The Texas Supreme Court ruled that the franchise tax does not impose a tax on a natural person’s share of partnership income, without voter approval, in violation of Article VIII, §8 (Bullock Amendment) of the Texas Constitution.
The taxpayer, a limited partnership, argued that because the income of a partnership is allocated to each partner according to the partner’s partnership interest, the franchise tax applies to each partner’s allocated share of partnership income. The taxpayer asserted that, in this manner, the franchise tax is a tax on the net incomes of its partners and, thus, violates the Bullock Amendment as to partners who are natural persons. The Bullock Amendment prohibits the state from implementing an income tax on the net incomes of natural persons, including a person’s share of partnership income, without voter approval.
The Comptroller argued that the franchise tax is not an income tax because it can result in taxes due even if the entity loses money. The comptroller further argued that whether the tax is an income tax was irrelevant because Texas has adopted the entity theory for partnership law and a tax imposed on a limited partnership entity does not constitute a tax on the net incomes of the partnership’s individual partners.
The taxpayer countered the entity theory argument by taking the stance that Texas has not adopted the entity approach for partnership income. Thus, according to the taxpayer, partnership income is divided into shares essentially owned by the partners regardless of whether the income shares are actually distributed to the partners.
The court agreed with the comptroller’s entity theory argument and stated that, under Texas law, the entity theory applies to partnership income and profits. Individual partners do not own any of either while they remain in the partnership’s hands and have not been distributed to the partners. Furthermore, the court pointed out that the Bullock Amendment does not preclude the taxation of business entities for the privilege of doing business in Texas and taking advantage of the option to limit the liability of the owners of a business as the taxpayer did by means of the limited partnership structure. In Re Allcat Claims Service, L.P., Texas Supreme Court, No. 11-0589, November 28, 2011.