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A coalition of large firms, which opposed a proposed state tax the firms contend favors some taxpayers over others, found itself unsuccessful in the deal-making process in the Texas Legislature’s current special session. “Certain groups got deals made,” Byron Egan, a corporate partner in Jackson Walker in Dallas, says, referring to behind-the-scenes negotiations over H.B. 3, the business tax bill that won a final nod from state lawmakers last week. The Senate passed the bill May 2. Gov. Rick Perry, who pushed for the business tax to help pay for a cut in property taxes, had not signed the bill by presstime May 4. To win medical groups’ support for H.B. 3, lawmakers agreed to allow doctors to exclude from their tax base Medicare, Medicaid and Children’s Health Insurance Program (CHIP) payments, as well as their actual costs for uncompensated care. “They didn’t offer lawyers any deals,” says Egan, whose firm is one of 18 in the coalition. A key lawmaker says doctors need special treatment. State Rep. Jim Keffer, R-Eastland, chairman of the House Ways and Means Committee, says doctors are “hamstrung,” because they have to deal with underfunded medical programs. “Out in the rural areas, where I’m from, we don’t want to get to the point where they refuse to take or no longer can take Medicare, Medicaid or CHIPs situations,” he says. Entities affected by H.B. 3 will begin paying the tax May 18, 2008. Egan says most firms, whether they’re large or small, will feel the pinch from the business tax, which will replace the franchise tax. But firms organized as general partnerships or lawyers who are sole proprietors aren’t subject to the tax, says Steve Kuntz, a tax partner in Houston’s Fulbright & Jaworski, another firm in the coalition. Other coalition firms are Akin Gump Strauss Hauer & Feld; Allen Boone Humphries Robinson; Andrews Kurth; Baker Botts; Bracewell & Guiliani; Cantey & Hanger; Carrington Coleman Sloman & Blumenthal; Doyle, Retrepo, Harvin & Robbins; Gardere Wynne Sewell; Hunton & Williams; Collier, Reed, Cousins & Blair; Strasburger & Price; Thompson & Knight; Vinson & Elkins; and Weil Gotshal & Manges.
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The firms organized the coalition in 1997 to oppose a bill that would have expanded the franchise tax to partnerships. [ See "Big Firms Scrambling to Fight 4.5% Tax,"Texas Lawyer , May 5, 1997, page 1.] Perry called the special session this year so lawmakers can overhaul the school finance system, which the Texas Supreme Court held unconstitutional in November 2005. In its 7-1 ruling in Neeley, et al. v. West Orange Cove Consolidated School District, et al., the Supreme Court held that the funding mechanism for schools has evolved into an unconstitutional state property tax. The court set a June 1 deadline for lawmakers to adopt a new system. The business tax, dubbed a margin tax, is one part of the plan for addressing the court’s directive. Under H.B. 3, the state will levy the tax on a firm’s gross receipts, after the firm takes deductions of up to $300,000 per employee for compensation, which includes wages and benefits. The remaining amount then would 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. The coalition firms had proposed an increase in the per-person compensation cap from $300,000 to as much as $550,000. Jay Thompson, an insurance partner in Thompson, Coe, Cousins & Irons in Austin, says his firm believes that, if there is going to be a broad-based business tax, the tax that H.B. 3 imposes is fair. “I think the big law firms did not serve us well by opposing this and trying to get a bigger deduction for high salaries,” Thompson says. But Egan says the tax is discriminatory. Manufacturers and retailers can deduct for the cost of goods sold as well as some employee compensation and will be taxed at half the rate paid by firms and other businesses in the service industry, Egan says. Service industry taxpayers don’t get to deduct any overhead costs they incur, he adds. Egan also contends the bill will tax law partners’ income from the firm. “Basically, it’s a discriminatory income tax; that’s the bottom line,” he says. Texas Constitution Article 8, �24(a) bars the state from imposing a tax “on the net incomes of natural persons,” including a person’s share of partnership income, without prior voter approval. Keffer says attorneys who have reviewed H.B. 3 for Perry and the Legislature say it wouldn’t impose an income tax. Barry McBee, first assistant state attorney general, wrote in an April 17 letter to Deirdre Delisi, Perry’s chief of staff, that a bill imposing a tax on a partnership rather than on a partner’s share of partnership income and on something other than “net income” avoids the constitutional referendum requirement. Not satisfied with McBee’s analysis, Texas Comptroller Carol Keeton Strayhorn, an independent candidate for governor this year, has asked Attorney General Greg Abbott to address the income tax issue in a formal opinion. Abbott has not yet responded to Strayhorn’s April 21 request. While the coalition firms are concerned about H.B. 3, Texas Trial Lawyers Association president Marc Stanley says TTLA believes the bill is fair to attorneys. “It treats us on a par with everyone else,” says Stanley, a partner in Stanley, Mandel & Iola in Dallas. Stanley says TTLA was concerned that the bill not tax lawyers for “flow-through funds,” such as the money a lawyer receives and then pays a co-counsel on the case. “It was important that the Legislature recognize that, and it did,” he says. While Thompson views H.B. 3 as fair to attorneys, he questions the constitutionality of a provision in the bill that makes an insurance corporation subject to the margin tax if it violates a refund order issued by the state insurance commissioner. Thompson says the provision � added as an amendment during the House’s debate of H.B. 3 � confuses the state’s power to tax with its power to punish wrongdoers. “I don’t know of any state that says you don’t have to pay a tax unless you’re in violation of an order,” Thompson says.

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