A Texas administrative law judge (ALJ) recently allowed a transportation company to exclude its fuel surcharge reimbursements from gross receipts when computing its Revised Texas Franchise Tax (RTFT) liability.1 Because the taxpayer properly excluded the reimbursements on its amended federal return, it was allowed to exclude the reimbursements from its gross receipts on its corresponding amended RTFT return.


The taxpayer, a company that transported freight on a contract basis, charged and collected from its customers a reimbursement of fuel costs, referred to as a fuel surcharge. Due to the volatility of fuel prices, contracted freight rates did not reimburse the taxpayer for its fuel costs at times of high fuel prices. The fuel surcharge, a commonly used mechanism in the transportation industry, was a scheduled charge per gallon above a certain floor. This surcharge was separately stated on the invoices sent to customers and varied weekly based on the national average price for diesel fuel. The taxpayer acknowledged that the fuel surcharge was an estimate and explained that there was no markup in its calculation. The fuel surcharge was intended to recover the excess fuel costs on a dollar-for-dollar basis. The taxpayer included the fuel surcharge in the gross receipts of its originally filed federal income tax return and RTFT report. In addition, the taxpayer imposed accessorial fees for which the taxpayer was reimbursed, including off-loading, stop-off, escort and shuttle fees. The accessorial fees, which were also invoiced as a separate line item, were not included in the gross receipts of its originally filed federal income tax return and RTFT report.

Subsequently, the taxpayer amended its federal income tax return to exclude the fuel surcharge reimbursements from both revenue and deductible expenses, consistent with its treatment of the accessorial fees. The taxpayer based this amendment on the federal income tax “reimbursement theory” that prohibits the deduction of certain reimbursed expenses as ordinary and necessary business expenses under Internal Revenue Code (IRC) Section 162 and requires the exclusion of the reimbursed payments from gross income.2 The taxpayer also amended its Texas report and requested a refund based on the elimination of the fuel surcharge from the total revenue portion of the tax base. As the taxpayer was a service provider, and was not a producer or acquirer of goods, the Texas cost of goods sold (COGS) deduction was not available to the taxpayer, and the fuel surcharge could not have been deducted under that provision.

In denying the refund, the auditor explained that “[t]hese charges are additional charges to customers for the provision of the taxpayer’s transportation services rather than expenses paid to the taxpayer for the reimbursement.” The taxpayer appealed the denial and requested a hearing.

Computation of Total Revenue for RTFT

The RTFT base is generally total revenue reported for federal income tax purposes less the highest of three potential deductions: (i) 30 percent of total revenue; (ii) compensation; or (iii) COGS.3 For corporations, Texas total revenue is computed by adding (i) the amount reportable as income on federal Form 1120, line 1c (gross receipts or sales); (ii) the amounts reportable as income on Form 1120, lines 4 through 10 (items such as interest and gross royalties); and (iii) any total revenue reported by a lower tier entity as includible in the taxable entity’s total revenue.4 The amount reported on line 1c is included in Texas total revenue “to the extent the amount entered complies with federal income tax law.”5

Reimbursement Items Excludable from Texas Gross Receipts

The ALJ held that the taxpayer could properly exclude the fuel surcharge from gross receipts for RTFT purposes and was entitled to a refund. The taxpayer previously had included the fuel surcharge on line 1c of its federal tax return. The taxpayer’s amended federal return excluded the fuel surcharge resulting in a change in the corresponding Texas “amount reported.” Thus, the dispute required the ALJ to determine whether the amount the taxpayer reported on line 1c of its amended federal return complied with federal income tax law. As the relevant Texas law follows the federal law, the case was accordingly decided under the federal authorities on the “reimbursement theory.”

According to the ALJ, the “reimbursement theory” is best summarized in an Internal Revenue Service (IRS) General Counsel Memorandum.6 This memorandum explains that “[t]he ‘reimbursement theory’ has developed under the principle that a taxpayer is not allowed a section 162 deduction for expenditures that are made with a right or expectation of reimbursement since they are in the nature of loans or advancements and are not ordinary and necessary business expenses.”7 Also, the memorandum clarifies that “[t]he reciprocal of disallowing a deduction under the reimbursement theory is that reimbursement payments will not be includable in the recipient’s gross income.”8 Furthermore, “[t]he application of the reimbursement theory requires initially that the expenditure would otherwise constitute a section 162 business expense of the taxpayer.”9

In this case, it was undisputed that the taxpayer’s fuel cost was an ordinary and necessary business expense (although notably not otherwise qualified for the COGS deduction for RTFT purposes in this situation).

