Multistate Tax Trends: SALT Litigator Zachary Milliken on Texas Franchise Tax Mistakes, AI Sales Tax Risks, Successful Dispute Resolution, and the Future of State Tax Audits

Rebecca Newton-Clarke, J.D., Catalyst Executive Editor, Checkpoint News

Multistate tax practice is always evolving. The Catalyst state team stays on top of trends, frequently consulting with SALT practitioners on the front lines and incorporating their insights, along with our in-depth analysis, into Checkpoint Catalyst topics that integrate into CoCounsel Tax. This Multistate Tax Trends Q&A series for Checkpoint News delivers quick, actionable insights from some of the practitioners our team follows most closely.

This installment features Zachary Milliken, an associate attorney with Chamberlain Hrdlicka whose practice focuses on state and federal tax controversy and litigation. Based in San Antonio, Zachary represents corporations, partnerships, and individuals, and has deep experience in successfully navigating Texas franchise tax and sales and use tax disputes. He has successfully challenged Comptroller audit assessments, coordinated refund claims exceeding $1 million, and navigated many administrative hearings with favorable outcomes.

Here Zachary and Catalyst’s Rebecca Newton-Clarke discuss the franchise tax’s gross receipts foundation, the Comptroller’s pivot to rolling conformity, performance-based sourcing after Sirius XM Radio, economic nexus calculation errors, missed manufacturing and data center incentives, Texas’s administrative appeals process, and how AI and conformity gaps are forcing businesses to rethink multistate compliance.

Our team was intrigued by your “Cracks in the Franchise Tax” post on the recent Texas Court of Appeals decision in Hancock v. American Airlines.  The court held that the franchise tax is, in effect, imposed on gross receipts despite the margin tax framing. From your perspective advising clients on Texas franchise tax controversy and planning, what are the most common misconceptions businesses have about how the tax works, and where do you see the biggest opportunities?

One of the biggest misconceptions is that the franchise tax is analogous to a corporate income tax. It isn’t. The calculation may begin with a measure that resembles net income, but the available deductions are limited, many ordinary business expenses are never accounted for, and the tax base is often much closer to gross receipts than taxpayers initially appreciate. The Hancock v. American Airlines decision reinforces what practitioners have long experienced in audits, that businesses can have relatively little taxable income for federal purposes yet still owe significant Texas franchise tax. (Hancock v. American Airlines, Inc.¸ No. 15-24-00113-CV (Tex. App.—Austin, Apr. 9, 2026).)

Another common misconception is that the franchise tax is largely an accounting exercise. However, many of the most consequential issues require (or provide the opportunity for) statutory interpretation, and therein lie some of the best opportunities. Questions surrounding sourcing, the availability of cost of goods sold deduction, combined reporting, exclusions from total revenue, and apportionment often have a much greater effect on liability than adjustments to the starting point of the tax base.

In December 2025, the Texas Comptroller announced that the agency is taking a rolling conformity approach for many components of the franchise tax base. Subsequent Memorandum Decisions confirmed and clarified this approach, which represents a significant departure from the Comptroller’s historic position that all elements of the franchise tax base were based on the IRC as effective January 1, 2007. How are you thinking about this shift?

Although the Comptroller’s December 2025 announcement certainly represents a meaningful shift, it’s important for taxpayers and practitioners to note that it is not a sweeping adoption of rolling conformity. For franchise tax purposes, the Texas Tax Code still defines the “Internal Revenue Code” by reference to the Code in effect for the federal tax year beginning January 1, 2007. (See Tex. Tax Code Ann. § 171.0001(1), Tex. Tax Code Ann. § 171.1011.) With its new interpretation, the Comptroller is now drawing a sharper distinction between provisions that expressly incorporate the IRC and provisions that reference amounts reported on federal return. Under the new approach, items pulled from federal return line items are determined under current federal tax law, while provisions that explicitly cite the IRC remain tied to the 2007 Code.

From a policy perspective, the shift seems like a logical response to the widening gap between the 2007 Code and current federal tax law. After nearly two decades of federal changes, tying the state’s franchise tax to outdated laws and policies starts to make less sense. The Comptroller’s announcement suggests that that the permanent bonus depreciation provisions authorized by the One Big Beautiful Bill Act of 2025 were a major catalyst, but the implications do extend further.

