Total Revenue vs. Cost-of-Goods
Texas franchise tax is based on a business’s margin, but there are four distinct ways to calculate it. Choosing the method that minimizes your taxable margin can save you thousands. In this post, we’ll compare:
- Total Revenue × 70%
- Total Revenue − Cost-of-Goods Sold (COGS)
- Total Revenue − Compensation
- Total Revenue − $1 Million Deduction
We’ll explain each, provide examples, and lay out a step-by-step guide to help you pick the lowest-tax option for your 2025 filing.
Applicable Tax Authority & Code References
- Margin Computation Methods: Texas Tax Code § 171.101(a) lists four margin calculations: total revenue times 70%; total revenue minus COGS; total revenue minus compensation; or total revenue minus $1 million.
- COGS Definition: Tex. Tax Code § 171.1012 and Rule 3.588 define allowable COGS.
- Compensation Deduction: Tex. Tax Code § 171.1013 limits wages and cash compensation to $450,000 per person for reports due in 2024–2025.
- Election Requirement: The chosen method must be elected on your annual franchise tax report and is binding for that privilege period (§ 171.101(d)).
Margin Methods Comparison
| Method | Calculation | Best For | Notes |
|---|---|---|---|
| 70% of Total Revenue | Total Revenue × 0.70 | Service firms with low COGS | Margin capped at 70% of revenue; simplest option. |
| Revenue − COGS | Total Revenue − COGS | Manufacturers, retailers | Must track federal-deductible COGS under § 171.1012. |
| Revenue − Compensation | Total Revenue − W-2 Wages (≤ $450k/person) | Payroll-heavy entities | Excludes employer payroll taxes; cap applies § 171.1013. |
| Revenue − $1,000,000 | Total Revenue − $1 000 000 | Smaller businesses | Flat deduction regardless of actual costs. |
Detailed Example
Acme Manufacturing, Inc.
- Total Revenue (2024): $5,000,000
- COGS: $3,200,000
- Compensation Paid: $900,000 (two officers paid $500k each, capped at $450k each ⇒ $900k max)
| Method | Computed Margin | Tax Rate* | Tax Base |
|---|---|---|---|
| 70% of Revenue | $3,500,000 | 0.375% | $3,500,000 |
| Revenue − COGS | $1,800,000 | 0.375% | $1,800,000 |
| Revenue − Compensation | $4,100,000 | 0.375% | $4,100,000 |
| Revenue − $1M | $4,000,000 | 0.375% | $4,000,000 |
*Assumes standard 0.375% rate (non-retail)
Result: Deducting COGS delivers the lowest margin ($1.8 M), making it the optimal choice for Acme.
Step-by-Step Guide to Selecting Your Margin Method
- Gather Data
- Total revenue from your federal return (Form 1120, 1120-S, or 1065).
- COGS per § 171.1012.
- W-2 wages/cash compensation and benefits per § 171.1013.
- Compute All Four Margins
- Multiply revenue × 70%; subtract COGS; subtract compensation (capped); subtract $1 million.
- Compare Margins
- Identify the smallest margin—this minimizes your taxable base.
- Elect Method on Your Report
- On Form 05-158 (Long Form) or 05-169 (EZ Computation), indicate your chosen calculation (§ 171.101(d)).
- Calculate Tax
- Apply applicable rate: 0.375% standard (0.75% for wholesale/retail).
- File & Pay
- Submit return and payment voucher (Form 05-170) by May 15, 2025 (or next business day).
- Record & Review
- Keep confirmation of filing/election; reassess method next year.
Conclusion
By running each margin calculation and electing the one that yields the lowest margin, you can significantly reduce your Texas franchise tax. Whether you qualify for a hefty COGS deduction or benefit most from the flat $1 million subtraction, methodically comparing all four options ensures you pay only what you owe.
Schedule a Meeting to determine which margin method best suits your business and to streamline your 2025 filing.
About Our CPA
Anshul Goyal, CPA, EA, FCA, is a licensed Certified Public Accountant in the United States and admitted to practice before the IRS as an Enrolled Agent. He represents clients in tax litigation, specializes in cross-border tax compliance for U.S. businesses and Indian nationals, and delivers tailored tax planning strategies.
Disclaimer
This blog is for general informational purposes only and does not constitute tax, legal, or accounting advice. Consult a qualified professional regarding your specific situation. Anshul Goyal, CPA, EA, FCA, and Kewal Krishan & Co. disclaim any liability for actions taken based on this content.
FAQs
1. How often can I change my margin method?
You may elect a different method each privilege period, but once chosen on your report it’s binding for that year.
2. What costs qualify as COGS?
Only costs for acquisition/production of tangible personal or real property, as defined in Tex. Tax Code § 171.1012.
3. Can I include payroll taxes in compensation?
No. Only W-2 wages and cash compensation (plus deductible benefits) count under § 171.1013; payroll taxes are excluded.
4. What if my deduction exceeds total revenue?
If any calculation yields a zero or negative margin, it’s treated as zero margin—no negative tax base.
5. Does the EZ Computation affect these methods?
Entities electing EZ Computation cannot claim COGS, compensation, or the $1 million deduction; instead they pay 0.331% of apportioned revenue up to $20 M.