Under Texas law, “passive entities” are exempt from the Margin Tax and are not included in a combined Margin Tax return.
What is a passive entity under Texas law?
In order to qualify as a passive entity under Texas law, passive entities must have at least 90% of their gross income for federal income tax purposes from partnership allocations from downstream non-controlled flow-through entities, dividends, interest, royalties, or capital gains from the sale of real estate, securities, or commodities.
Under Texas law, real estate rentals, and other income from mineral interests, are not passive income sources unless they are classified as royalties, bonuses, or delay rental income from mineral properties and income from other non-operating mineral interests.
Passive entities may only apply to non-business trusts, general partnerships and limited partnerships.
LLCs and S-corps cannot qualify as passive entities, even if 90% of their income is from qualifying passive sources.
There may be planning opportunities and Texas tax savings available to investors, particularly those investing in stocks and bonds, undeveloped land, or non-operating mineral interests where it is unlikely that the type of investment will change. Furthermore, the ownership of rental property or operating and non-operating mineral interests or mixes of investments involving some active type makes it much harder to predict whether or not in any particular year an investor will be able to avoid the Margin Tax. However, if an investor can separate the types of investments, and maintain that separation, it may be worthwhile to put passive assets in a limited partnership and other active assets in another entity type.
We Welcome Your Questions
If you are a business that owns real estate, securities, commodities or receives interest, dividends or royalties, and are subject to the Margin Tax, please contact the trusted advisors of REDW’s State and Local Tax (SALT) group.