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Taxes totaling $320,000 a year � that’s how much a Texas firm with $100 million in gross revenues and 71 percent of its business operations apportioned to the state could face paying under a tax plan that Gov. Rick Perry’s Tax Reform Commission is scheduled to unveil March 29. That figure, based on numbers for a hypothetical firm, is the calculation of Glen A. Rosenbaum, a tax partner in Vinson & Elkins in Houston. He’s the spokesman for a coalition of 18 major firms keeping an eye on tax proposals in Austin, as the Texas Legislature gears up for a 30-day special session beginning April 17. Firms in the coalition are Akin Gump Strauss Hauer & Feld; Allen Boone Humphries Robinson; Andrews Kurth; Baker Botts; Bracewell & Guiliani; Cantey & Hanger; Carrington Coleman Sloman & Blumenthal; Doyle, Restrepo, Harvin & Robbins; Fulbright & Jaworski; Gardere Wynne Sewell; Hunton & Williams; Jackson Walker; Jones Day; Meadows, Owens, Collier, Reed, Cousins & Blau; Strasburger & Price; Thompson & Knight; Vinson & Elkins; and Weil Gotshal & Manges. Perry announced March 17 that he would call the special session so state lawmakers can overhaul the school finance system, which the Texas Supreme Court ruled unconstitutional in November 2005. In its 7-1 ruling in Shirley Neeley, et al. v. West Orange Cove Consolidated Independent School District, et al., the high court held that the school funding system has evolved into an unconstitutional state property tax. The court set a June 1 deadline for state lawmakers to adopt a new system. The 24-member Tax Reform Commission, which Perry appointed last year, has drafted recommendations for the Legislature to consider during the upcoming special session. “The centerpiece [of the recommendations] is to lower property taxes by a third,” says John Sharp, the commission’s chairman and the former state comptroller. To help pay for the $6 billion property tax cut, Sharp says, the commission will recommend that the Legislature replace the business franchise tax, which only a limited number of businesses pay, with a margin tax that would apply to a larger number of businesses, including limited liability partnerships. Byron Egan, a partner in Jackson Walker in Dallas, says proponents of the tax proposal are trying to categorize the margin tax as something other than an income tax. “That’s really what it is.” As proposed, the state would levy the tax on a business’ gross receipts after the business takes deductions, either for employees’ compensation or the cost of goods sold. The resulting figure would then be apportioned to Texas based on a firm’s business activity in the state. Firms then would apply a 1 percent rate to the apportioned amount. Firms in the coalition are unhappy with the proposed amount for the cap on deductions, the fact that some businesses can deduct more than other businesses, and differences in tax rates for different kinds of businesses. Under the proposal, Rosenbaum says, a firm could deduct from its gross revenues up to $300,000 per employee for compensation and employer-paid insurance costs and retirement benefits. Another option allows a company to deduct for the cost of goods sold. The coalition thinks the deductions are unfair because they apply differently to different types of businesses. As an example, Rosenbaum says compensation � including portions of top executives’ salaries � can be included in the cost-of-goods-sold deduction along with raw materials. The service industry’s deduction is only for compensation, he says. Sharp says manufacturers could include compensation of employees involved in the manufacturing process in the cost-of-goods-sold deduction. The coalition also points out that some businesses would be taxed at a lower rate. Steve Kuntz, a tax partner in Houston’s Fulbright & Jaworski, says retailers would pay taxes at half the rate that everyone else pays. “The federal income tax doesn’t differentiate,” Kuntz says. Sharp says wholesalers and retailers operate on higher margins in their businesses than other entities. “You can’t do [a margin tax] for wholesalers and retailers with anything other than half of what you do for everyone else.” As proposed, wholesalers and retailers would pay one-half of 1 percent on their base after taking the cost-of-goods-sold deduction. Other business entities � including law firms � would pay the tax on the remaining 1 percent of their base after taking the deduction for compensation. The commission proposes to exempt sole proprietorships, general partnerships and companies with annual gross receipts of $300,000 or less from paying the tax.
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Sharp accuses coalition firms of trying to scuttle the margin tax. In a March 16 letter to legislators, Sharp wrote that the 18 firms want a $500,000 to $550,000 per employee exclusion from any tax before they will sign off on a tax proposal. “I don’t believe it’s possible for us to come up with something they would agree to, unless it was so minimal it wouldn’t affect anything,” Sharp says in an interview. “We are not trying to scuttle the margin tax,” Rosenbaum says, noting that the coalition has proposed various alternatives that would be equivalent to the tax liability that the firms would have under the current earned-surplus component of the franchise tax. The coalition offered several suggestions for adjusting the margin tax � including increasing the per-person compensation cap from $300,000 to between $500,000 and $550,000 � in a Feb. 13 letter to the Sharp commission. Sharp says he thinks the coalition is missing an opportunity to get behind a fair tax. “A much worse [tax] will come later if this one fails, I believe,” he says. Many people in the legal profession disagree with the coalition’s approach, Sharp says. “We’ve had lots of calls from law firms that have said, “We agree with this and when the time comes, we’re going to endorse it.’ ” But Sharp declines to say which firms have indicated they are supporting the plan. Marc Stanley, president of the Texas Trial Lawyers Association, announced March 17 that TTLA’s membership believes lawyers should join other segments of the business community in supporting a reasonable tax plan. “We are willing to pay our fair share,” says Stanley, a partner in Stanley, Mandel & Iola in Dallas. Rosenbaum says the margin tax, as proposed, probably wouldn’t apply to a large number of TTLA members. Stanley says he believes a majority of the membership would have to pay the tax. Rosenbaum says that if the Sharp commission plan is filed as a bill, the coalition will continue to work for a compromise in the Legislature. What the Legislature will do with the commission’s recommendations remains in question, however. Lt. Gov. David Dewhurst says the Legislature should focus some of its attention on improving schools, which could cost the state more money. State Rep. Jim Keffer, R-Eastland, chairman of the House Ways and Means Committee, where tax bills usually originate, says lawmakers don’t know yet in which direction they’ll go. Keffer says the Sharp commission’s margin tax proposal is completely different from tax plans the Legislature has considered in the past. “We’ve never looked at anything like that before,” Keffer says. That’s because there isn’t another tax quite like this, Rosenbaum says. “Texas would be the first state that has a tax that’s computed according to this methodology,” he says.

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