Tax Planning for Franchises
Taxation is a critical topic for any company, and tax structuring is constantly changing as your business grows. This makes it more important than ever for franchisees and franchisors to review and stay on top of their franchise tax-planning strategies. Franchisees can realize significant tax benefits in a few key areas.
When most franchisees start out, their corporate presence is restricted to a single location or state. But as the business grows, it may expand both within the state and in other jurisdictions. Expansion can take place in various forms. This can be an actual brick and mortar store or location where products or services are sold, or it may entail employees selling additional franchises in other locations or states.
Either way, if your business is expanding, your taxation and liabilities will most likely change. These changes can be drastic and extremely quick, so you need to make sure to be aware and factor them into your business strategies.
Often overlooked are a vast number of tax credits available to franchisees. Two of the most important are the work opportunity tax credit (WOTC) and the FICA tip credit, which is applicable to restaurant franchises.
WOTC can reduce income tax for franchise companies that hire employees from certain targeted groups, such as financial aid recipients, qualified veterans, qualified ex-felons, or the disabled. In many cases, WOTC is calculated based on wages that cover services rendered during the one-year period starting on the day the employee begins work. The credit is valid for qualified individuals who begin work on or before Dec. 31, 2019. After Jan. 1, 2020, this credit expires, so businesses are highly encouraged to take full advantage of it if they are able.
Businesses that employ workers who earn tips such as wait staff can claim a credit against their federal income tax based on the share of FICA and Medicare taxes that they pay on employees’ reported tip income. The calculation is a bit more complicated than simply multiplying reported tips by the FICA percentage.
Many new franchise businesses choose cash basis accounting rather than accrual basis. The former is generally easier to track and understand since the company pays tax on income when it’s received. The cash basis method is tied to cash flow without regard to accounts receivable and accounts payable.
As a company grows, the accrual basis offers a more precise view of long-term financial health. It may also offer appealing tax advantages, allowing it to defer tax obligations
When making an accounting method change, timing is critical. You’ll need to be able to anticipate when you’ll reach the income threshold governing accrual accounting.
Building costs and improvements are a major component of many franchise businesses. For tax purposes, these costs are generally depreciated over a lengthy 39-year period. Nonetheless, by undertaking a cost segregation study, franchisees can realize the tax benefits of more rapid depreciation. Cost segregation identifies personal property that can be depreciated over a variety of shorter recovery periods utilizing accelerated depreciation.
By performing a cost segregation study during the year that a franchise is being constructed or remodeled allows the franchisee or franchisor to immediately optimize tax savings and accurately classify assets.
Waiting until post-construction will not be too late, but you will have to use IRS Form 3115, Application for Change in Accounting Method. This will allow you to go back and claim missed depreciation on assets acquired as far back as 1987 without amending prior tax returns.
Consider how much your franchise has grown since the last time you updated your strategy. You will need to factor in the numerous tax credits available to the franchise(s) that you may not have been aware of. You may also find that there is a large number of funds you could use to reinvest in your business.
Running a franchise and managing the capital assets day-to-day can be overwhelming. The staff at Heemer Klein will help eliminate this stress so you have more time to grow your franchise.