Texas requires receipts from sales of services for franchise tax purposes to be sourced to the location of performance. The Texas Supreme Court’s decision in Sirius XM Radio v. Hagar effectively rejected an effort to apply market-based sourcing: “the Legislature chose the word ‘performed’— not ‘received’—and any test that blurs this critical distinction parts ways with the statute.” How does performance-location sourcing create strategic considerations for multistate businesses compared with market-based states like California and New York?

The Texas Supreme Court’s decision in Sirius XM Radio v. Hegar does an excellent job distinguishing between the two primary sourcing rules that typically govern state taxes imposed on service businesses. (Sirius XM Radio, Inc. v. Hegar, 643 S.W.3d 402 (Tex. 2022).) “Market-based” (or “destination”) rules look to where the benefit of the service was received, while “performance-based” (or “origin”) rules look to where the service was performed. For the purposes of computing franchise tax in Texas, the operative rule is Tex. Tax Code Ann. § 171.103(a)(2), which directs taxpayers to include “receipts from . . . each service performed in this state” in apportioning margin (emphasis added). Based on this language, Texas has long been regarded as a “performance-based” state.

The appellant in Sirius XM Radio was the widely known broadcasting company by the same name, and the receipts at issue were the monthly fees it received from its Texas-based subscribers. Sirius business operations included: content production at its New York and D.C. studios; uplink transmission facilities in Georgia and New Jersey; satellites launched from Kazakhstan and remotely operated from Ecuador; and lastly, a small “chip set” installed in its customers’ radio receivers to decrypt the broadcast transmission. (Id.  at 405.) Both Sirius and the Comptroller agreed that the proper test was the location where the services were performed (not received), but came to the predictable, opposite conclusions. The disconnect was the Comptroller’s reliance on his recently enacted administrative rule, which provided “a service is performed at the location of the receipts-producing, end-product act” and when such act existed, disregarded the location of all preceding essential acts for sourcing purposes. (34 Tex. Admin. Code § 3.591(e)(26)(A) (2021) (repealed 2023).) For Sirius, the Comptroller argued, decryption of the final incoming broadcast transmission was a “receipt-producing, end-product act” that controlled the location of the broadcast subscription service Sirius provided.

Ultimately, the Court held for Sirius, emphasizing that “the most natural reading of ‘service performed in this state’ supports locating . . . the service at the place where the taxpayer’s personnel or equipment is physically doing useful work for the customer[,]” and that the Comptroller’s attempt to “focus only on the location where the performance is received or its effects felt” was contrary to the Legislature’s intent. Sirius XM Radio, at 408 (emphasis added).

Sirius XM Radio highlights certain strategic considerations that exist for performance-based sourcing that generally are not present under a market-based regime. First, the analysis centers on factors within the taxpayer’s own control (i.e. the location of its own personnel, equipment, and facilities). This gives taxpayers with a national footprint the opportunity to structure their operations accordingly. Second, the performance-based analysis tends to incorporate on a broader set of facts and circumstances (e.g. Sirius’ production studios, uplink facilities, satellites, etc. all arguably played some role in performing the service), leaving interpretative flexibility that isn’t as prevalent in the more rigid market-place systems. .

Texas has receipts-based economic nexus thresholds for both franchise tax and sales tax purposes. Do any particular activities or transaction types create a particular risk of businesses miscalculating their Texas nexus exposure for either or both taxes?

The principal risk is assuming that Texas’s two $500,000 economic nexus thresholds are interchangeable. Although the dollar amount is the same, the thresholds apply and are calculated differently for the two taxes.

For the franchise tax, a foreign taxable entity establishes economic nexus if it has more than $500,000 of gross receipts from business done in Texas during its federal income tax accounting period, as determined under the franchise tax sourcing rules. (Tex. Tax Code Ann. § 171.001 (and related sections); 34 Tex. Admin. Code § 3.586.)

