Franchise Tax Frequently Asked Questions

No. A passive entity is specifically defined for franchise tax purposes in Texas Tax Code Section 171.0003.

To qualify as a passive entity, the entity must be a partnership or trust, other than a business trust, for the entire accounting period on which the tax is based. The entity may not qualify as passive for the accounting period during which the conversion occurs even if it meets the 90 percent income test. The entity may qualify as passive for subsequent reports.

No. However, if an entity meets the criteria as a passive entity, the entity may qualify as passive even if the entity has some rental income. Texas Tax Code Section 171.0003(b).

To the extent the IRC treats the recapture of depreciation under these sections as ordinary income, the recaptured amount is not passive income when computing the 90 percent test under Texas Tax Code Section 171.0003(a)(2). Note that the term "Section 1250 recapture," which is treated as ordinary income for federal tax purposes, should not be confused with the term "unrecaptured Section 1250 gain," as defined in IRC Section 1(h)(6), which is treated as a capital gain for federal tax purposes and qualifies as passive income when computing the 90 percent test.

For 2024 and later reports, a passive entity that is registered, or is required to be registered with the Secretary of State (SOS) or the Comptroller’s office, must file either a Long Form Report or an EZ Computation Report annually to affirm that the entity qualifies as a passive entity. The entity need only blacken the circle in the taxpayer information section at the top of the form that identifies it as such. A passive entity is not required to file a Public Information Report or an Ownership Information report.

For reports due prior to 2024, passive entities that are registered or are required to be registered with either the SOS or the Comptroller's office are required to file Form 05-163, Texas Franchise Tax No Tax Due Report, to affirm that the entity qualifies as passive for the period upon which the tax is based. A passive entity is not required to file an Ownership Information Report or a Public information Report.

If a partnership or trust qualifies as a passive entity for the period upon which the franchise tax report is based, is not registered and is not required to register with either the SOS or the Comptroller's office, then it will not be required to register or file a franchise tax report with the Comptroller's office.

IRC requires that a taxpayer who has a net Section 1231 gain for the tax year review the five preceding tax years for possible recapture of net Section 1231 losses for the prior years. If there were any net Section 1231 losses during the period, the taxpayer must treat the current year's net Section 1231 gain as ordinary income to the extent of the amount of unrecaptured net Section 1231 losses for the past period. As a result, the recapture is not considered passive income when computing the 90 percent test under Texas Tax Code Section 171.0003(a)(2).