Texas Comptroller of Public Accounts    STAR System


9808711R



STAR SUPERSEDED WITHOUT SUMMARY 

Accession No.(s): 9808711R

Document superseded on: 08/15/2013 



STATE OF TEXAS
COMPTROLLER OF PUBLIC ACCOUNTS
FRANCHISE TAX

Section 3.558.  Earned Surplus:  Officer and Director Compensation.  (Tax Code, 
sec. 171.110).

(a) The provisions of this section apply to franchise tax reports originally 
due after January 1, 1992.

(b) Definitions.  The following words and terms, when used in this section, 
shall have the following meanings, unless the context clearly indicates 
otherwise.

(1) Internal Revenue Code - 

(A) For reports originally due on or after January 1, 1998, the Internal 
Revenue Code (IRC) of 1986 in effect for the tax year beginning on or after 
January 1, 1996 and before January 1, 1997.

(B) For reports originally due on or after January 1, 1996 and before January 
1, 1998, the Internal Revenue Code of 1986 in effect for the tax year beginning 
on or after January 1, 1994, and before January 1, 1995.

(C) For reports originally due on or after January 1, 1992 and before January 
1, 1996, the Internal Revenue Code of 1986 in effect for the tax year beginning 
on or after January 1, 1990, and before January 1, 1991 (1990 IRC).

(D) The franchise tax law requires that the 1990 IRC be used for reports 
originally due prior to January 1, 1996.  Because of this requirement, there 
may be differences between federal taxable income reported for federal income 
tax purposes and reportable federal taxable income for franchise tax purposes 
for franchise tax reports originally due prior to 1996.  To the extent that 
such differences exist, the 1990 IRC must be used to report the differences for 
reports originally due on or after January 1, 1996.  For example, if a 
corporation was denied any portion of an IRC sec. 179 deduction on an asset in 
computing taxable earned surplus on a franchise tax report due prior to January 
1, 1996 (because the sec. 179 deduction exceeded the $10,000 limit allowed 
under the 1990 IRC), the corporation will be allowed to compute depreciation on 
the asset based on the 1990 IRC (i.e., the corporation may depreciate the asset 
based on the $10,000 sec. 179 deduction allowed under the 1990 IRC) for reports 
originally due on or after January 1, 1996. 

 (2) Employee - Every individual classified as an employee under Internal 
Revenue Code, sec. 3401, and the applicable regulations (i.e., common law 
employees).  An individual is treated as an employee of the party for whom 
services are performed even if the employee is reimbursed by a third party 
under a common paymaster or similar arrangement.  For the purposes of this 
section: 

(A) directors of a corporation or banking corporation are treated as employees 
of the corporation; 

(B) managers of a limited liability company are treated as employees even 
though the managers may also be members. 

(3) Compensation - The amount reportable to an officer or director for the tax 
reporting period as includable in the officer/director's federal taxable income 
without regard to any monetary limitations imposed for federal income tax 
purposes.  Compensation does not include any amount reported to an 
officer/director which is disallowed as a reduction to federal taxable income 
for any taxable period for federal income tax purposes.  For example, 
compensation does not include employee remuneration for which a deduction is 
disallowed under Internal Revenue Code, sec. 162(m).  Compensation is included 
wherever reportable on federal tax reporting forms including a Form W-2 Wage 
and Tax Statement, a Form 1099-MISC, or Schedule K-1 of Form 1065.  For example 
(if all compensation is deductible): 

(A) if a corporation (subject to the add-back of officer and director 
compensation) issues a Form W-2 to an officer, the compensation included in 
earned surplus is the amount reflected on Form W-2 that must be included in the 
officer's federal taxable income (Block 10 of the 1991 Form W-2); 

(B) if a corporation (subject to the add-back of officer and director 
compensation) issues an officer and director of a corporation a Form W-2 and a 
Form 1099-MISC, compensation included in the corporation's earned surplus for 
that officer/director is the sum of the amount reflected on Form W-2 that the 
officer must include in federal taxable income, the amount reflected on Form 
1099-MISC as nonemployee compensation that the director must include in federal 
taxable income, plus any compensation which would be reportable on Form 
1099-MISC except for monetary limitations. 

(4) Officers and directors of a corporation other than a banking corporation - 
Except as provided in paragraph (10) of this subsection, the officers and 
directors determined in accordance with the laws of the corporation's state of 
incorporation and the corporation's bylaws. 