By contrast, Texas sales tax applies a separate economic nexus standard for remote sellers based on taxable sales, using a $500,000 gross-revenue threshold measured over the preceding 12 months (with no transaction-count threshold). (Tex. Tax Code Ann. § 151.107; Tex. Admin. Code § 3.286.)

As a result, a business may exceed the franchise tax threshold without triggering sales tax nexus (for example, if much of its Texas receipts are not taxable sales), or vice versa because the two taxes rely on different sourcing rules and different measures of economic activity.

Examples of some of the riskier transaction types include services, digital offerings, and receipts from intangibles or financial transactions. As previously addressed, the franchise tax sources services based on where they are performed, not where their benefit is received. However, internet hosting is sourced to the customer’s location. Licenses of patents, copyrights, trademarks, and similar intangibles not subject to sales and use tax, are sourced based on where the intangible is used in Texas for franchise tax purposes. Understandably, it’s easy for businesses to miscalculate by applying a single sales tax approach to these receipts. Another recurring error is overlooking that a Texas sales and use tax permit creates a presumption of franchise-tax nexus, and that physical-presence activities such as installation, repair, delivery, inventory, employees, contractors, or other in-state representatives can independently create nexus even when one of the receipts thresholds has not been met.

On the sales tax front, Texas (along with Washington State and Maryland) is at the forefront of aggressively taxing automated services. The Comptroller’s rule on taxable “data processing” is exceptionally broad. Meanwhile, as of last year the Texas Code requires de novo judicial review on all questions of law. Our team read your colleague Bryan J. Dotson’s article—First Sales Tax Opinion by New Texas Intermediate Court of Appeals Could Spell Trouble for the Comptroller’s Recent Amendments to the Data Processing Services Rule—with great interest. How are you advising clients whose historically nontaxable offerings could potentially be construed as taxable under the rule?

Texas is certainly taking an expansive view of taxable automated and data processing services. The statute itself is broad, defining data processing to include (among other things) word processing, data entry, data retrieval, data search, information compilation, payroll and business accounting data production, other computerized data and information storage or manipulation, and even the use of a computer or computer time for such services. Tex. Tax Code Ann. § 151.0035. Some relief is provided in that 20% of the total amount charged for these services is exempt from sales and use tax. (Id.  at § 151.351; Tex. Admin. Code § 3.330(c)(4).)

Another hurdle are the administrative rules extending an aggressive reach into bundled offerings for these services. For mixed transactions involving data processing services, the Comptroller now utilizes an “ancillary” standard rather than the traditional (and more forgiving) “essence of the transaction” test to determine taxability. Under Tex. Admin. Code 3.330(e)(2), if a taxable data processing service represents more than 5% of a single charge for a bundled service, the entire charge is presumed taxable unless the taxable portion is reasonably and separately stated at the time of the transaction.

Take for instance an invoice totaling $10,000, comprised entirely of nontaxable services apart from $600 (or 6%) in taxable data processing services. If the data processing component is appropriately separately stated, only $480 ($600 less the 20% exemption) of the total invoice would be subject to the applicable state and local tax rates. If improperly bundled, however, the entire $10,000 invoice is presumed taxable. Such harsh results can be easily avoided with some careful planning and intentional administration implementation. As the saying goes, “an ounce of prevention is worth a pound of cure.”

Given that it holds exclusive intermediate appellate jurisdiction over tax refund suits and challenges to the validity of state rules, the recent establishment of the Fifteenth Court of Appeals is a significant change. As my colleague addressed, the court recently signaled a willingness to deviate from established precedent by the Third Court of Appeals, which may present an opportunity to challenge the Comptroller’s limiting policy towards bundled data processing services.

Manufacturing and energy production are always big business in Texas, and data centers are increasingly locating in the state as well. What sales tax exemptions, credits, or incentives do you find are most at risk of being overlooked or misunderstood?

The scope of the manufacturing exception seems to be a common point of confusion, with taxpayers applying it too broadly in some circumstances while overlooking it in others. Texas provides a significant exemption for property used in manufacturing, but the statute is highly specific.

