Texas Franchise Tax Reform and 2026 Comptroller Apportionment Guidance: What Businesses Need to Know
Texas imposes a franchise tax — officially called the "margins tax" — on the privilege of doing business in the state. Unlike a traditional income tax, the franchise tax base is calculated as the lesser of four alternative apportionment methods: 70% of revenue, revenue minus COGS, revenue minus compensation, or 30% of revenue. The tax rate is 0.75% for most businesses (0.375% for wholesalers and retailers), with a no-tax-due threshold that was permanently raised to $2.47 million in annualized total revenue beginning with the 2024 report year.
The 2023 session's most consequential change was HB 3 and HB 5, which together overhauled the COGS deduction calculation. The revised definition of "cost of goods sold" for franchise tax purposes now explicitly includes direct labor costs allocated to production, a significant expansion that had previously been contested in administrative appeals. Manufacturers, construction companies, and certain service businesses with substantial direct labor components should revisit their COGS schedules for the 2024 and 2025 report years to determine whether the expanded definition yields a more favorable tax base calculation under the revenue-minus-COGS method.
The 2025 session continued this trajectory with SB 2 (franchise tax), which adjusted the apportionment formula for businesses operating in multiple states. Texas has used single-factor receipts apportionment — meaning only the revenue factor, not property or payroll, determines the Texas-sourced share of margin. The 2025 amendment modified how receipts from digital services and intangible property are sourced to Texas, moving to a customer-location test for software-as-a-service revenues rather than the prior cost-of-performance approach. For SaaS companies with Texas customers, this expands their Texas receipts base; for companies whose software development costs are concentrated in Texas but whose customers are elsewhere, the change may reduce apportionment.
The Comptroller's January 2026 apportionment guidance addressed several ambiguities that had accumulated since the 2023 amendments. Most significantly, the guidance clarified that mixed-revenue businesses with both tangible goods and service components must allocate COGS between the two categories using a reasonable method consistently applied — the Comptroller will not accept a blanket allocation of all labor to COGS if the business also provides services that generate revenue not eligible for COGS offset. The guidance also addressed intercompany transactions, confirming that management fees, royalties, and administrative cost allocations paid to affiliated entities are not includable in COGS for the receiving entity and may be limited in the payor's calculation under the arm's-length standard.
Businesses that filed based on the pre-guidance interpretation should evaluate whether amended reports are necessary for open years. Texas franchise tax has a four-year statute of limitations for refund claims, and the 2026 guidance may support amended filings for 2022-2024 report years where the COGS position was conservative. Conversely, businesses that took aggressive positions on labor-COGS allocations should assess their audit risk in light of the clarification. The Comptroller has signaled increased audit focus on COGS deductions as one of the highest-volume adjustment items in recent examination cycles.