The ALJ explained that the next step in determining whether the reimbursement theory causes a disallowance of the deduction is ascertaining whether a right or expectation of reimbursement exists when the expenditure occurs. Previously, it was thought that the right of reimbursement had to be unconditional in order for the expenditure not to be deductible as a business expense under IRC Section 162, but the U.S. Court of Appeals expanded the principle to include less than an absolute right to reimbursement.10 Furthermore, the United States Tax Court has held that expenditures were not deductible where they were supported by a reasonable expectation of recovery.11

After conducting a thorough analysis, the ALJ concluded that the fuel costs that the taxpayer initially paid, and for which it received fuel surcharge reimbursements, were ordinary and necessary business expenses otherwise deductible under IRC Section 162. However, due to the taxpayer’s more than reasonable expectation that it would be substantially repaid by its clients, the reimbursement payments were not deductible under IRC Section 162 or includible in the taxpayer’s federal gross receipts. As a result, the amounts reported on line 1c of the taxpayer’s amended federal income tax return were required by Texas law to be included in the calculation of its total revenue on its RTFT report. Therefore, the taxpayer’s refund claim should be granted. The treatment of the fuel surcharges was consistent with the way the taxpayer reported the accessorial fees, which had not been contested by the Comptroller, and the ALJ saw no reason to treat the two amounts in a different manner.

In support of his decision, the ALJ noted that he had applied the same approach in a 2013 decision.12 That matter concerned a Texas corporation whose business activities included warehousing and exporting merchandise. The taxpayer acted as the forwarding agent and representative of an affiliated company and paid the out-of-pocket costs of the affiliated company’s clients. The clients reimbursed the taxpayer for these out-of-pocket costs. The taxpayer initially attempted to claim these costs as exclusions from total revenue as flowthrough funds,13 but the Comptroller disallowed the deductions and recalculated the RTFT reports using the E-Z computation method.14 The taxpayer and the Comptroller’s staff resolved two of the tax years at issue in that matter by allowing the taxpayer to amend its RTFT reports to exclude the out-of-pocket costs provided the taxpayer filed amended federal income tax returns for the corresponding years. The Comptroller’s staff had determined that federal income tax law allowed the taxpayer to report its gross receipts either with or without the reimbursements for the out-of-pocket costs. After the taxpayer amended its federal returns to exclude the reimbursed amounts, it was permitted to amend the corresponding RTFT reports to exclude these same reimbursed amounts.


For purposes of reporting total revenue, Texas law generally follows the corresponding federal income tax authorities. Items that are properly included in federal gross income also are included in the Texas return. Likewise, items of revenue excluded from the federal return income line items enumerated in the Texas income determination statute15 are generally excludable from Texas total revenue. This point is illustrated in the ALJ’s 2013 decision where the state looked through the state return to see if the gross receipts on the federal return properly “mirrored” the state return.16

In addition to being an ordinary and necessary business expense, in order to exclude the gross receipt item, the taxpayer must also have a reasonable expectation to be reimbursed. This need not be an absolute right of reimbursement and the amount used in the case at issue was an estimate, not an exact amount. Therefore, it is neither necessary to have an absolute right to reimbursement nor a precisely calculated amount of the cost to be reimbursed to qualify for exclusion under the “reimbursement theory.” Because the taxpayer had created its own charts to calculate the fuel surcharge, it was not required to be reimbursed based on an “industry standard.” The taxpayer maintained records of payment and supporting calculations of billings.

While expressly pertaining to the taxpayer’s fuel surcharge and accessorial fees, this ruling could provide favorable precedent for excluding gross receipts related to a number of reimbursed ordinary and necessary business expenses. The reimbursement theory may be applied separately and distinctly from the Texas statutory exclusions for items reported as gross receipts or other income for federal income tax, such as foreign royalties, foreign dividends, certain net distributive income and certain flow-through funds.17 Although not discussed in this decision, amounts excluded from total revenue are likewise excluded from the Texas and everywhere gross receipts for apportionment purposes.18