Texas State and Local Tax Changes for the New Year

By Christina A. Mondrik, JD, CPA, TBLS Board Certified – Tax Law

The new year brought with it a new Texas Comptroller, new legislation, new litigation options, and some new interpretations by the Texas State Comptroller’s office that may mean big changes for entities engaged in business in the state.

Welcoming a New Comptroller

On July 1, 2025, after accepting a new position as Chancellor of Texas A&M University, Comptroller Glenn Hegar administered the oath of office to Acting Comptroller Kelly Hancock, who was appointed to the position by Governor Greg Abbott. Comptroller Hegar was elected to three four-year terms. The Comptroller of Public Accounts position will be on the ballot in the 2026 elections. Acting Comptroller Kelly Hancock is anticipated to seek election to keep the role.

Texas Franchise Tax Changes

Both legislative changes and policy interpretations have impacted the Texas franchise tax, which is a tax imposed on entities in exchange for the privilege of doing business in the state. The franchise tax is calculated based on a margin calculation, or an alternative EZ computation, based roughly on gross receipts. Both computation methods are apportioned based on Texas gross receipts to gross receipts everywhere. Tax reporting responsibilities apply to entities physically present in Texas or deriving at least $500,000 of gross receipts from Texas sources. The franchise tax thresholds and rates for 2026-2027 published by the Texas Comptroller are shown below.

* Available online at: https://comptroller.texas.gov/taxes/franchise/

In 2023, the Texas Legislature doubled the no tax due threshold and eliminated “no tax due” reporting, so businesses under the threshold file public information reports or owner information reports to maintain compliance. The Texas franchise tax is a complicated tax that receives a lot of attention but does not generate significant revenue compared with other funding sources. In 2025, the Texas franchise tax represented only 8.4 percent of the total state and local tax budget. Millions of businesses operate in Texas. Of those, 131,000 actually owe franchise tax. (A Field Guide to the Taxes of Texas, December 2025, available online at https://comptroller.texas.gov/transparency/revenue/docs/96-1774.pdf)

Several of the revisions made by the Texas Legislature in its 2025 session involved franchise tax credits. Of these, the most notable was the revision to the franchise tax research and development (R&D) credit. There have been three versions of the R&D credit over time:

• Subchapter O credits (repealed 1/1/2008)
• Subchapter M credits (repealed 1/1/2026)
• Credit carryforwards under new Subchapter T (effective 1/1/2026)

The new Subchapter T R&D credit set forth in Texas Tax Code §§ 171.9201 through 171.9312. Unlike the Subchapter M credit, the new R&D credit is tied to amounts reported on the federal Form 6765 that pertain to Texas activities, which should simplify the computation for CPAs preparing franchise tax reports. The legislature also repealed the R&D sales and use tax exemption, which previously could be taken in lieu of the franchise tax credit. Elimination of the exemption also removes issues related to whether a purchase could qualify for other types of sales and use tax exemptions.

The amount of the credit has also increased. The revised R&D credit generally equals 8.722 percent of the difference between current period qualified research expenses and 50 percent of the average of the three prior period’s qualified research expenses. The percentage is increased to 10.903 percent for entities contracting with one or more public or private higher education institutions. The credit is non-assignable, but there is a refundable credit available for businesses not otherwise owing the franchise tax.

The legislature also enacted a Strong Families Credit, in Subchapter P, allowing taxable entities making designated contributions to eligible organizations, certified by the OneStar Foundation, based on criteria outlined in new Texas Tax Code § 171.803. In general, the eligible organizations serve at-risk families by offering comprehensive case management services and helping fathers learn and improve parenting skills and be more engaged in their children’s lives through in-school programs and online resources. Certain activities are prohibited, such as providing abortion services or receiving certain types of public funding. The credit is limited to the lesser of the amount of the contribution or $1 million.

In December 2025, Acting Comptroller Hancock announced policy changes involving a renewed approach and interpretation of statutory language enacted around the time the franchise tax changed to the margin calculation in 2007 and 2008.

Texas Tax Code § 171.0001, which sets forth the general definitions, under subsection (9) defines “Internal Revenue Code” as “the Internal Revenue Code of 1986 in effect for the federal tax year beginning on January 1, 2007, not including any changes made by federal law after that date, and any regulations adopted under that code applicable to that period.”

Section 171.1011, which involves “Determination of Total Revenue from Entire Business” references form numbers, rather than the Internal Revenue Code (IRC), generally. Subsection (a) states that “[i]n this section, a reference to an Internal Revenue Service form includes a variant of the form. … A reference to an Internal Revenue Service form also includes any subsequent form with a different number or designation that substantially provides the same information as the original form.”

