Combined Group

A combined group in Texas is an affiliated group of taxable entities engaged in a unitary business that must file a single franchise tax report. It functions as a single taxpayer for credit purposes, allowing members to aggregate qualified research expenses and determine eligibility based on the group’s collective business activities and ownership structure.

The concept of a combined group is central to the Texas franchise tax, often referred to as the margin tax, and it fundamentally dictates how the Research and Development (R&D) tax credit is calculated, reported, and audited. To understand the meaning of a combined group in this context, one must look beyond simple corporate parent-subsidiary relationships and examine the dual requirements of common ownership and the unitary business principle. This framework ensures that the state treats a single economic enterprise as one entity, preventing the manipulation of tax liabilities through intercompany transactions while providing a consolidated mechanism for incentivizing technological innovation. Since the inception of the modern R&D credit via House Bill 800 in 2013, and its significant expansion under Senate Bill 2206 in 2025, the combined group has been the primary vehicle through which capital-intensive industries in Texas—such as aerospace, biotechnology, and software development—access state-level tax relief.

Statutory Definitions and the Foundation of Combined Reporting

The Texas Tax Code provides the definitive legal basis for what constitutes a combined group. Under Section 171.0001(7), a combined group means taxable entities that are part of an affiliated group engaged in a unitary business and that are required to file a group report under Section 171.1014. This definition relies on two distinct statutory concepts: the affiliated group and the unitary business.

Affiliated Group and the 50 Percent Control Threshold

An affiliated group is defined as a group of one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or non-corporate, or by one or more of the member entities. The definition of controlling interest is a specific bright-line test that varies by the legal form of the entity involved. This is a critical distinction from federal controlled group definitions under Internal Revenue Code (IRC) Section 41(f), which often utilize an 80 percent threshold for certain aggregation purposes. In Texas, the threshold is consistently set at more than 50 percent.

Entity Type	Statutory Definition of Controlling Interest
Corporation	More than 50% of the total combined voting power of all classes of stock, or more than 50% of the beneficial ownership interest in the voting stock.
Partnership, Association, or Trust	More than 50% of the capital, profits, or beneficial interest in the entity.
Limited Liability Company (LLC)	More than 50% of the total membership interest or more than 50% of the beneficial ownership interest in the membership interest.

These ownership rules apply regardless of whether the owner is a corporation, a partnership, or an individual. For example, if an individual owns 51 percent of three different LLCs, those LLCs are considered part of an affiliated group. Furthermore, Texas law includes a specific attribution rule for spouses: an individual is considered to own the stock or interest that their spouse owns, though there is no attribution for other family members like children or parents.

The Unitary Business Doctrine

Ownership alone does not create a combined group; the affiliated entities must also be engaged in a unitary business. Section 171.0001(17) defines a unitary business as a single economic enterprise made up of separate parts of a single entity or of a commonly controlled group of entities that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit.

The Texas Comptroller of Public Accounts applies several factors to determine if a unitary business exists. These factors are designed to identify whether the entities are operating as a cohesive whole rather than as a portfolio of independent investments.

• General Line of Business: Members are in the same industry, such as manufacturing, wholesaling, or retailing.
• Vertical Integration: Members represent different steps in a vertically structured process, such as a group where one member explores for oil, another refines it, and a third markets the finished product.
• Horizontal Integration/Centralized Services: Members share common centralized functions, such as management, legal, accounting, purchasing, or financing, which produce an exchange of value and economies of scale.

In the context of the R&D tax credit, the unitary business requirement prevents the splitting of research activities across unrelated entities to bypass credit limitations. Conversely, it allows a group to use the research expenses of a loss-making subsidiary to offset the franchise tax liability of a profitable manufacturing member, provided they are unitary.

The Evolution of the Texas R&D Credit Regime

The application of combined group rules has been refined through two major legislative eras. Understanding these eras is essential for correctly applying revenue office guidance to historical and future tax periods.

