Texas revises IRC conformity date policy for its franchise tax

Comptroller press release

On Dec. 1, 2025, the acting Texas Comptroller issued a press release announcing an immediate update to the Comptroller’s interpretation of Texas franchise tax depreciation rules. In its press release, the Comptroller concluded that businesses could take advantage of new bonus depreciation rules adopted under the One Big Beautiful Bill Act (OB3). The Comptroller noted the flexibility available under the Texas franchise tax law to apply the current IRC for depreciation calculations instead of the general 2007 IRC, conformity date contained in the law.

The decision was made following what the Comptroller characterized as a “fresh legal review.” As such, the Comptroller concluded that beginning with the 2026 franchise tax report, businesses could deduct the full cost of qualifying fixed assets in the year of purchase.

Comptroller memorandum guidance

On Dec. 19, 2025, the Comptroller’s director of tax policy issued a memorandum to its director of the audit division to provide further guidance on the policy change indicated in the Comptroller’s press release, including changes to the total revenue, COGS and apportionment calculations. It concluded that for the 2026 franchise tax report, the current federal tax law is to be used instead of the 2007 IRC, when determining amounts used to compute the franchise tax, unless the statute or rule references the IRC (in which case the 2007 IRC is used).

Total revenue calculation

Based on the requirement that taxable entities derive the total revenue base through line items on federal forms filed by the taxable entity rather than through a direct reference to the IRC, the Comptroller concluded that the line items as reported on its federal tax return calculated under the federal tax law in effect for that federal tax year are used for Texas franchise tax purposes. However, a different rule applies when a category of income or expense specifically references the IRC. In that case, the 2007 IRC is controlling to derive these amounts.

The Comptroller’s memorandum includes an example to clarify the application of these rules. Texas allows foreign royalties and dividends to be subtracted from total revenue, including IRC Sec. 78 gross-up dividends and amounts reported under IRC Secs. 951-964.⁶ The foreign royalties and dividends are initially included in total revenue through federal form line-item references, and hence, such inclusions are determined under current federal tax law.

The amounts eligible for subtraction specifically reference IRC Secs. 78 and 951-964 and thus are determined under the 2007 IRC. According to the memorandum, this means that IRC Sec. 951A global intangible low-taxed income (GILTI) is included in the total revenue calculation and not eligible for the subtraction because this provision was not added to the IRC until the 2018 tax year. The net effect is the full inclusion of Sec. 951A amounts in the taxable margin base.

COGS and the net depreciation adjustment

For purposes of calculating COGS, the statutory definition provides for inclusion of depreciation reported on the federal income tax return on which the franchise tax report is based, and under the Comptroller’s new interpretation, depreciation would be calculated under rules contained in the current IRC rather than the 2007 IRC. This interpretation will have consequences for taxable entities that are reporting gains from the sale of depreciable assets for which depreciation has been taken over a period of time based on the 2007 IRC provisions.

The Comptroller’s guidance provides that a taxable entity reporting gains from the sale of depreciable assets associated with and necessary for the production of goods, and for which the taxable entity included depreciation in the COGS calculation, reports the federal gain without adjustment.

However, the Comptroller is providing for an equitable transitional adjustment on the taxable entity’s 2026 franchise tax report, in which a taxable entity has the option to include a net depreciation adjustment in the COGS calculation for qualifying assets listed as being includible in the COGS direct cost amount. This adjustment is based on the difference between federal and Texas COGS depreciation for a particular asset, with such asset being placed in service prior to the accounting period on which the 2026 franchise tax report is based (as long as such assets have not been disposed of before this date).

The net depreciation adjustment is then calculated through a three-step process with respect to qualifying assets. The first step is to calculate the positive or negative difference in the depreciation claimed for federal income tax and Texas franchise tax purposes for each year in which the qualifying asset was in service until the end of the 2025 tax report period.

