Franchise Tax: Aerospace & Defense Contractors

Ensuring that aerospace and defense contractors can deduct a portion of their costs of contracting with the federal government from their state franchise tax liability will help grow the aerospace and defense sector in Texas. Please read this LIFT Perspective for more information.

Background: The Texas Franchise Tax

The Texas franchise tax is the state’s primary business tax, generating 10 percent of state tax revenues in 2013. The tax captures the majority of businesses operating in Texas, but also contains a wide range of exemptions, revenue-based exclusions, and multiple methods by which a business can calculate its tax liability.

There is also a series of provisions that define specific ways in which businesses in certain sectors of the economy may calculate their tax liability in a way that reflects the unique challenges of different business sectors. For example, Chapter 171 of the Tax Code, which governs the franchise tax, contains sections that are specific to movie theaters, pipeline entities, motor vehicle rental and leasing companies, and lending institutions. The tax itself also distinguishes between retail businesses and all other businesses by levying a lower rate for retailers.

The Aerospace and Defense Sector

However, due to the types of products and services they supply, aerospace and defense contractors receive only a limited benefit from the Franchise Tax deductions. Because of the increasing sophistication of defense products, aerospace and defense contracts span both tangible products and services lines of business. Under current law, companies can either take a deduction on direct manufacturing costs — Cost of Goods Sold (COGS) — or compensation, but not both. This only allows aerospace and defense contractors to take a deduction on a portion of their costs. COGS, for example, only covers the cost of production of tangible property so the COGS deduction does not properly reflect the costs of providing goods and services. In order to provide some parity for this vital sector of our economy and allow aerospace and defense contractors to remain competitive in an ever tightening federal defense contracting environment, Texas should allow the industry to conform the Franchise Tax deduction to the cost definitions contained in the Federal Acquisition Regulations (FAR), which more accurately reflect the costs incurred by aerospace and defense contractors.

According to the Office of the Governor, Texas’ aerospace and defense sector provides more than 400,000 jobs in the state. Jobs in the aerospace sector alone offer average salaries in excess of $80,000, while the state is also home to 15 military bases. All ten of the largest federal contractors have a presence in Texas, as does each of the top ten federal contractors for 2013.

Ensuring that these types of companies can deduct a portion of their costs of contracting with the federal government from their franchise tax liability will help grow the aerospace and defense sector in Texas.

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