The Subchapter M Era (2014 to 2025)

Enacted by the 83rd Legislature in 2013 (House Bill 800), Subchapter M introduced the modern R&D tax credit. A defining feature of this era was the mutual exclusivity between the franchise tax credit and a sales tax exemption.

Under Subchapter M, a person engaged in qualified research could choose between a franchise tax credit based on qualified research expenses (QREs) or a sales and use tax exemption for depreciable tangible personal property used directly in research. For a combined group, this choice was restrictive: if any member of the combined group claimed the franchise tax credit on a report, no member of the group could claim the sales tax exemption for the period covered by that report. This required combined groups to coordinate their procurement and tax planning meticulously, as a single sales tax exemption claim by a small subsidiary could potentially disqualify a multi-million dollar franchise tax credit for the entire group.

The Subchapter T Era (Post-2025)

In June 2025, Senate Bill 2206 was signed into law, fundamentally restructuring the R&D incentive landscape for reports due on or after January 1, 2026. This legislation repealed the sales tax exemption for R&D equipment (Tax Code Section 151.3182) and replaced the existing credit with a more permanent and lucrative version under Subchapter T.

Feature	Subchapter M (Pre-2026)	Subchapter T (Post-2025)
Standard Credit Rate	5% of the difference over the base	8.722% of the difference over the base
Higher Ed Contract Rate	6.25% of the difference over the base	10.903% of the difference over the base
No Prior QREs Rate	2.5% of total QREs	4.361% of total QREs
No Prior QREs (Higher Ed)	3.125% of total QREs	5.451% of total QREs
Sales Tax Exemption	Available as an alternative	Repealed effective Jan 1, 2026
Refundability	Not generally available	Available if no franchise tax is due
Carryforward Period	20 years	20 years

Subchapter T maintains the combined group as the central taxable entity, but it significantly simplifies the compliance burden by removing the elective conflict with sales tax and increasing the credit rates to make Texas more competitive with the approximately 29 other states offering similar incentives.

Revenue Office Guidance on Combined Group Calculations

The Texas Comptroller’s Office has issued specific guidance via the State Automated Tax Research (STAR) system and administrative rules (specifically 34 TAC §3.599) on how to compute the credit at the group level.

Aggregation of QREs and the Single Taxpayer Principle

The most significant guidance for combined groups is found in STAR Document 202503004M. This memorandum clarifies that for the purposes of the R&D credit, all members of a combined group are treated as a single taxpayer. This has three primary implications:

• Aggregate QREs: The R&D credit is calculated at the group level based on the combined qualified research expenses of every member of the group. If Member A spends $1 million and Member B spends $2 million, the group’s current-year QRE is $3 million.
• Consolidated Base Amount: The base amount (usually 50% of the average QREs from the three preceding years) must also be calculated on a consolidated basis. This includes the historical expenses of all current members, even if they were not part of the group in those prior years.
• Disregarded Intragroup Transactions: Transactions between members of the same combined group are disregarded. If Member A pays Member B (a fellow group member) to perform research, that payment does not increase the group’s total QREs, as it is essentially moving money within a single economic unit.

Federal Alignment and the Line 48 Rule

Under the new Subchapter T, the definition of QREs is explicitly tied to the amount reported on line 48 of IRS Form 6765 (Credit for Increasing Research Activities) for research conducted in Texas. This is a departure from prior years where taxpayers and the Comptroller often argued over the specific eligibility of individual expenses under the Four-Part Test.

For a combined group, this means the reporting entity must identify the portion of the federal QREs that are attributable to Texas-based activities for each member. The law provides for rolling conformity to the Internal Revenue Code, meaning Texas will automatically follow federal law as it changes, as well as federal audit outcomes. If the IRS conducts an audit and adjusts the QREs for a member of the group, the Texas credit must be adjusted accordingly on an amended franchise tax report.

Membership Changes: Adding and Losing Group Members

Because the R&D credit is calculated based on a rolling three-year average, changes in the composition of the combined group require complex adjustments to both current QREs and the base amount.

