Frequently Asked Questions
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Note: TTC means Texas Tax Code and IRC means Internal Revenue Code
- 1. What is a passive entity?
- An entity is considered passive if it is a general, limited or limited liability partnership, or a non-business trust and the entity's federal gross income during the period on which margin is based consists of at least 90% of the following income:
- dividends, interest, foreign currency exchange gain, periodic and nonperiodic payments with respect to notional principal contracts, option premiums, cash settlement or termination payments with respect to a financial instrument, and income from a limited liability company;
- distributive shares of partnership income to the extent that those distributive shares of income are greater than zero;
- net capital gains from the sale of real property, net gains from the sale of commodities traded on a commodities exchange, and net gains from the sale of securities; and
- royalties from mineral properties, bonuses from mineral properties, delay rental income from mineral properties and income from other non-operating mineral interests. TTC 171.0003(a)(2).
Rent is not considered passive income for the Texas franchise tax. TTC 171.0003(b).
- 2. Can a limited liability partnership qualify as a passive entity?
- Yes. General, limited and limited liability partnerships may qualify as a passive entity. TTC 171.0003(a)(1).
- 3. Can a limited liability company qualify as a passive entity?
- No, only partnerships and trusts, other than a business trust, can qualify as a passive entity. TTC 171.0003(a)(1).
- 4. Is a passive entity the same for franchise tax as it is for federal tax?
- No, the determination of a passive entity for franchise tax is not the same as that under the IRC.
- 5. If an LLC converts to a limited partnership can the entity qualify for passive if it meets the 90% passive income test?
- 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% income test. The entity may qualify as passive for subsequent reports.
- 6. Is rental income considered passive income?
- No, rental income is not considered passive income. 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. TTC 171.0003(b).
- 7. Is the recapture of depreciation under IRC Sections 1245, 1250 and 1254 considered passive income?
- To the extent the Internal Revenue Code 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 TTC sec. 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 under TTC sec. 171.0003(a)(2). (Updated 10/27/15)
- 8. Do passive entities have to file reports?
- Effective for franchise tax reports originally due on or after Jan. 1, 2011, passive entities that are registered or are required to be registered with either the Texas Secretary of State (SOS) or the Comptroller's office are required to file a No Tax Due Information Report (Form 05-163) to affirm that the entity qualifies as passive for the period upon which the tax is based. Previously, an entity that filed as passive on a prior report was not required to file a subsequent franchise tax report as long as the entity continued to qualify as passive. A passive entity is not required to file an Ownership Information Report.
If a partnership or trust qualifies as a passive entity for the period upon which the franchise tax report is based and is not registered, and 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. (Updated 01/26/11)
- 9. Is the recapture of net section 1231 losses considered passive income?
- 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% test under TTC 171.0003(a)(2). (Updated 06/19/08)
- 10. Are lottery winnings considered passive income?
- No; lottery winnings do not qualify as passive income under TTC 171.0003. (Updated 06/19/08)