Tax Considerations for Franchise Businesses: Fees, Depreciation, and Entity Selection

Franchise businesses present a specific set of tax planning opportunities that franchise owners often overlook. Under IRC 197, the initial franchise fee and any amount paid for the franchise rights are treated as Section 197 intangible assets, amortized ratably over 15 years regardless of the actual term of the franchise agreement. This applies to the initial franchise fee, transfer fees, and any premium paid for an existing franchise. In contrast, ongoing royalty payments (typically 4-8% of gross revenue) and advertising fund contributions (typically 1-3% of revenue) are currently deductible as ordinary and necessary business expenses under IRC 162. Beyond the franchise fee treatment, franchise owners benefit from the same small business tax provisions as other businesses: 100% bonus depreciation on equipment and qualified improvement property, the QBI deduction (franchise businesses are generally not SSTBs), WOTC credits for hiring qualifying employees, and Section 179 expensing. Multi-unit franchise owners face additional considerations around entity structuring, intercompany transactions, and state tax nexus across multiple locations.

What are the key strategies for franchise owners?

Do I need to collect sales tax on my services?

Whether services are subject to sales tax depends entirely on the state where the service is performed or delivered. Most states exempt professional services (accounting, legal, consulting) from sales tax, but a growing number tax specific services like repair and maintenance, landscaping, and personal care services. Some states tax all services unless specifically exempted, while others exempt all services unless specifically listed as taxable. If you operate in multiple states, you need to check each state’s rules because a service taxable in one state may be exempt in another. Failing to collect and remit required sales tax creates a personal liability for the business owner, and states can audit back several years with penalties and interest.

How do multi-unit franchise owners handle taxes across locations?

Each location’s income and expenses should be tracked separately for management purposes, but all units typically flow through the same entity and tax return. If locations are in different states, you may owe state income tax in each state where you have nexus, requiring separate state returns and apportionment calculations. Sales tax obligations are location-specific: you register, collect, and remit in each jurisdiction where you operate. Multi-unit owners often benefit from cost segregation studies on each location’s build-out to accelerate depreciation deductions. Consider whether a holding company structure (parent LLC owning separate LLCs for each location) provides better liability protection and operational flexibility.

How are franchise fees and royalties treated for tax purposes?

Initial franchise fees paid to acquire a franchise are treated as Section 197 intangible assets and amortized over 15 years, regardless of the actual franchise agreement term. Ongoing royalty payments based on a percentage of gross sales are deductible as ordinary business expenses in the year paid, reported on Schedule C or the applicable business return. Advertising fund contributions required by the franchisor are also deductible as ordinary business expenses, separate from the royalty calculation. If you sell or terminate your franchise, any remaining unamortized franchise fee balance is deductible in the year of disposition, and the gain or loss on the sale is generally treated as ordinary income under IRC 1253 unless the franchise agreement gives the franchisee significant rights that qualify for capital gains treatment.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.