| (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) C corporation--A corporation defined in Internal Revenue Code, §1361(a)(2). (2) 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 §179 deduction on an asset in computing taxable earned surplus on a franchise tax report due prior to January 1, 1996 (because the §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 §179 deduction allowed under the 1990 IRC) for reports originally due on or after January 1, 1996. (3) Qualified Subchapter S Subsidiary--A corporation as described in the Internal Revenue Code, §1361(b)(3)(B). (4) S corporation--A corporation as described in the Internal Revenue Code, §1361. (5) Tax reporting period--For the purposes of this section, the period upon which the tax is based under the Tax Code, §171.1532 or §171.0011. (c) A corporation shall be treated as an S corporation to the extent the corporation qualifies for such treatment during the tax reporting period. See §3.558 of this title (relating to Earned Surplus: Officer and Director Compensation) regarding compensation used in computing earned surplus of an S corporation.
(d) Where and to the extent an S corporation allocates income and deductions to shareholders, such items will be treated as income and deductions of the S corporation as though the corporation were taxed as a C corporation for federal income tax purposes. (1) Federal income tax requirements or limitations imposed on the S corporation apply for the purposes of this section. (2) Unless otherwise provided, federal income tax limitations or other restrictions imposed on the shareholders of the S corporation with regard to claiming losses, deductions, and other items are ignored in determining taxable earned surplus of the S corporation. (e) Treatment of specific items reported to S corporation shareholders in computing reportable federal taxable income. (1) No deduction or reduction is allowed for excess net passive income tax, built-in gains taxes, capital gains taxes, the federal tax on fuels,
or similar taxes imposed on the S corporation. (2) Ordinary income from trade or business activities is included while ordinary losses from such activities are deducted. (3) Net income from rental activities is included and net losses are deducted. (4) Dividend income received by an S corporation is included except for: (A) amounts reportable under the Internal Revenue Code, §78 or §§951-964; (B) dividends from a subsidiary, associate, or affiliate that does not transact a substantial portion of its business in the United States. If 80% or more of a corporate payor's gross receipts (as computed for earned surplus) are attributable to business outside the United States, the corporate payor is not doing a substantial portion of its business within the United States. The payor's gross receipts are measured based on the period upon which the recipient's tax is
based under the Tax Code, §171.0011 or §171.1532; (C) dividends from a subsidiary, associate, or affiliate that does not maintain a substantial portion of its assets in the United States. If 80% or more of a corporate payor's tangible assets (based on original cost) are situated outside the United States, the corporate payor does not maintain a substantial portion of its assets within the United States. The payor's assets are valued at the end of the tax reporting period upon which the recipient's tax is based under the Tax Code, §171.0011 or§171.1532; and (D) dividends which qualify for exclusion under the provisions of §3.555(k) of this title (relating to Earned Surplus: Computation). (5) Royalty income is included. (6) Taxable interest is included unless the interest qualifies for exclusion under the provisions of §3.555(k) of this title (relating to Earned
Surplus: Computation). Interest income which is exempt from federal income taxes is not included and expenses related to such income are not deductible in computing reportable federal taxable income. (7) Salaries and wages used in computing ordinary income or loss are allowed in computing reportable federal taxable income after reduction for any jobs credit claimed on the federal income tax return for the S corporation. Other expenses which are reduced for credits claimed on the return similarly are allowed net of such credits. (8) Deductions for charitable contributions are allowed. (9) Capital losses in excess of capital gains may be deducted. (10) If deductions for oil and gas depletion or intangible drilling costs are allowed to shareholders of an S corporation rather than to the entity itself, the S corporation must compute such deductions as though the entity were taxed as a C corporation for federal
income tax purposes. (11) The corporation is allowed to deduct Internal Revenue Code, §179, amounts reported to shareholders subject to limitations imposed on the S corporation at the corporate level. (12) An S corporation may deduct foreign income taxes reported to shareholders unless the taxes are otherwise deducted in computing taxable items reported to shareholders. (13) The corporation is not allowed to deduct amounts reported to shareholders which are personal in nature even though such items may qualify as itemized deductions on the shareholder's income tax return. (f) Unless otherwise provided under the Tax Code, §171, this section, or the rules applicable to the Tax Code, §171, S corporations are treated the same as any other corporation in computing earned surplus. (g) Qualified Subchapter S Subsidiary (QSSS). (1) A QSSS may not file a
consolidated or combined franchise tax report with its parent S corporation. (2) Except as otherwise provided in this paragraph, the earned surplus of the QSSS and parent S corporation will be computed as though the parent S corporation and QSSS had filed separate S corporation returns for federal income tax purposes. That is, the QSSS will be treated as an S corporation for earned surplus computation purposes. For example, sales between the parent S corporation and QSSS must be used in computing earned surplus even though the parent S corporation and QSSS are treated as one corporation for federal income tax purposes. (3) The parent S corporation's share of the items of income or loss of the QSSS is not included in the parent S corporation's taxable earned surplus or gross receipts to the extent the items would be reportable by the QSSS if a separate S corporation return were filed. (4) Distributions from the QSSS
to the parent S corporation will not be included in taxable earned surplus or receipts of the parent S corporation if such amounts would be excluded from reportable federal taxable income of the parent S corporation if the QSSS was an S corporation (not qualifying as a QSSS) and the parent S corporation were an individual shareholder in that corporation.
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