combined Group Extension Requests - Due May 15th

The Comptroller’s web site recently posted tips on filing 2009 margin tax report extensions. Several of these tips and other considerations discussed below should be of particular interest to combined group filers.

It is not necessary to determine the exact make-up of a combined group by the deadline for filing extension requests. The extension affiliate list does not have any substantive impact on how taxable entities should file their franchise tax reports. For example, an entity improperly included in a combined group for extension purposes could still qualify as a passive entity, or file separately using a deduction election different than the combined group’s deduction election.

If, however, the extension affiliate list differs from the final affiliate schedule, the combined group will not be in good standing unless it provides the Comptroller an explanation in writing before the extended due date (November 16, 2009). If, for example, the extension affiliate list includes entities later omitted from the final affiliate schedule, the group must explain how any omitted entities will report - separately, or as a part of another combined group. The group may also need to provide the Comptroller’s Office with a written request that the proper amount of tax be allocated from the combined group’s extension payment to cover the omitted entity’s extension payment. Finally, the extension affiliate list must also indicate any entities that have no Texas nexus - without this indication, the Comptroller will assume listed entities have Texas nexus.

IRS Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.