(5) Executive officers and directors of a banking corporation -

(A) Executive officer of a banking corporation (bank), which includes a limited 
banking association, means a person who participates or has authority to 
participate (other than in the capacity of a director) in major policymaking 
functions of the bank, whether or not the officer has an official title, the 
title designates the officer an assistant, or the officer is serving without 
salary or other compensation.  The chairman of the board, the president, every 
vice president, the cashier, the secretary, and the treasurer of a bank are 
considered executive officers unless the officer is excluded, by resolution of 
the board of directors or by the bylaws of the bank, from participation (other 
than in the capacity of a director) in major policymaking functions of the 
bank, and the officer does not actually participate therein.  The term is not 
intended to include persons who may have official titles and may exercise a 
certain measure of discretion in the performance of their duties, including 
discretion in the making of loans, but who do not participate in the 
determination of major policies of the bank and whose decisions are limited by 
policy standards fixed by the senior management of the bank.  For example, the 
term does not include a manager or assistant manager of a branch of a bank 
unless that individual participates, or is authorized to participate, in major 
policymaking functions of the bank. 

(B) Directors of a banking corporation. 

(i) For a banking corporation, other than a limited banking association, 
directors are determined based on the bank's charter, bylaws, and other 
requirements imposed by the appropriate regulatory or legal authorities. 

(ii) For a limited banking association, "directors" means the managers or 
directors determined based on the articles of association, regulations, and 
participation agreement if management is vested in a board of managers or board 
of directors.  If management is not vested in a board of managers or board of 
directors, "directors" means the participants in the limited banking 
association. 

(iii) Advisory directors as defined in the Code of Federal Regulations, Title 
12, sec. 215.2, are not considered directors for the purposes of this section. 

(6) Officers and directors of a limited liability company - For the purposes of 
this section, the "officers or directors" are the managers or similar 
management persons identified in the articles of organization, operating 
agreement, or similar agreements required under the laws of the state in which 
the company is organized, except as provided in paragraph (10) of this 
subsection. 

(7) Shareholder - An individual, corporation, organization, government or 
governmental subdivision or agency, business trust, estate, trust, partnership, 
association, or other legal entity in whose name shares issued by a corporation 
are registered, in whose name membership interests in a limited liability 
company are held, or in whose name participation shares in a limited banking 
association are held, unless the formation of an entity is for tax avoidance 
purposes as indicated in this paragraph.  Any entity or individual in whose 
name shares of more than one class of stock are held shall be counted as one 
shareholder for the purposes of this section.  For example, a shareholder 
having both common and preferred stock is counted as one shareholder.  However, 
ownership interests held by separate legal entities will be counted as separate 
shareholders (or members) even if the separate legal entities have common 
shareholders (or members).  If a trust, partnership, or other entity (the 
investor) which is a shareholder or other owner in a corporation (the investee) 
is organized or maintained primarily to avoid the add-back of compensation 
under the Tax Code, sec. 171.110(a)(1), each shareholder or owner of such 
investor shall be considered a shareholder of the investee for the purposes of 
the Tax Code, sec. 171.110(b)(1). 

(8) Tax reporting period - For the purposes of this section, the period upon 
which the tax is based under the Tax Code, sec. 171.1532 or sec. 171.0011. 

(9) Unless otherwise indicated in this section, the following will apply. 

(A) "Banking corporation" includes, but is not limited to, a limited banking 
association. 

(B) "Corporation" includes, but is not limited to, a banking corporation and 
limited liability company. 

(C) "Director of a corporation" includes, but is not limited to, a director of 
a limited liability company (as defined in paragraph (6) of this subsection) 
and a director of a banking corporation (as defined in paragraph (5) of this 
subsection).

(10) Officer of a corporation -

(A) Unless otherwise indicated in this section, "Officer of a corporation" 
includes, but is not limited to, an executive officer of a banking corporation 
(as defined in paragraph (5) of this subsection), an officer of a limited 
liability company (as defined in paragraph (6) of this subsection), and an 
officer of a corporation other than a banking corporation (as defined in 
paragraph (4) of this subsection).

(B) For a limited liability company or a corporation other than a banking 
corporation, any person designated as an officer (or as a manager in the case 
of a limited liability company) is presumed to be an officer of the corporation 
for purposes of Tax Code, sec. 171.110, and subject to compensation add-back if 
that person:

(i) holds an office created by the board of directors or pursuant to the 
corporate charter or bylaws (or the articles of organization, operating 
agreement, or similar agreement in the case of a limited liability company); 
and

(ii) has legal authority to bind the corporation with third parties by 
executing contracts or other legal documents.

(C) A limited liability company or a corporation other than a banking 
corporation may rebut the presumption that a person is an officer if it 
conclusively shows, through the person's job description or other 
documentation, that the person does not participate or have authority to 
participate in significant policymaking aspects of the corporate operations.

