Legally speaking: A word about franchise taxes

Attorney Ryan Solis
Attorney Ryan Solis
Attorney Ryan Solis

So, you have decided to start your own business, and you distinctly remember the Chamber of Commerce seminar speaker explain that in order to protect your personal assets you need to form a business entity.  Wanting to protect your assets, you file the necessary paperwork with the Texas Secretary of State and “voila!”, you now have a limited liability company or a corporation. What many new business owners are unaware of, however, is the danger in not complying with Texas franchise tax laws. 

Failure to file franchise tax reports and pay accrued taxes can result in the officers or directors of a business being personally liable for debts and liabilities of the business – the very reason why the entity was formed in the first place. 

Franchise taxes are imposed upon an LLC or corporation that does business in Texas or that is chartered in Texas.  The rate of the tax varies depending on the type of business in which the entity is engaged.    Generally speaking, however, businesses are not required to pay franchise taxes if it is determined that the taxes owed are less than $1,000 or if the gross revenue of the business is less than one million dollars.  Even if a business falls within either of these categories it still must file franchise tax reports with the Comptroller’s Office by May 15th of each year. Did you make it?   

Failure to file franchise taxes or file a franchise tax report will result in the Comptroller’s office forfeiting the charter of the entity.  After an entity has been forfeited, the Comptroller will notify the Texas Secretary of State (SOS).  If the LLC or corporation’s privileges have not been revived within 120 days from the date of forfeiture by the Comptroller, the SOS will forfeit the charter of the entity.  Once this occurs, the SOS will note in the official records that the particular business has had its charter forfeited.  This means that the entity is no longer in good standing with the State of Texas. 

Once the SOS has forfeited the charter, the directors and officers of the corporation or LLC are personally liable for any debts or liabilities that incur from the time the tax or report should have been paid or filed until the time the charter is revived.  This is an extreme penalty. 

As mentioned above, one of the main reasons for creating a business entity is the personal protection that is afforded its shareholders or members.  Once corporate privileges have been forfeited, the officers and directors are treated as if they were in a general partnership with their personal assets within reach of any creditor.  For example, a corporation does not file its franchise tax report on May 15th.  On July 1st Litigious Larry walks into the business and slips on a banana peel.  Larry sues the business for personal injuries he suffered when he fell.  Ordinarily, any claims that Larry may have would be limited to the assets of the business; he would only be able to pursue what the corporation has.  After the corporation’s charter had been forfeited, however, the officers and directors will be liable to Larry for any personal injuries he suffered as a result of the fall. 

This begs the question: what can a business do once the SOS has forfeited its charter? The answer is to start back at square one with the Comptroller’s office.  A business will need to file reports for each year in which reports were not filed and, if applicable, it will need to pay delinquent franchise taxes.  There may be fines and penalties that will need to be addressed as well.  Once franchise tax issues have been resolved, the Comptroller will issue a Certificate of Tax Clearance form.  This form will indicate to the SOS that the forfeited entity has met its franchise tax requirements.  This clearance form will be filed with the SOS along with an Application for Reinstatement.  Upon receiving these two forms, the SOS will then revive the charter of the LLC or corporation.  Unfortunately for officers and directors, the personal liability to which they are subject during the forfeited period will not be waived.  The officers and directors will be protected going forward, but this protection will not be retroactive. 

A corporation or an LLC is an excellent way to protect the personal assets of business owners.  Care must be taken, however, to ensure that franchise tax responsibilities are met.  The last thing an officer or director wants is to lose their personal protection simply because May 15th came and went.