Attribution of Credit Carryforwards

If a member leaves a combined group, the credit carryforward generated in previous years does not automatically remain with the group. According to Rule 3.599 and associated guidance, the credit carryforward is attributed to each member that was included in the report for the year the carryforward relates.

• Usage by the Departed Member: The member that leaves can take its attributed portion of the carryforward and use it on its own future franchise tax reports (or as part of a new combined group).
• Usage by the Remaining Group: The remaining combined group can only continue to use the portion of the carryforward attributed to the members who stay in the group. If the group wants to carry forward a credit, the members who were originally attributed that credit must remain part of the group on the last day of the accounting period for that report.

Mergers and Acquisitions

If one member of a combined group merges into another member of the same group, the credit attributes remain with the surviving entity and the group as a whole. However, if a combined group acquires a new entity from outside the group, that new member’s historical QREs must be included in the group’s base amount calculation for future periods to ensure the incremental nature of the credit is preserved.

Compliance and Reporting Procedures for Combined Groups

The Comptroller requires specific forms and procedures for a combined group to validly claim the R&D credit. Failure to follow these procedures can lead to a summary denial of the credit during the report processing phase.

Required Documentation

A combined group must file the following as part of its annual franchise tax report:

• Form 05-158-A/B (Long Form): The primary franchise tax return.
• Form 05-166 (Affiliate Schedule): This form must list every member of the combined group, including those without nexus in Texas. The reporting entity must also be listed on this schedule.
• Form 05-160 (Credits Summary Schedule): Where the total amount of R&D credit being claimed for the year is summarized.
• Form 05-178 (R&D Activities Credits Schedule): This is the detailed worksheet where the group aggregates its QREs and calculates the credit based on the relevant rate (Standard vs. Higher Ed vs. No Prior QREs).

Determining the SIC Code and Accounting Period

The reporting entity of a combined group must select a Standard Industrial Classification (SIC) code that is appropriate for the group as a whole. This is determined based on the primary business activity of the group, which is calculated using the total revenue of the combined group after subtracting intercompany revenue.

Furthermore, the group must align its accounting period. If members file a federal consolidated return, the group’s Texas accounting period is the federal taxable period. If members have different accounting periods, the reporting entity must prepare separate income statements based on the group’s chosen accounting period to determine the QREs for the period.

Case Study and Example Calculation: The Nexus-Tech Combined Group

To illustrate the practical application of these rules, consider the Nexus-Tech combined group, consisting of a parent company and two subsidiaries.

Scenario Background

• ParentCo: A holding company with no research activities.
• ResearchSub: A subsidiary conducting 100% of its research in Austin, Texas.
• MfgSub: A subsidiary that manufactures the products designed by ResearchSub.
• University Contract: In 2025, ResearchSub contracted with Texas A&M University for $200,000 of specialized testing.

The group is unitary because ResearchSub designs the products that MfgSub manufactures (vertical integration), and all three share a centralized management team in Dallas (centralized services).

Step 1: Aggregating Current Year QREs (2025 Activities)

The group identifies its Texas QREs from line 48 of the federal Form 6765.

Member	Texas Wages	Texas Supplies	Contract Research	Total Member QRE
ParentCo	$0	$0	$0	$0
ResearchSub	$1,500,000	$300,000	$200,000 (Univ)	$2,000,000
MfgSub	$500,000	$100,000	$100,000 (Third Party)	$700,000
Group Total	$2,000,000	$400,000	$300,000	$2,700,000

Note: The contract research for ResearchSub is with a Texas higher education institution, which triggers the enhanced rate.

Step 2: Calculating the Base Amount

The group analyzes its historical Texas QREs for the three preceding years (2022, 2023, and 2024).

• 2024 Total Group QRE: $2,400,000
• 2023 Total Group QRE: $2,000,000
• 2022 Total Group QRE: $1,600,000

Average Prior QREs = $2,000,000.