Under Tex. Tax Code Ann. § 151.318(a), exempt items generally include component parts of products for sale, property directly used in actual manufacturing that is necessary or essential and directly causes a chemical or physical change, certain quality-control, pollution-control, safety, and utility-support equipment, and specified cleanroom property for semiconductor and pharmaceutical biotechnology manufacturers. Just as important, Tex. Tax Code Ann. § 151.318(c) excludes intra-plant transportation equipment, hand tools, janitorial and office items, sales and distribution property, research and development property, storage and maintenance property, and much of the transmission and distribution equipment for electricity. Texas authorities also emphasize that each item must stand on its own and taxpayers cannot assume that all equipment in an integrated plant qualifies merely because some processing occurs there.

Related utility exemptions are also easy to miss or misapply. Gas and electricity used to power exempt manufacturing equipment may be exempt, but where a single meter serves both exempt and taxable uses, the taxpayer generally is expected to establish use is predominantly for exempt purposes through a utility study. Tex. Tax Code Ann. § 151.317; Tex. Admin. Code § 3.295. Another recurring trap is contractor status. If a business manufactures items but installs them as improvements to real property, it may lose the manufacturing exemption for purchases used in that activity. Tex. Tax Code Ann. § 151.056(f).

Data center incentives are also easy to overlook because they sit outside the ordinary manufacturing framework; certification and ongoing compliance obligations also demand heightened attention. Texas has a temporary exemption for tangible personal property used in qualifying data centers which covers a broad list of equipment and systems necessary and essential to operations. Tex. Tax Code Ann. § 151.359(b). Still, the exemption excludes several components and is available only if the facility satisfies detailed statutory requirements, including minimum square footage, job creation, capital investment, certification by the Comptroller, and more. Tex. Tax Code Ann. § 151.359(c)-(h).

Your practice includes significant federal tax work. Are you seeing an increase in Texas or other states auditing federal tax positions during state-level examinations?

I have not seen an increase in activity involving state audits of federal tax positions, not yet at least. In my experience, efforts by state and local governments to audit a federal tax position are not particularly common. However, that is not to say they don’t occur; California and Alabama, for instance, have independently challenged easement deductions outside of a federal return. And I am sure there are other examples I simply haven’t crossed.

That state audits of federal tax positions have not been historically common is likely just a product of the general structure most state income tax regimes employ. State income taxes generally define “net income” for state or local income tax purposes as “net income as returned to and ascertained by the federal government” subject to specific state or local adjustments (additions or subtractions). The federal report serves as a baseline of sorts, a shortcut. Moreover, the states generally require a taxpayer audited by the IRS to report any federal changes. Apart from the specific language, the requirement to report federal changes arguably supplants the state or local government audit of that same information. These inferences, however, don’t preclude state governments from auditing the federal position; and absent a law that explicitly does, I don’t see why a state could not re-calculate a federal return they believe to be wrong.

Although I haven’t personally seen an increase yet, I do expect to in the coming years as, for example, states continue to decouple from the IRC, adopt fixed-date conformity, or selectively conform to only certain federal positions. In 2018, the New Hampshire DOR issued a report in response to the TCJA explaining as much. In the fixed-date conformity scenario, “taxpayers must identify any subsequent changes that may impact their tax liability and account for those changes on their state return.” (See New Hampshire Department of Revenue Administration. “Potential Effects of TCJA on Business Profits Tax.” Report to New Hampshire Senate and House Ways and Means Committees. RSA 21-J:3, XXXIII. (Publ. Apr. 23, 2018).)

Earlier we addressed Texas’ shift towards conformity, but several states are taking the opposite approach. California does not conform to IRC provisions as modified by OBBBA and has otherwise decoupled from several specific provisions. (California, Legislature, Senate. SB 711, 2025-2026 Reg. Sess. Oct. 2, 2025.) It is not unreasonable to suspect that as more states decouple from the current IRC, the more common state audits of the federal report could become.

Texas has a unique administrative appeals process. What considerations would you present to a business deciding whether to settle or litigate a Texas tax controversy?

The Texas Comptroller’s administrative appeals process is far from perfect; however, recent legislative changes have significantly expanded the options available to taxpayers seeking to challenge a state tax determination. Deciding which path to pursue depends on the taxpayer’s willingness to pay, ultimate goals, and the disputed issues. The Texas Notification of Audit Results marks the official conclusion of a Comptroller audit and also triggers the taxpayer’s right to appeals.