The adjustment is zero if no depreciation has been claimed as part of COGS for Texas franchise tax purposes. The second step is to add the depreciation adjustment for each year, and the total adjustment (which cannot be negative) is included in the entity’s COGS reported on the 2026 franchise tax report.

Following a calculation of the taxable entity’s COGS, the third step is to make the net depreciation adjustment, but this adjustment cannot take the taxable entity’s margin below zero. If this happens, the margin is reduced to zero, with a carryforward of the depreciation adjustment available until used.

Apportionment calculation

In addition to the depreciation adjustment, the Comptroller’s revised interpretation of conformity to federal provisions has also led to a policy of declaring consistency in measuring the gross receipts factor and total revenue. As such, beginning with the 2026 franchise tax report, a taxable entity is required to calculate gross receipts for apportionment purposes based on current federally reported amounts (rather than using the 2007 IRC to determine such amounts), except in cases where the apportionment statute or rule specifically references the IRC.

Commentary

The Comptroller’s policy change is applicable to all components of the franchise tax, and the Comptroller has advised that Tex. Admin. Code Secs. 3.587 and 3.588 (relating to the calculation of total revenue and COGS) will be revised to incorporate the policy change. This represents a change in the Comptroller’s interpretation of a Texas franchise tax statute governing IRC conformity, which has remained the same since its enactment in 2007.

However, the change in interpretation is only being applied on a prospective basis, which could result in challenges by taxpayers who seek to apply the new interpretation retroactively to prior periods still open under the statute of limitations. The Texas legislature also could consider whether clarifying changes to the underlying statute should be made to support the Comptroller’s policy.

Numerous questions regarding the policy and the equitable net depreciation adjustment remain unanswered. The Comptroller’s comments regarding the treatment of GILTI (and presumably its successor concept, net CFC tested income (NCTI)) in its memorandum may be instructive, but as a general matter, the need for taxpayers to review every aspect of the Texas franchise tax law to determine whether to use 2007 or current year federal law in order to determine how to calculate a particular amount will be challenging for taxpayers and practitioners alike.

A system in which taxpayers are required to use specifically identified federal line items in calculating certain Texas franchise tax components under the current IRC while requiring a tie-in to a much older IRC with respect to other Texas franchise tax matters will, at a minimum, increase compliance burdens on taxable entities for the 2026 franchise tax reporting period.

The Comptroller’s decision to provide a carryforward of the net depreciation adjustment to the extent that such adjustment results in negative margin is unusual. The Texas Tax Code does not contain statutory support for this concept, and excess COGS deductions that historically have resulted in a negative margin have never been convertible into an attribute that could be carried forward.

In addition, since the mechanics of the net depreciation adjustment only apply to assets that have been disposed of by taxable entities in 2026, it will be interesting to see whether the Comptroller ultimately allows the adjustment for future years in which assets are disposed, or whether the adjustment might be allowed in 2026 for all assets (rather than just the assets disposed of in 2026 for a federally taxable gain).

Since taxpayers have been allowed an annual option to use the highest of four deductions to arrive at taxable margin, the Comptroller will need to provide guidance with respect to the net depreciation adjustment for taxable entities that may not have consistently used the COGS deduction in calculating its taxable margin in previous tax years. The language in the memorandum suggests that the depreciation adjustment is only allowed for the incremental depreciation that would have been available in years where the COGS deduction was elected on the prior report.

However, suppose the absence of bonus depreciation in a prior year for Texas purposes may have caused one of the other deductions to be more advantageous at the time of filing. Prior to 2026, the accumulated basis difference could have been accounted for as an adjustment to the gain upon disposition, but that may no longer be an option, resulting in a detriment for some taxpayers.

To the extent that the net depreciation adjustment results in the creation of an attribute that can be carried forward (because margin cannot be reduced below zero), it will be necessary to determine whether such attribute can be transferred between members of a unitary group, or transferred to a new unitary group in the event of an ownership change. Further, challenges may arise when a taxpayer with a carryforward might not be eligible for a COGS deduction in a subsequent year.