Section 171.1012, which involves “Determination of Cost of Goods Sold” does not directly reference the IRC in calculating cost of goods sold (COGS), but sets forth a specified set of instructions for calculating the amount for computing margin. Subsection (c)(6), which outlines direct costs, references “depreciation, depletion and amortization, reported on the federal income tax return on which the report under this chapter is based, to the extent associated with and necessary for the production of goods, … .”

On December 1, 2025, Acting Texas Comptroller Kelly Hancock issued a press release updating the franchise tax depreciation rules to align with federal provisions to allow Texas businesses to take advantage of the bonus depreciation authorized by the federal One Big Beautiful Bill Act of 2025 (OBBBA), when computing their Texas franchise tax liabilities. [See Press Release, available online at https://comptroller.texas.gov/about/media-center/news/20251201-acting-texas-comptroller-kelly-hancock-updates-franchise-tax-depreciation-rules-to-align-with-federal-provisions-1764005132713]

The OBBBA, signed July 4, 2025, permanently reinstates and expands federal bonus depreciation provisions that allow businesses a 100% deduction for property acquired after January 19, 2025, and temporarily extends those provisions to purchase of qualified production property.  The law allows buildings, which are typically depreciated over 39 years, to be deducted immediately if they are qualified production property. Qualified production property includes building property located in the United States, for which the construction began after January 19, 2025 and before January 1, 2029, that is placed in service before January 1, 2031, and is used as an integral part of a qualified production activity. The taxpayer must be the original user of the property and must designate the property by making a timely federal election. The Texas franchise tax changes are effective with the 2026 franchise tax report, which is based on reported amounts from business the taxpayer conducted during 2025.

According to the press release, the Comptroller’s office reevaluated and reinterpreted the text of Texas Tax Code Chapter 171 to allow for the change:

Historically, the Comptroller’s office used the 2007 IRC for franchise tax depreciation. After a fresh legal review, the agency determined the depreciation provision in Texas law is not tied to 2007 and can reflect the IRC in effect for each tax year. This means that beginning with the 2026 franchise tax report, businesses may elect to deduct the full cost of qualifying fixed assets – such as machinery, equipment and furnishings – acquired after Jan. 19, 2025.

“This is a big win for Texas taxpayers,” Hancock said. “Not only does it deliver upfront tax relief, it also eliminates the burden of maintaining two different sets of books for federal and state taxes, slashing red tape for business operations in Texas.”

Later that month, on December 19, 2025, the Texas Comptroller of Public Accounts issued an interoffice memo to Emma Fuentes, Director Audit Division from Jenny Burleson, Director Tax Policy Division, on the “Conformity of Texas Franchise Tax to the Internal Revenue Code.” The memo announces a major shift in the Comptroller’s interpretation of Texas Tax Code Chapter 171:

Beginning with the 2026 franchise tax report, a taxable entity will determine amounts taken from the federal tax return under the federal tax law in effect for that federal tax year, unless the statute or rule references the IRC. This change applies to all components of the franchise tax. Where the statue or rule references the IRC, a taxable entity must compute such amounts under the 2007 IRC.

The Tax Policy memo then goes on to explain that taxpayers may include a one-time net depreciation adjustment in computing cost of goods sold (COGS) for qualifying assets under Texas Tax Code § 171.1012(c)(6). The adjustment is based on the difference between depreciation claimed for federal income tax and the depreciation claimed for Texas franchise tax COGS for each asset. The memo also addresses other provisions:

• Foreign royalties and dividends under § 171,1011(c)(1)(B)(ii) are determined by IRC §§ 78 or 951-964, and do not include the current IRC § 951A global intangible low-taxed income (GILTI), which was added to the IRC after January 1, 2007.
• Total revenues will be calculated with respect to the current IRC.
• Depreciation will be calculated with respect to the current IRC, with a one-time adjustment, as detailed in the memo.
• Single-factor gross receipts apportionment will also be calculated with respect to the current IRC.

The Comptroller’s Tax Policy Division plans to amend both Rule 3.587 (Margin: Total Revenue) and Rule 3.588 (Margin: Cost of Goods Sold) to implement these revised interpretations.