Base Amount = 50% of Average = $1,000,000.

Step 3: Computing the Credit (Subchapter T Rates)

The group’s total current QRE is $2,700,000. The Difference over the base is: $1,700,000

Since the group has a university contract, it must bifurcate the credit calculation based on the portion of the Difference attributable to university research.

Component	Calculation	Credit Amount
University Portion	$200,000 x 10.903%	$21,806.00
Standard Portion	($1,700,000 – $200,000) x 8.722%	$130,830.00
Total R&D Credit		$152,636.00

Step 4: Applying Limitations

The Nexus-Tech group has a total franchise tax liability of $250,000 for the 2026 report. The credit is limited to 50% of the tax due before other credits.

• Maximum Credit Allowed: $250,000 x 0.50 = $125,000.
• Credit Claimed: $125,000.
• Carryforward to 2027: $152,636 – $125,000 = $27,636.

If the group’s revenue had been below the $2.65 million no tax due threshold, the group would have been eligible for a full refund of the $152,636, and the 50% limitation would not have applied.

Audit and Controversy: Current Trends in Texas

The Texas Comptroller currently faces a backlog of over 1,300 R&D audits, leading to a shift in how these cases are handled. For combined groups, understanding the audit landscape is as important as understanding the law itself.

The Focus on Statistical Sampling

The Comptroller’s Audit Division has significantly increased its reliance on statistical sampling, following IRS Revenue Procedure 2011-42. For large combined groups with complex research portfolios, the auditor and taxpayer can agree to a sample of projects. If the auditor finds that 90% of the sampled projects meet the qualifying criteria, then 90% of the total group QREs will be allowed. This is often the only efficient way for a group with hundreds of subsidiaries and thousands of employees to substantiate its claim.

High-Scrutiny Industries

Auditors are specifically trained to look for disqualified activities that are common in certain sectors. For example, in the oil and gas industry, routine well maintenance and seismic data surveys that do not involve technological uncertainty are frequently rejected. In the services sector, research that adapts an existing product to a specific customer’s needs is often disallowed as adaptation rather than innovation. Combined groups in these industries should maintain project-level documentation that clearly articulates the technological uncertainty being resolved through experimentation.

The Statute of Limitations Risk

A major risk for combined groups is the loss of credits due to the statute of limitations. A refund claim (which includes the creation of an R&D credit for a prior year) must be filed within four years of the date the tax was due and paid. If a group discovers it missed QREs from 2020, but the 2020 report year is closed, it cannot create that credit to carry it forward to 2026. However, Rule 3.599(g)(5) allows the Comptroller to verify QREs in a closed year to verify the accuracy of a carryforward being used in an open year.

Nuanced Insights and Final Thoughts

The transition to Subchapter T and the permanent extension of the R&D credit represent a strategic shift by the State of Texas to encourage high-wage job creation and vertical manufacturing synergy. For combined groups, the elimination of the sales tax exemption option removes a significant layer of planning complexity but also removes a safe harbor for companies that are consistently in a tax-loss position.

The new refundability provision is perhaps the most significant second-order effect of SB 2206. By allowing non-taxpaying entities to receive cash refunds, Texas is effectively subsidizing the R&D of early-stage startups and technology firms that are not yet profitable. For a combined group, this creates an incentive to keep pre-revenue research subsidiaries within the same unitary group as mature manufacturing entities, as the group can now monetize research costs either as a tax offset or a cash refund, depending on the group’s aggregate revenue.

Ultimately, the meaning of a combined group in the Texas R&D context is that of a single, integrated economic taxpayer. Whether it is the aggregation of expenses, the attribution of carryforwards upon membership changes, or the consolidated filing requirements, the law consistently looks to the group rather than the individual legal entity. This holistic approach requires businesses to maintain robust, group-wide data tracking and a clear understanding of the unitary links that bind their various subsidiaries together for Texas tax purposes.