In short
Texas does not have a franchise tax exemption, credit, or special rate for data center companies. An AI data center company doing business in Texas must pay the state franchise tax on its taxable margin, just like any other business. Tex. Tax Code Ch. 171 The primary Texas incentive for AI data centers is a sales and use tax exemption under Chapter 151, which can eliminate millions of dollars in state sales tax on equipment and power. Tex. Tax Code §§ 151.359 and 151.3595 A new research and development franchise tax credit, Subchapter T, took effect on January 1, 2026, and could benefit AI data centers that perform qualifying research in Texas. SB 2206, Press release The sales tax exemption is under serious political pressure and may be scaled back or repealed in the 2027 legislative session. If that happens, franchise tax planning, including the R&D credit, will matter more than ever.
What is the Texas franchise tax and who pays it?
The Texas franchise tax is a privilege tax on doing business in the state. It is a margin tax, meaning it is based on a company’s total revenue minus certain deductions, not on its net income. Every taxable entity formed in Texas or doing business in Texas must pay the tax unless it falls into an excluded category. Tex. Tax Code § 171.001, Texas Comptroller Franchise Tax Overview
Taxable entities include corporations, limited liability companies, limited partnerships, professional associations, business trusts, and joint ventures. Sole proprietorships and general partnerships owned entirely by natural persons and whose liability is not limited by statute are not taxable entities. [https://www.law.cornell.edu/regulations/texas/34-Tex-Admin-Code-SS-3-581] [https://statutes.capitol.texas.gov/Docs/TX/htm/TX.171.htm#171.0002] [https://comptroller.texas.gov/taxes/franchise/] [https://comptroller.texas.gov/taxes/franchise/] Franchise Tax Thresholds, Franchise Tax Overview
A typical AI data center operator structured as an LLC or corporation is subject to the tax.
The tax is calculated on a figure called taxable margin. To get taxable margin, start with total revenue and then subtract the greater of either cost of goods sold or compensation, or $1 million if you make no election. The taxable margin cannot be less than 70 percent of total revenue, so the deduction cannot exceed 30 percent of total revenue. Under the statute, the margin is the lesser of (A) the lesser of 70 percent of total revenue or total revenue minus $1 million and (B) total revenue minus the greater of $1 million or, at the entity’s election, either cost of goods sold or compensation. Tex. Tax Code § 171.101
For most businesses, the tax rate is 0.75 percent of the taxable margin that is apportioned to Texas. Retailers and wholesalers pay a lower rate of 0.375 percent. Tex. Tax Code § 171.002
The Comptroller has released the specific dollar amounts for the 2026 to 2027 report period.
| Item | 2026 to 2027 amount |
|---|---|
| No-tax-due threshold (total revenue) | $2,650,000 |
| Standard tax rate | 0.75% (0.375% for retail/wholesale) |
| Compensation deduction limit per person | $480,000 |
| EZ computation rate (entities ≤ $20M revenue) | 0.331% |
| EZ computation total revenue cap | $20,000,000 |
[https://comptroller.texas.gov/taxes/franchise/]
If a company’s total revenue is at or below $2,650,000, it owes no franchise tax. Starting in 2024, companies below the threshold no longer file a full franchise tax report. They must still submit an information report. [https://comptroller.texas.gov/taxes/publications/98-806.php]
The EZ computation is a simpler alternative for eligible small businesses. Instead of calculating margin, they can pay tax at 0.331 percent of total revenue. This may be helpful if the company’s margin would otherwise be higher.
Texas apportions taxable margin to the state using a single factor gross receipts formula. That means you multiply the total taxable margin by a fraction, Texas gross receipts divided by total gross receipts. [https://comptroller.texas.gov/taxes/publications/98-806.php] If an AI data center serves customers outside Texas, only the Texas share is taxed.
Taxable entities that are part of an affiliated group engaged in a unitary business must file a combined group report. [https://comptroller.texas.gov/taxes/publications/98-806.php] For a large AI company with multiple operating subsidiaries in Texas, this can add complexity.
Annual franchise tax reports are due May 15. [https://comptroller.texas.gov/taxes/publications/98-806.php]
Is there a franchise tax exemption for data centers?
No. Texas does not have a franchise tax exemption, credit, or reduced rate specifically for data centers. The franchise tax law in Chapter 171 applies to data center companies the same way it applies to any other business. The large incentive that Texas provides is a sales and use tax exemption, not a franchise tax exemption.