The first option is the Comptroller’s administrative appeals process, which requires the taxpayer to file a petition for redetermination within 60 days (20 for a “jeopardy determination”). Under Tax Code section 111.009, taxpayers are entitled to a hearing. First, however, the taxpayer must engage in informal and formal exchanges, first with the auditor, then a hearings attorney. Tex. Admin. Code § 1.11– Tex. Admin. Code § 14. If a hearing is necessary, it occurs before an administrative judge whose proposed decision must be approved by the Comptroller. (Tex. Admin. Code § 1.33, Tex. Admin. Code § 1.34). Lastly, the taxpayer is required to file a motion for a rehearing, which the Comptroller is entitled to grant or deny. (Tex. Admin. Code § 1.35.) The entire process takes roughly two years to complete and for many taxpayers, is clearly not the right path.

Taxpayers who should take the administrative appeals path generally fall into two categories. The first group include taxpayers who can benefit from a civil exchange with a reasonable auditor or hearings attorney (of which there are many) during the pre-hearing phase. This includes taxpayers with credible documentation not previously considered or other straightforward disputed issues and taxpayers whose primary goal is a payment plan and penalty abatement. The second group of taxpayers are those with compelling legal arguments who are unable, or unwilling, to pay the liability at issue. Without paying, a taxpayer’s only path to district court is by exhausting their administrative remedies. (Tex. Tax Code Ann. § 112.201.)

The second option is to submit payment under protest, which enables the taxpayer to skip the administrative appeals process entirely and go directly to district court. (Tex. Tax Code Ann. § 112.052.) This path is the better path for taxpayers with compelling and technical legal arguments challenging an established Comptroller position. Arguably, an administrative hearing is not the ideal venue for these types of arguments. According to a 2021 report, the Comptroller’s position was upheld in 84.8% of 2,875 administrative hearings held from 2007 through December 1, 2020. Of the remaining hearings, 10.3% resulted in partial relief to taxpayers, and only 4.9% resulted in a taxpayer victory. (Texas Taxpayers and Research Association. “What Are The Odds? Tax Disputes and the Role of the State Office of Administrative Hearings (SOAH).” TTARA Research Foundation Report, pg. 6. January 26, 2021.)

More states are mulling or adopting gross receipts taxes. A few years ago, the State of Washington considered converting its B&O tax into a franchise margin tax modeled on Texas’ law, but the effort didn’t gain traction in the legislature. Do you see elements of Texas’s approach that might appeal to other states, particularly states with tax schemes built around income taxes who may be looking to reduce uncertainty around P.L. 86-272 and internet activities?

I can appreciate that certain features of Texas’ franchise tax approach could seem attractive, particularly to states trying to respond to uncertainty stemming from P.L. 86-272. For example, a gross-receipts or margin-style tax is generally framed as a tax on the privilege of doing business rather than a net income tax and in turn, reduce direct exposure to P.L. 86-272, which applies to state net income taxes and not to every tax measured by receipts or margin.

Ultimately, however, I have a hard time envisioning Texas’s franchise tax becoming a principal model for states that are trying to respond to P.L. 86-272 uncertainty. For many of the reasons already discussed (margin tax, obscure base-computation rules, limited deductions, etc.), the Texas Franchise Tax is somewhat unusual and would be difficult to transplant and implement. An alternative, simpler solution for states with a more conventional corporate income tax may be to adjust their established systems. For example, the Multi-State Tax Commission has task force which is essentially trying to define the scope of P.L. 86-272 and providing guidance on protected versus unprotected activities. I see more states looking to the MTC rather than redesigning their business tax base around a Texas-style margin tax.

We’ve focused on Texas in this conversation, but I’d like to widen the lens here at the end. Looking ahead three years, what do you think will be the most significant developments in state and local tax, and how should businesses and their advisors prepare?

