Navigating taxes can get complex, especially for franchise owners, who must balance meeting rigid tax regulations and the unique demands of franchise ownership, be it royalty fees or franchise taxes.
Getting into a franchise is often much easier than starting your own business from scratch, but it has some drawbacks, the two major ones being franchise fees and advertising costs. The franchisee must pay a portion of their profits to the franchisor as part of being involved in the franchise, and they must pay a fixed amount to cover corporate advertising costs. Understanding and utilizing specific tax tips will help you maximize your business venture. In fact, hiring a CPA firm specializing in helping franchise owners can give you that extra leg up from the competition and help you save more money come tax season.
In today’s post, our CPA team will give you the top three tax tips to help you as a franchise owner. Consult with your CPA to get more specific advice on tax-saving strategies.
1. Leverage Write-Offs & Accelerated Depreciation
Like any entrepreneurial venture, franchise owners can leverage tax write-offs and accelerated depreciation of certain assets. The following costs are generally fully deductible in the year they’re incurred:
- Payroll
- Commercial lease payments
- Equipment and supplies
- Utilities
Franchise owners often have to purchase their own equipment. This is subject to accelerated depreciation as it’s used year after year. An experienced CPA can carefully model the accelerated depreciation of certain assets with the immediate deductibility of royalty payments and explain its effects on after-tax cash flow.
Remember that the tax benefits of asset depreciation aren’t the only thing you can look forward to as a franchisee. If you’re in a highly desirable industry or franchise, your net worth can appreciate significantly. In a highly desirable industry or a franchise, this pays to own your business. You’re not taxed on any gains until you decide to sell. And even when you do, tax strategies are available to minimize the tax burden.
2. Take Advantage of Retirement Contributions
Investing in retirement accounts for you and your employees can lower your tax burden.
Franchise owners are in the unique position of having access to large retirement saving options, such as a 401(k) or a SEP IRA. Business owners can contribute up to 25% of their salary to a SEP IRA, which hits a limit cap of $69,000 annually in 2024. This is a higher contribution limit than the traditional IRA.
401(k) retirement plans allow deferment of up to $23,000 annually. They also feature profit-sharing that can be used for employees, with limits up to $69,000 or $76,500. In addition to these retirement plans, there are defined contribution plans with higher max contribution limits. These can be added to an existing SEP IRA or 401(k), maximizing retirement savings.
3. Know When to Deduct and When to Capitalize
If a franchise agreement has little to no franchise fees, franchise royalties can still be required. Franchise fees must be capitalized and deducted as amortization expenses over 15 years, whereas royalties may be expensed as they are paid. When payments are made in fixed or equal amounts over the life of a franchise agreement, and they qualify as contingent serial payments, they can often be deducted as expenses rather than capitalized. Periodic payments that depend on selling goods and services sold under the franchise are deductible.
Contingent payments that don’t qualify for deduction must be capitalized into the basis of the franchise; this means you won’t get a tax benefit until years later! Royalty payments, for instance, are deductible in the year when they occur.
What is a Franchise Tax?
A franchise tax is not based on profit. It’s not like an income tax that’s proportionate to profits earned. It’s assessed on a business’s net worth rather than yearly earnings. Franchise tax is considered a general or administrative expense. Non-profits, certain LLCs, and cooperatives don’t owe any franchise tax.
Some states have discontinued their franchise tax, such as Kansas, Missouri, Pennsylvania, and West Virginia.
Consequences of Not Paying Franchise Tax
The penalties for neglecting to pay franchise taxes are similar to what you’d see on normal tax avoidance: tax penalties, fees, interest charges, and possibly a tax lien can be placed on the company’s assets.
Hire a CPA Advisor Who is On Your Side
The best way to strategically start cutting costs and saving on taxes is to hire a CPA who understands franchises’ unique business structure and has a vested interest in helping you save money and grow revenue. A CPA can help you discover what costs to capitalize or expense, as well as provide specific strategies for mitigating tax burdens. If you’re looking at expanding your locations across state lines, it is worth getting a tax analysis by a CPA before you start your venture.
State Tax Consulting
Although it may sound strange to some franchise owners, state income taxes greatly depend on investments made in that particular state. For instance, if a larger capital investment is made in your state, then the state’s income tax may increase without any corresponding increases in profit.
So, if you’re a franchise owner with numerous locations in multiple states, it’s important to understand the impact of various sales and use taxes on your business.
A CPA can help you determine specific steps for mitigating various tax burdens:
- Sales Tax: taxes on sales of goods or services
- Use Tax: the storage, use, or consumption of personal property within the state
- Taxes on Net Income: total sales of a company minus its expenses
- Gross Receipts: taxes on gross sales; only applies to TX, Nev., Ore., Wash., OH, Tenn.
- Occupational Taxes: taxes based on one’s occupation or profession
- Property Taxes: taxes on personal property or equipment
Grow Your Business as a Franchisee with Abacus CPAs
We help franchisee owners navigate the challenges of tax accounting and financial planning. Call 417.823.7171 to schedule a consultation with one of our professional CPAs in your area.