The data center sales and use tax exemption is found in Chapter 151 of the Tax Code. It can exempt qualifying purchases of servers, cooling equipment, electricity, and other tangible personal property from the 6.25 percent state sales tax. For very large projects, it can also waive local sales taxes. The exemption lasts up to 10, 15, or 20 years depending on the size of the investment. Tex. Tax Code § 151.359, Tex. Tax Code § 151.3595
The table below summarizes the two tiers of this incentive.
| Feature | Qualifying Data Center (Std) | Qualifying Large Data Center Project |
|---|---|---|
| Min investment | $200 million over 5 years | $500 million over 5 years |
| Min qualifying jobs | 20 | 40 |
| Min size | 100,000 sq ft (single building) | 250,000 sq ft (contiguous parcels) |
| State sales tax exemption | Yes (6.25%) | Yes (6.25%) |
| Local sales tax exemption | No (local tax still due) | Yes |
| Exemption duration | 10 years ($200M–$250M) or 15 years ($250M+) | Up to 20 years |
| ERCOT reservation | Not required | 20 MW transmission capacity |
Major operators like Microsoft, Google, Amazon Web Services, Coreweave, Oracle, and Anthropic all have registered AI data centers in Texas that use this sales tax exemption. Comptroller data center list Yet every one of those companies still owes the Texas franchise tax on its Texas margin, year after year, unless it qualifies for some other provision.
How does the franchise tax apply to a typical AI data center operator?
When an AI data center operator files its annual franchise tax report, it calculates the tax just as any other business would. The main planning points are as follows.
- Choosing the largest deduction. Data centers often have large payrolls for technicians, engineers, and security personnel. The compensation deduction can be valuable, but it is capped at $480,000 per person for the 2026–2027 period. If the company can use the cost of goods sold deduction, that may be larger, but data centers providing services (like colocation) may not qualify for COGS unless they structure their business appropriately. Because of the 70 percent floor, the effective 30 percent deduction is often the limiting factor. Many operators use the compensation deduction.
- Apportionment. If the AI data center serves customers across the country, only the portion of its margin that comes from Texas is taxed. The apportionment formula uses Texas gross receipts over total gross receipts. A data center that hosts cloud services for out-of-state customers may have a relatively low Texas apportionment factor, which reduces franchise tax.
- Passive entity exemption. If the operator is structured as a general or limited partnership or a trust other than a business trust that earns at least 90 percent of its federal gross income from dividends, interest, royalties, and other specified passive categories and no more than 10 percent from conducting an active trade or business, it is not subject to franchise tax because it qualifies as a passive entity as defined by Section 171.0003, is excluded from the definition of taxable entity under Section 171.0002(b)(3), and the tax is not imposed under Section 171.001(c). Tex. Tax Code § 171.0003, Tex. Tax Code § 171.0002(b)(3), Tex. Tax Code § 171.001(c) For example, an AI data center property company that leases the facility to an operating company on a triple-net basis might qualify if it does not provide significant active services. However, the Comptroller has not published any rulings confirming this structure for data centers. The line between passive ownership and active business is fact-specific and can be blurry.
- Combined reporting. Unitary groups must combine their Texas businesses into one report. An AI company with a Texas data center subsidiary and a separate Texas sales subsidiary would likely have to file a combined report, pooling margins and deductions.
A new R&D franchise tax credit can help some AI data centers
In 2025, Texas overhauled its research incentives. SB 2206, signed by Governor Abbott on June 17, 2025, created a new franchise tax credit for qualified research expenses, effective for reports due on or after January 1, 2026. SB 2206
The credit is set out in new Subchapter T of Chapter 171. It replaces the old Subchapter M R&D credit and consolidates the incentive into the franchise tax system. At the same time, SB 2206 repealed the old R&D sales tax exemption under Section 151.3182, so there is no longer a sales tax break for R&D equipment. SB 2206
The new credit is calculated as a percentage of qualified research expenses (QREs) in Texas that exceed a base amount. The base amount is 50 percent of the average QREs in the three preceding tax periods. If the company had no QREs in prior years, an alternative simplified credit applies at half the regular rate. The rates are as follows.
- 8.722 percent of new qualifying QREs.
- 10.903 percent if the research is conducted under a contract with a Texas public or private institution of higher education.
- 4.361 percent simplified rate (5.451 percent with higher education contract) for companies with no QREs in one or more of the three prior tax periods.