Texas Sales and Use Tax Developments

Texas sales and use tax issues continue to focus on taxable services, local tax rates and exemptions. In the area of taxable services, the Comptroller promulgated changes to Rule 3.330 addressing Data Processing Services, effective April 2, 2026 (50 TexReg 2226). This development is the one most likely to affect the largest number of taxpayers, as the Texas sales and use tax represented 58.3 percent of the total state and local tax budget in 2025. (A Field Guide to the Taxes of Texas, December 2025, available online at https://comptroller.texas.gov/transparency/revenue/docs/96-1774.pdf). Data processing services are taxable under Texas Tax Code §§ 151.0101(a).

The revised data processing rule introduces the concept of evaluating whether data processing is “ancillary” to another nontaxable service. The Comptroller excludes from the definition of "data processing service," data processing that is sold for a single charge with another service if the data processing service does not have a separate value and the data processing service is ancillary to the other service. Rule 3.330 (a)(1)(C) places the burden on the taxpayer to demonstrate the data processing service does not have a separate value and is ancillary to the other service and sets forth a list of factors to consider in making that determination.

Effective October 1, 2025, the Comptroller may treat marketplace provider services as taxable data processing services when they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. The rule provides an example of a marketplace provider’s charges for services to store product listings and photographs, maintain transaction records, and compile analytics for its marketplace seller.

New Administrative and Litigation Options

The Texas Legislature in its 89th Session during 2025 also made statutory changes expanding the evidence available to resolve tax disputes, allowing alternatives to state tax lien filings and providing expanded options for bypassing the administrative process in legal challenges.

The legislature broadened the opportunities for taxpayers to submit records and supporting documents in audits and hearings. The law changed the word “contemporaneous” to “sufficient” in Texas Tax Code §§ 111.0041(c) (pertaining to the burden to produce records and substantiate claims, generally), 112.052(d) (pertaining to protest lawsuits), 112,151(f) (pertaining to managed audits) and 112.202 (pertaining to lawsuits after redetermination). The legislature also repealed the requirements in tax refund hearings under Texas Tax Code § 111.105(e) related to a 180-day “notice and demand” for all evidence to support the refund claim. (SB 266, 89th L.S.)

New Texas Tax Code § 112.201(c-1)(B) provides alternatives to the filing of a state tax lien while a lawsuit after redetermination is pending. These alternatives make the lawsuit after redetermination, which requires exhaustion of administrative remedies, but does not require full payment, more available for businesses that would otherwise be harmed by a filing of a lien while the litigation is pending. The alternatives include providing the Comptroller security in a sufficient amount to secure payment of the entire disputed amount (including penalties and interest); a cash deposit filed with the Comptroller or paid into the court’s registry; or a surety bond, letter of credit or other form of guarantee. (SB 266, 89th L.S.)

Prior legislation effective September 1, 2021, introduced not only the lawsuit after redetermination, but also a refund claim bypass procedure, which allows taxpayers to bypass the administrative process and proceed to court following procedures set forth in Texas Tax Code § 111.106. Managed audit administrative bypass procedures are available in new Texas Tax Code § 111.0091. Like the refund claim bypass procedures, a written notice of intent to bypass the redetermination process for a managed audit is due by the 60th day after the date the Comptroller issues a letter notifying the taxpayer of the audit results and must contain the material facts and each specific legal basis, as well as the amounts of the disputed underpayments or overpayments contained in the managed audit results. Like in a refund claim administrative bypass, the Comptroller’s office may require a conference before the matter proceeds to the state district court. (SB 266, 89th L.S.)

Effective September 1, 2025, the Texas Legislature has reformed procedures by which state agencies are to adopt rules. The legislation also imposes regulatory requirements and addresses the level of deference to be given to state agencies’ interpretation of laws and rules in certain judicial proceedings, establishing a Texas Regulatory Efficiency Office to support agencies in reviewing the cost benefit analysis of rules and directing that courts are not required to give judicial deference to agency interpretations. (SB 14, 89th L.S.)

With all these changes afoot and more to come, 2026 promises to be another exciting year for those practicing in the area of state and local tax, the businesses they support, and the CPAs who advise them regarding their tax compliance requirements.

Note: This article does not attempt to address all tax and administrative changes from the legislative session. For a complete list of legislation, check Texas Legislature Online, available at: https://capitol.texas.gov/. For a complete list of rules, review the Texas Register, available at: www.sos.state.tx.us/texreg/index.shtml.

About the Author: Christina A. Mondrik, JD., CPA, TBLS Board Certified – Tax Law, practices law as the founder and principal attorney of the Austin law firm of Mondrik & Associates. She may be contacted at cmondrik@mondriklaw.com.

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