Over the next three years, I expect states to continue searching for new revenue sources while refining how they tax an increasingly digital and mobile economy. It’s reasonable to expect apportionment and sourcing, particularly market-based sourcing for services and digital transactions, to remain one of the most significant areas of controversy as states continue to expand their tax bases. Also, depending on whether Maryland can defend its digital advertising tax in currently pending litigation, I would expect other states to follow suit. New York’s new tax “on high-value residential properties in New York City that are not the owner’s primary residence,” and California Proposition 40, commonly referred to as the “Billionaire Wealth Tax”, suggest a growing effort to tax ultra-high net worth taxpayers.

Lastly, I would expect states to continue implementing new tax incentives, particularly for industries like data centers, as they balance economic development against growing budget pressures. For taxpayers and their advisors, the best preparation is to stay proactive by monitoring legislative developments and as necessary, reevaluating multistate tax positions. Tax rules seem to mirror the pace of change of the industries they govern which, right now, are arguably evolving more quickly than ever.

Related Resources from Checkpoint News, CoCounsel Tax, and Checkpoint

• Checkpoint News subscribers:
• • Multistate Tax Trends: SALT Litigator Jennifer Karpchuk on Market-Based Sourcing Frictions, Digital Ad Taxes, and Multi-Jurisdictional Audit Risks, by Catalyst’s Rebecca Newton-Clarke
  • Multistate Survey: Income Tax Immunity Erodes as States Follow MTC Statement on P.L. 86-272, by Catalyst’s Tom Cornett and Rebecca Newton-Clarke
• CoCounsel Tax Templates:
• • Indicate State’s Approach to P.L. 86-272 and Internet Activities
  • Determine Corporate Income Tax Sourcing Rules for Receipts from Digital and Electronically Delivered Goods and Services
  • Indicate State’s Approach to Economic Nexus for Corporate Net Income Tax Purposes
  • To access CoCounsel Tax templates, log in to CoCounsel and click the CoCounsel Templates navigation link in the left panel. 
• Checkpoint subscribers can dive deeper into sourcing, OBBBA conformity, P.L. 86-272, and electronically delivered goods and services, with:
• • Nexus Assistant Charts: covering nuances of economic nexus, physical presence nexus, P.L. 86-272, and threshold computation
  • Catalyst Topic # 1007, Sales Factor, providing in-depth state-by-state analysis of the sales factor for corporate income tax apportionment, including rules for sourcing receipts to a specific state jurisdiction
  • Catalyst Topic # 1005, Sales Factor, providing in-depth state-by-state analysis of taxpayers subject to allocation and apportionment, the types of income allocated or apportioned, and each state’s standard apportionment formula, as well as industry-specific rules and alternative apportionment provisions
  • Catalyst Topic # 1002: Corporate Tax Nexus, providing in-depth state-by-state analysis of corporate income tax economic nexus and P.L. 86-272 policies, as well as background context and insights
  • Catalyst Topic # 1003, IRC Conformity, providing in-depth state-by-state analysis of each state’s conformity to the IRC, federal tax concepts, and major federal legislation from TCJA through the CARES Act and OBBBA, including conformity dates, the effect of federal tax elections, and agency guidance
  • Catalyst Topic #305, Limitation on Deduction of Business Interest Under IRC 163(j), providing in-depth state-by-state analysis of state conformity to the federal limitation on the deduction of business interest under IRC 163(j), breaking down variations in conformity, such as granular analysis of the state’s approach to changes enacted by TCJA, the CARES Act, and OBBBA
  • Catalyst Topic # 403, Bonus Depreciation and Expensing, providing in-depth state-by-state analysis of each state’s conformity to bonus depreciation under IRC 168(k) and 168(n), and expensing under IRC 179, as affected by major federal legislation from TCJA through the CARES Act and OBBBA
  • Catalyst Topic # 1051: Sales and Use Tax: Electronically Delivered Goods and Services, providing in-depth state-by-state analysis of electronically delivered goods and services, including SaaS and AI offerings, as well as bundled transactions, sourcing, threshold computation, and marketplace intermediary platforms such as online travel companies, meal-delivery platforms, and more
  • Catalyst Topic # 1010: Corporate Tax: Electronically Delivered Goods and Services, providing in-depth state-by-state analysis of nexus and sourcing issues related to electronically delivered goods and services, including cryptoassets.

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