Texas Tax Talk: Previewing 2023 Legislative Priorities
Law360 recently published an article by Baker Botts Special Counsel Alison Andrews and Partner Matthew Larsen.
A version of this piece can be read on Law360, here.
The Texas Legislature meets in the first half of every odd year. In the fall before each legislative session, the Texas House Ways and Means Committee and the Texas Senate Finance Committee each previews a list of priority tax and fiscal issues that might be addressed in the upcoming session.
Texas House Speaker Dade Phelan, R-Beaumont, and Lt. Gov. Dan Patrick, acting for the Senate, recently handed down interim charges — issues the committees in their respective chambers are directed to consider in preparation for the 88th legislative session, which meets in 2023.Property tax relief and reform, tax incentives, and sales tax sourcing are among the most high-profile tax items in these interim charges.
Property Tax Relief
With inflation and the corresponding rise in property values, property tax relief is a high priority for many in this upcoming legislative session. Both the Senate Finance and House Ways and Means Committees will consider ways to provide such relief.
for such a purpose.
Businesses — particularly large, capital-intensive industrial businesses — already bear a disproportionate tax burden because of Texas' comparatively high property tax rate. A rate paydown, as opposed to an increase in the homeowners exemption, would have the most broad-based impact on taxpayers. Increasing the homestead exemption would target homeowners only.
Property Tax Reform
The House Ways and Means Committee and the Senate Local Government Committee are directed to evaluate the effects and implementation of the property tax rate limitations imposed by Senate Bill 2 from the 2019 legislative session and related legislation, and to consider ways in which the property tax system might be further reformed.
S.B. 2 requires cities, counties and special-purpose districts to hold an election before raising taxes if the combined taxes would result in more than a 3.5% increase in the average homeowner's property taxes. The Local Government Committee will also evaluate whether efficiency audits should be performed on cities, counties and special-purpose districts before any tax ratification elections occur.
There are exceptions to the 3.5% limit on tax increases without voter input.
One exception is for areas of declared disasters, where the limit is increased to 8%. While the exception is arguably intended to be used in situations where a disaster has caused physical damage, recent House Ways and Means Committee testimony suggests that local taxing jurisdictions may be taking advantage of that provision and applying the COVID-19 disaster declaration to override the 3.5% limit.
Taxing jurisdictions may also exceed the 3.5% limit as long as the increase does not generate more than $500,000, which could reduce protections for taxpayers in smaller taxing jurisdictions.
Any unused portion of the 3.5% can be carried forward for up to three years, allowing taxing jurisdictions to raise taxes by a larger percentage in years with higher tax bases.
When it is evaluating S.B. 2, the House should look at ways to prevent taxing jurisdictions from avoiding the 3.5% limit, such as: (1) limiting the application of the disaster provision to districts that are impacted physically by the disaster; (2) limiting the number of years smaller jurisdictions may rely on the $500,000 limitation rather than 3.5%; and (3) eliminating the ability to carry forward the unused increments.
The House Ways and Means Committee and Senate Local Government Committee will also review the appraisal process itself. The Local Government Committee is broadly charged with reviewing prior legislation and ensuring appraisal guidelines are effective, and that taxpayers have enforcement mechanisms.
The charge to Ways and Means is more detailed, requiring the committee to study specific aspects like the accuracy of appraised values and effectiveness of appraisal districts, the methods of selecting personnel, and ways to protect taxpayers and ease of their participation in the process.
Incentives
Also, the House Ways and Means Committee directives include a comprehensive review of the potential impact of failure to renew Chapter 313 of the Tax Code.
Chapter 313 allows school districts — which impose half or more of the typical Texas property tax — to place a 10-year value limitation on the appraised value of a qualifying large industrial project for maintenance and operations tax purposes.
Because Chapter 313 lowers the property tax burden of large manufacturing projects, and because most states have similar programs, it is critical in attracting capital-intensive businesses to Texas. However, Chapter 313 will expire at the end of 2022 with no incentive program to replace it.
In the last legislative session, the House considered several bills to extend — and in some cases reform — Chapter 313. However, the Senate declined to consider any of the proposed bills. Unsurprisingly, given the Senate's inaction in 2021, the Senate's interim charges do not mention any school district property tax incentives.
The House, on the other hand, will be evaluating potential school district incentives, including an analysis of other states' incentives and proposals for replacement programs.
It is critical that the Senate act on school district incentives.
Competition for large, capital-intensive, job-creating industrial projects is intense, and property tax expenses for such projects — which, without incentives, are higher in Texas than in most competing states — are often a critical component of the site selection process.
Many industrial projects that have selected Texas touted Chapter 313 as a critical factor in the selection decision, and Texas' recent success in attracting new industry cannot afford to be derailed by an uncompetitive tax landscape.
Sales Tax Sourcing
Another important tax interim charge for the House Ways and Means Committee is evaluating the changes in local sales tax sourcing made in recent amendments to Comptroller Rule 3.334 — most importantly, changes to the treatment of internet orders.
Tax Code Section 321.203 states that the sale of a taxable item for local sales tax purposes occurs where the sale is consummated. The question of where a sale is consummated can become complicated where the buyer and seller are not in the same location.
Until the recent rule changes, orders placed remotely (whether online, via mail, or over the telephone) have been sourced to the locality of the seller's fulfillment center — "origin-based sourcing" — so long as the fulfillment center met certain requirements to be treated as a place of business.
Sales would not be considered consummated at the buyer's location — "destination-based sourcing" — unless possession was transferred at a location other than a place of business of the seller and the seller has no place of business in Texas; the order was initially received at a place of business outside Texas; or the purchaser placed the order directly with the supplier and the item was delivered directly to the purchaser.
Under these rules, many retailers entered into incentive agreements with cities to locate their fulfillment centers in that city so that the local taxing jurisdiction would receive the sales taxes on remote orders — including online orders — and with a portion of such taxes rebated to the seller.
The comptroller's amendments to Rule 3.334 changed that practice. Rule 3.334(b)(5) says that orders not received by sales personnel, including orders received by a shopping website or shopping application, are received at locations that are not places of business of the seller. The sales taxes associated with those orders are then sourced to the jurisdiction in which the item is delivered rather than the fulfillment center.
Several cities with incentive agreements relying on the former rules filed lawsuits against the comptroller challenging the amendments. In City of Round Rock Texas v. Hegar,1 and City of Coppell Texas v. Hegar,2 the plaintiff taxing jurisdictions challenged the rule as conflicting with the statute — imposing additional burdens, conditions and restrictions beyond those imposed by statute — and on several procedural grounds.
In August, the 201st District Court of Travis County, Texas, held that the rule's enactment violated the requirements of the Texas Administrative Procedure Act because it did not adequately set forth the costs to local governments of the rule changes, and remanded it back to the comptroller to be revised or readopted with a sufficient analysis of economic impact.
The comptroller has readopted the rule in its current form along with a rule preamble that attempts to address the court's request for an economic impact analysis. It is unclear whether the comptroller's attempt will satisfy the court.
Whether or not the rule is upheld, the House Ways and Means Committee will be evaluating the potential impact of a move to destination sourcing for internet and other sales, and considering whether to take legislative action on local sales tax sourcing.
Alison Andrews is special counsel and Matthew Larsen is a partner at Baker Botts LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
1 City of Round Rock Texas v. Hegar, Cause No. D-1-GN-21-003203, In the 201st District Court of Travis County, Texas.
2 City of Coppell Texas v. Hegar, Cause No. D-1-GN-21-003198, In the 201st District Court of Travis County, Texas.
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