The credit is capped at 50 percent of the franchise tax due before applying any credits. SB 2206 § 171.9207 Any unused credit carries forward for up to 20 consecutive reports. SB 2206 § 171.9208
Qualified research expenses are defined as the portion of the amount reported on Federal Form 6765, line 48, that is attributable to research in Texas. SB 2206 § 171.9202 This ties the Texas credit directly to the federal research credit definition under Internal Revenue Code Section 41, which requires that the research be technological in nature, involve a process of experimentation, and be undertaken to discover information useful in developing a new or improved business component. The law provides rolling conformity with changes to the federal definition.
This credit matters for AI data center operators. Many of these companies conduct research and development on site. For example, training large AI models involves running repeated experiments on model architecture, hyperparameters, and data pipelines. The process often meets the federal R&D credit’s process of experimentation test. Developing custom cooling systems, power management software, or network optimization tools can also qualify.
No Texas Comptroller ruling has yet addressed whether AI model training specifically qualifies for the Texas credit. However, many technology companies already claim the federal R&D credit for these activities. Because the Texas credit conforms to the federal definition, a strong federal position supports a strong Texas position. Companies should document their research activities carefully and consider requesting a private letter ruling if the amounts are substantial.
Can an AI data center claim both the sales tax exemption and the R&D credit?
Yes, likely. The data center sales tax exemption (under Sections 151.359 and 151.3595) and the franchise tax R&D credit (under Subchapter T) are separate incentive programs. One reduces sales tax on purchases, the other reduces franchise tax. No statute says you cannot use both. An AI data center could buy servers tax free under the data center exemption and also claim the R&D credit for the wages of the engineers who configure those servers for research projects. However, the Comptroller has not issued any formal guidance confirming this dual use. The interaction is untested. Companies that plan to rely on both incentives should separate their recordkeeping and get professional advice.
The sales tax exemption is under political pressure
The Texas data center sales tax exemption has become a billion-dollar annual cost to the state. In 2026, the state is forgoing at least $1.3 billion in revenue from this exemption. Texas Tribune/Houston Public Media By the 2028 to 2029 biennium, the projected cost is $3.3 billion. Good Jobs First This rapid growth has drawn attention from lawmakers.
Senator Joan Huffman, who chairs the Senate Finance Committee, has called the exemption unsustainable and intends to file legislation to repeal or modify it in 2027. Texas Tribune/Houston Public Media Representative Helen Kerwin has proposed a moratorium on large rural data centers. Good Jobs First
The 2026 Senate interim charges explicitly include a study of the fiscal effects of data center investment and a review of the sales tax exemption. House interim charges are examining data center water use and grid impacts. Good Jobs First
The data center sales tax exemption is facing its most serious legislative challenge since it was enacted in 2013. Companies budgeting for new Texas projects should model a scenario in which the exemption is repealed, capped, or conditioned on new requirements.
If the exemption is scaled back, AI data center developers would pay full state sales tax on equipment and electricity, potentially adding tens of millions of dollars to project costs. In that environment, franchise tax planning, including the R&D credit and other incentives, would become more important.
Other Texas incentives for AI data centers
Beyond the franchise tax and sales tax, Texas offers additional programs that can reduce the overall tax cost of an AI data center project.
- Property tax abatement (Chapter 312). Local governments can grant property tax abatements on new improvements for up to 10 years. The abatement is negotiated directly with the city or county and is often used for large capital projects. An AI data center can get its property taxes reduced or eliminated for the first decade. [https://comptroller.texas.gov/economy/development/prop-tax/ch312/exec-summary-2024.php]
- Texas Enterprise Fund. The Governor’s Office awards discretionary cash grants to companies that are considering sites in Texas versus other states. The project must create at least 75 full-time jobs in an urban area or 25 in a rural area, and it must have local government support. The grants are deal-closing, meaning they are deployed to tip a decision in Texas’s favor. Funds are paid out only after the company meets its job and wage targets. [https://gov.texas.gov/business/page/texas-enterprise-fund]
These incentives can be layered on top of the sales tax exemption and the R&D credit. However, a data center that receives a property tax value limitation agreement under the old Chapter 313 program is not eligible for the data center sales tax exemption. Tex. Tax Code § 151.359(k) Texas is in the process of sunsetting Chapter 313 and may replace it with a new program. The interaction with any new program is not yet clear.
