Franchise Business Tax Rules: Deducting Franchise Fees, Royalties, and Startup Costs Under IRC 195 and IRC 197

By Yarik Yarosh, CPA ·September 5, 2026 ·5 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Opening a franchise is one of the most common paths to business ownership, but the tax rules for franchise costs are more restrictive than most new franchisees expect. Under IRC 197, the initial franchise fee is classified as a Section 197 intangible asset that must be amortized over 15 years using the straight-line method, regardless of the actual term of the franchise agreement. This is because IRC 197(d)(1)(F) specifically includes franchises, trademarks, and trade names in the definition of amortizable Section 197 intangibles. The 15-year amortization applies even if the franchise agreement is for a shorter term (such as 10 years), because the IRS treats the franchise right as having an indefinite useful life for purposes of Section 197. Ongoing royalty payments, advertising fund contributions, and technology fees are deductible as ordinary and necessary business expenses under IRC 162 in the year they’re paid or accrued. Pre-opening costs (training, site selection, pre-opening marketing, and travel) fall under the startup cost rules of IRC 195, which allow only $5,000 of immediate deduction (phased out for startup costs over $50,000), with the remainder amortized over 180 months beginning with the month the business opens.

✓Key takeaway

Franchise cost tax treatment:

Cost	Tax Treatment	Deduction Timing
Initial franchise fee	IRC 197 intangible (15-year straight-line amortization)	$3,333/year on a $50,000 fee
Ongoing royalties (4-8% of revenue)	Ordinary business expense (IRC 162)	Fully deductible when paid
Advertising/marketing fund contributions	Ordinary business expense	Fully deductible when paid
Technology/POS system fees	Ordinary business expense	Fully deductible when paid
Pre-opening training costs	Startup cost (IRC 195)	$5,000 immediate + 180-month amortization
Pre-opening travel	Startup cost	Same as above
Pre-opening marketing	Startup cost	Same as above
Equipment (kitchen, fixtures, furniture)	Section 179 or bonus depreciation	100% Year 1
Leasehold improvements (QIP)	15-year property with bonus depreciation	100% Year 1
Security deposits	Not deductible (asset until returned)	No deduction
Legal fees for franchise agreement review	Startup cost or organizational cost	IRC 195 or IRC 248

How are franchise costs deducted?

Hypothetical example

Round numbers. An entrepreneur opens a fast-food franchise. Total investment:

Cost	Amount	Tax Category
Initial franchise fee	$45,000	IRC 197 intangible
Pre-opening training (including travel)	$15,000	Startup cost (IRC 195)
Pre-opening marketing	$10,000	Startup cost
Legal and accounting (franchise review)	$5,000	Startup cost
Equipment (kitchen, POS, furniture)	$200,000	Section 179 / bonus depreciation
Leasehold improvements (buildout)	$150,000	QIP (15-year, bonus eligible)
Security deposit	$20,000	Not deductible
Working capital	$55,000	Not a deductible expense
Total investment	$500,000

Year 1 tax deductions:

1. Franchise fee (IRC 197):

Item	Amount
Franchise fee	$45,000
Annual amortization (15 years)	$3,000
Year 1 deduction (assuming mid-year convention, 6 months)	$1,500

2. Startup costs (IRC 195):

Item	Amount
Total startup costs	$30,000
Immediate deduction (first $5,000, but phased out if > $50,000)	$5,000
Remaining startup costs	$25,000
Monthly amortization ($25,000 / 180 months)	$139/month
Year 1 amortization (assume 6 months of operations)	$833
Total Year 1 startup deduction	$5,833

3. Equipment and improvements (Section 179 / bonus):

Item	Amount	Year 1 Deduction
Equipment	$200,000	$200,000 (100% bonus)
Leasehold improvements (QIP)	$150,000	$150,000 (100% bonus)
Total	$350,000	$350,000

4. Ongoing expenses (IRC 162, Year 1):

Item	Amount
Royalties (6% of $800,000 revenue)	$48,000
Advertising fund (2% of revenue)	$16,000
Technology fees	$6,000
Rent	$60,000
Employee wages	$200,000
Other operating expenses	$120,000
Total ongoing deductions	$450,000

Year 1 total deductions:

Category	Deduction
Franchise fee amortization	$1,500
Startup cost deduction	$5,833
Equipment and improvements (bonus)	$350,000
Ongoing business expenses	$450,000
Total deductions	$807,333

Against $800,000 in gross revenue:

Item	Amount
Gross revenue	$800,000
COGS (food cost, 30%)	($240,000)
Gross profit	$560,000
Total deductions (above)	($807,333)
Net loss	($247,333)

This loss can offset the owner’s other income (if the owner materially participates, which franchise operators virtually always do).

Multi-unit franchisee planning:

Units	Franchise Fees	Equipment	Year 1 Deductions	Tax Savings (37%)
1 unit	$45,000 ($1,500/yr)	$200,000	$357,333	$132,213
3 units	$135,000 ($4,500/yr)	$600,000	$1,072,000	$396,640
5 units	$225,000 ($7,500/yr)	$1,000,000	$1,786,667	$661,067

When the franchise agreement is terminated:

Scenario	Tax Treatment
Franchise agreement not renewed	Deduct remaining unamortized franchise fee (IRC 197(f)(1))
Franchise sold to new operator	Gain or loss on sale (franchise fee included in basis)
Franchise terminated early by franchisor	Deduct remaining unamortized franchise fee as a loss
Franchise acquired from another franchisee	New 15-year amortization period begins (but anti-churning rules apply if related parties)

Entity structure for franchisees:

Structure	Best For
S-Corp	Single-unit operator with $100K+ net income (payroll tax savings)
Multi-member LLC (partnership)	Multi-unit with partners (flexibility in profit allocation)
C-Corp	Reinvesting all profits; planning for significant growth (21% flat rate)
Separate LLC per unit	Asset protection (one unit’s liability does not threaten others)

Illustrative numbers only, not a real client and not advice for your facts.

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Cite this page

Yarik Yarosh, CPA. "Franchise Business Tax Rules: Deducting Franchise Fees, Royalties, and Startup Costs Under IRC 195 and IRC 197." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-tax-implications-franchise-business-deductions

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

Franchise Business Tax Rules: Deducting Franchise Fees, Royalties, and Startup Costs Under IRC 195 and IRC 197

How are franchise costs deducted?

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