In Re Allcat Claims Service, L.P. and John Weakly
356 S.W.3d 455, 2011 Tex. LEXIS 896, 55 Tex. Sup. Ct. J. 103 (2011)
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Rule of Law:
Under the entity theory of partnership law, a franchise tax imposed on a partnership's income is a tax on the business entity itself, not a prohibited tax on the net incomes of its individual, natural-person partners under the Texas Constitution.
Facts:
- In 1993, Texas voters adopted the Bullock Amendment, requiring a statewide referendum to impose a tax on the net incomes of natural persons, including their share of partnership income.
- In 2006, in response to a court order to reform public school funding, the Texas Legislature amended the state's franchise tax.
- These amendments expanded the franchise tax to apply to business forms that were previously exempt, including limited partnerships.
- Allcat Claims Service, L.P. is a Texas limited partnership providing adjusting services to property insurers.
- John Weakly is a natural person and a limited partner in Allcat.
- For tax years 2008 and 2009, the Texas Comptroller imposed the revised franchise tax on Allcat's income.
- The tax was calculated based on income that was allocated to Allcat's partners, including John Weakly, but had not yet been distributed to them as cash payments.
Procedural Posture:
- For tax years 2008 and 2009, Allcat Claims Service, L.P. paid its franchise taxes to the Texas Comptroller under protest.
- Allcat filed two separate lawsuits seeking a refund: one in the 201st District Court of Travis County and a second as an original proceeding directly in the Supreme Court of Texas.
- The 2006 Act that amended the franchise tax grants the Texas Supreme Court exclusive and original jurisdiction over any constitutional challenges to the Act.
- In its original proceeding, Allcat sought a refund, a declaratory judgment that the tax is unconstitutional, and an injunction against future collection of the tax.
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Issue:
Does the Texas franchise tax, when applied to a limited partnership's income that is allocated but not distributed to its natural-person partners, constitute a tax on the net incomes of natural persons that violates Article VIII, Section 24 of the Texas Constitution (the Bullock Amendment)?
Opinions:
Majority - Justice Johnson
No. The Texas franchise tax does not constitute a tax on the net incomes of natural persons and therefore does not violate the Bullock Amendment. Texas has unequivocally adopted the entity theory of partnership, which treats a partnership as a legal entity distinct from its partners. Under this theory, partnership income remains the property of the partnership entity until it is distributed to the partners. Therefore, a tax on the partnership’s income is a tax on the business entity for the privilege of enjoying a state-provided liability shield, not an income tax on the individual partners. The same legislature that adopted the entity theory in the Texas Revised Uniform Partnership Act also proposed the Bullock Amendment, indicating the two were not seen as conflicting.
Dissenting - Justice Willett
Justice Willett, concurring in part and dissenting in part, argues the Court lacks jurisdiction to decide the issue and therefore does not reach the merits of whether the franchise tax is constitutional. The dissent contends that the Court improperly found original mandamus jurisdiction where no statute expressly conferred it, as required by the Texas Constitution. Furthermore, the case does not meet the requirements for mandamus relief because the Comptroller has no clear, pre-existing ministerial duty to refuse to enforce a statute or to issue a refund before a court has declared that statute unconstitutional. The dissent also raises significant separation-of-powers concerns regarding the Act's provision requiring the Court to issue a ruling within a 120-day deadline, viewing it as a legislative encroachment on core judicial functions.
Analysis:
This decision solidifies the 'entity theory' of partnership for taxation purposes in Texas, creating a clear distinction between a tax on a business and a tax on an individual's income. By upholding the franchise tax on pass-through entities, the court affirmed the Legislature's power to structure broad-based business taxes without triggering the high procedural hurdles of the Bullock Amendment. The ruling limits the ability of owners of partnerships and other pass-through entities to argue that a tax on their business's profits is an unconstitutional 'indirect' tax on their personal income, thereby securing a significant state revenue source.