Key takeaways
- No franchise tax exemption exists for data centers. AI data center companies pay the standard 0.75 percent franchise tax on their Texas margin. The big Texas AI data center incentive is a sales tax exemption, not a franchise tax break.
- The R&D credit is real and new. For reports due after January 1, 2026, a company that conducts qualified research in Texas can earn a credit worth up to 8.722 percent of new research spending. It is capped at 50 percent of franchise tax and carries forward 20 years.
- AI research is likely qualifying, but unconfirmed. AI model training and algorithm development can fit the federal R&D definition, but no Texas ruling has confirmed it. Document activities thoroughly.
- Potential to stack incentives exists. You can probably use the sales tax exemption and the R&D credit together, but no guidance confirms it. Plan with care.
- Passive entity planning is a gray area. A property holding company that leases to an operator could avoid franchise tax if it meets the 90 percent passive income test. The Comptroller has not ruled on this for data centers.
- The sales tax exemption is at risk. Political momentum is building to repeal or limit it. Model a scenario without it.
- Other incentives remain available. Property tax abatements and Enterprise Fund grants can reduce project costs, and they work alongside the franchise tax and sales tax programs.
- Deadlines matter. Franchise tax reports are due May 15 each year. Start the R&D credit analysis early.
Frequently asked questions
Q:Does Texas have a franchise tax exemption for AI data centers?
A:No. Texas does not have a franchise tax exemption, credit, or special rate for data center companies. The primary data center incentive is a sales and use tax exemption under Chapter 151. Data center companies must still pay the regular Texas franchise tax on their taxable margin. Texas Franchise Tax Overview
Q:What is the Texas franchise tax rate?
A:For the 2026–2027 report period, the standard rate is 0.75 percent of apportioned taxable margin. Companies primarily engaged in retail or wholesale trade pay 0.375 percent. [https://comptroller.texas.gov/taxes/franchise/]
Q:What is the no-tax-due threshold for the Texas franchise tax?
A:For 2026–2027, if a company’s total revenue is $2,650,000 or less, it owes no franchise tax. The company must still file an information report but not a full tax report. [https://comptroller.texas.gov/taxes/publications/98-806.php]
Q:What is the new Texas R&D franchise tax credit?
A:Effective January 1, 2026, Texas offers a franchise tax credit for qualified research expenses. The credit equals 8.722 percent of qualifying QREs above a base amount, with higher rates for university contracted research. It is capped at 50 percent of franchise tax liability and carries forward 20 years. SB 2206
Q:Can AI data centers claim the R&D credit for AI model training?
A:Probably yes, but it is not yet confirmed by the Texas Comptroller. The credit follows the federal definition of qualified research, which many AI development activities satisfy. Companies should keep detailed records and consider a private letter ruling. No public ruling has directly addressed AI training.
Q:How does the data center sales tax exemption work?
A:The exemption allows qualifying data centers to buy certain tangible personal property (servers, cooling equipment, electricity, and more) free of the 6.25 percent state sales tax. To qualify, a project must meet minimum investment, job, and size thresholds. Large projects can also receive an exemption from local sales taxes and last up to 20 years. Tex. Tax Code § 151.3595
Q:Can a company get both the sales tax exemption and the R&D credit?
A:Yes, likely. The programs are separate, and nothing in the law prohibits using both. However, no Comptroller guidance has addressed stacking them. Companies should plan with care.
Q:Is the data center sales tax exemption going away?
A:It may be repealed or significantly limited. Key lawmakers have called it unsustainable and the legislature will study it in 2026. Changes could come as early as the 2027 session. Developers should plan for the possibility of higher costs. Texas Tribune/Houston Public Media
Q:What is the due date for Texas franchise tax reports?
A:Annual franchise tax reports are due on May 15. [https://comptroller.texas.gov/taxes/publications/98-806.php]
Q:Are there other Texas incentives for AI data centers besides the sales tax exemption?
A:Yes. Companies can seek property tax abatements under Chapter 312 from local governments for up to 10 years. The Texas Enterprise Fund can provide cash grants for projects that create jobs and compete with out-of-state locations. These are separate from the sales tax and franchise tax systems.
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Junde Liu, JD, LL.M. (Taxation) candidate at UF Law. Originally published on Compute Law Blog. This article is general information and does not constitute legal advice. Reading it does not create an attorney client relationship. The reader should not act on the basis of any content here without first consulting a licensed attorney in the relevant state. Last reviewed for accuracy May 23, 2026.