 (c) Unless otherwise excluded, if an individual is an officer or director of a 
corporation for a portion of a tax reporting period, compensation for such 
individual is included in computing earned surplus to the extent compensation 
is allocable to the portion of the tax reporting period when the individual was 
an officer or director. 

(d) If an individual is an officer or director of a corporation, all 
compensation to such individual in any capacity as an employee (as defined in 
subsection (b)(2) of this section) of such entity is included in computing 
earned surplus. 

(e) Compensation, as defined in subsection (b)(3) of this section, is included 
in computing earned surplus even if any portion or all of the compensation is 
capitalized for federal income tax purposes. 

(f) If any officer or director of a corporation performs services for such 
corporation which would normally be rendered to the corporation in that 
individual's capacity as an officer or director, any payment or other amount 
deducted by such entity will be compensation to the extent the comptroller 
determines that the intent was the avoidance of franchise tax.  For example, if 
officers of a parent and subsidiary perform services for both corporations 
which are billed to the subsidiary by the parent, the comptroller may consider 
all or any portion of the billings as compensation paid to that subsidiary's 
officers which are also officers of the parent.  Factors used to determine if 
such payments or other consideration are compensation may include, but are not 
limited to: 

(1) the extent of remuneration to such officers, directors, or managers by the 
entity for whom the services are performed; 

(2) the size and complexity of the business operations of the entity for whom 
the services are performed; and 

(3) the scope of business activities of the entity or individual providing the 
services. 

(g) Exemptions from compensation add-back. 

(1) Compensation is not included in computing earned surplus under the Tax 
Code, sec. 171.110, to the extent the compensation is attributable to any 
portion of a tax reporting period when a corporation has fewer than 36 
shareholders, a limited liability company has fewer than 36 members, or a 
limited banking association has fewer than 36 participants and 
participant-transferees. 

(2) A corporation or other entity subject to franchise tax is not required to 
include compensation in computing earned surplus for any portion of a tax 
reporting period during which the entity qualifies for treatment as an S 
corporation for federal income tax purposes.  If the corporation fails to 
qualify as an S corporation or S corporation status is terminated for any 
reason, the compensation will be included in determining earned surplus at the 
earlier of the time that the entity fails to qualify as an S corporation or S 
corporation status is terminated unless the entity otherwise qualifies to 
exclude compensation in computing earned surplus. 

(3) For the purposes of this subsection, remuneration of officers and directors 
shall not be considered compensation if such remuneration is excessive.  
Factors used in determining to what extent remuneration is excessive may 
include, but are not limited to: 

(A) the officer's or director's qualifications; 

(B) the nature, extent, and scope of the officer/director's work; 

(C) the size and complexity of the business; 

(D) a comparison of remuneration with the gross and net income of the business; 

(E) the prevailing general economic conditions; 

(F) remuneration compared to distributions to shareholders; 

(G) prevailing rates of remuneration for comparable positions in comparable 
concerns; and 

(H) the remuneration policy of the taxpayer as to all employees. 

(4) A corporation is required to include compensation in computing earned 
surplus for any portion of a reporting period during which the corporation 
fails to qualify for exclusion under the Tax Code, sec. 171.110(b). 

(h) Subsidiary corporations.  A subsidiary corporation may not qualify for the 
exclusion under the Tax Code, sec. 171.110(b), if it has a parent corporation 
which does not qualify for the exclusion. For the purposes of the Tax Code, 
sec. 171.110(c), a corporation qualifies as a parent if it ultimately controls 
the subsidiary even though the control may arise through any series or group of 
other subsidiaries or other entities. 

(1) Control is presumed if a parent company directly or indirectly owns, 
controls, or holds a majority of the outstanding voting stock of a corporation 
or ownership interests in another entity. 

(2) In determining if a corporation is a parent, the comptroller will take into 
account ownership through a related corporation, corporate group, or other 
noncorporate entity.  If the corporation has control, as defined in paragraph 
(1) of this subsection, of a related corporation, corporate group, or other 
noncorporate entity that owns a corporation, the entire stock or membership 
interest owned by the related corporation, corporate group, or other 
noncorporate entity will be considered controlled by the corporation owning the 
related corporation, corporate group, or other noncorporate entity. 


Effective Date:  August 17, 1998
Filed with Secretary of State:  July 28, 1998







ACCESSION NUMBER: 9808711R  
SUPERSEDED: Y
DOCUMENT TYPE: L
DATE: 08/17/1998
TAX TYPE: FRANCHISE