Just like outlining a marketing strategy and properly training employees, tax planning is a critical piece of managing a franchise. But many franchise owners simply don’t have the time or background knowledge to adequately or strategically tackle the tax implications of owning a franchise.
In fact, many businesses don’t even know where to begin.
In this article, we’ll outline 5 of the most important and commonly overlooked tax considerations impacting franchisees and provide practical steps you can take to begin optimizing your tax situation.
With the right approach, these items are the low-hanging fruit and relatively easy to tackle.
Tax Consideration #1: Entity Selection Planning
How you decide to structure your franchised business (S Corp vs. C Corp vs. LLC) will have a significant impact on your tax situation.
Practical Advice: Work with a tax team that has specific experience with franchised businesses. This will ensure that you are aware of all the pros and cons of each option for your specific business. Among other things, the right tax professional will help you:
- Weigh potential risks to your personal assets
- Minimize tax liability
- Choose the right structure for your business
Tax Consideration #2: Quarterly Taxes
Forgetting (or simply failing) to pay quarterly taxes is more common than many people think.
Practical Advice: Some franchisees are just unaware of the need to pay income taxes on a quarterly basis. Others have cash flow issues that prevent them from doing so. Whatever the reason, we recommend taking steps to ensure your business pays quarterly income taxes.
Paying quarterly income taxes can help your business in the following ways:
- Avoid significant estimated tax underpayment penalties and interest from being assessed by the IRS and (most states)
- Optimize cash flow management and minimize large tax liability balances due each April
- Educate your team on the estimated tax payment rules for self-employed business owners
- Facilitate the budgeting and financial planning processes
For small business owners managing multiple aspects of their operation without an experienced accounting team, the processes of estimating taxes and submitting quarterly payments can be complicated.
Engaging a tax team that has specific experience with franchised businesses can take this item off your plate and streamline many aspects of financial planning.
Tax Consideration #3: Perspective about selective spending (re: deductions & write-offs)
There are several legitimate tax deductions and write-offs that can minimize the tax liability for a franchised business (e.g. franchise fees, rebranding interior spaces, retirement plan contributions, advertising expenses, insurance, lease payments, etc.)
However, too many businesses spend money on unnecessary things simply to get a tax deduction or write-off by year-end.
Practical Advice: Stop spending with the intention of getting a tax deduction or write-off. Wasteful spending is worse than actually paying the higher tax liability. It’s often better to just pay the tax and keep 70% of your after-tax income than to waste money on unnecessary equipment or other business expenses just to save 30% on your tax liability.
Business owners should stop thinking that paying income tax is a horrible strategy as the goal should rarely be to pay no income tax every single year.
Tax Consideration #4: Depreciation
When a franchised business owner renovates or makes improvements to a store, strategic depreciation planning can lead to recovering a portion of their investment through a tax deduction.
Bonus depreciation is an additional/accelerated depreciation — beyond the standard depreciation schedule — that allows business owners to deduct a portion of certain capital investments in the year these items are placed in service, rather than spreading the deduction over several years.
Practical Advice: Carefully manage depreciation decisions. This way, you’ll improve short-term and long-term financial outcomes while making critical improvements to the business. Working with the right tax team also ensures that you:
- Maximize depreciation benefits available for certain interior renovations and improvements by classifying them as qualified improvement property.
- Take advantage of bonus depreciation while it’s still available (bonus depreciation is currently set to decline annually through 2026).
- Take advantage of the always-popular Section 179 expense deduction provision that allows eligible businesses to fully deduct equipment and certain automobile purchases for tax purposes.
- Make the right decisions for long-term and short-term planning so deductions properly align with your cash flow needs and available financing options.
- Remember that business equipment purchases and renovations need to be placed in service prior to 12/31/2024 in order to take the depreciation deduction for 2024.
Tax Consideration #5: Your Future
Decisions about retirement and business succession are obviously very important. Including tax considerations in these decisions is critical to protect the future for yourself and your loved ones.
Practical Advice: The future will be here before you know it, so don’t delay. As soon as possible, create a detailed strategy for the following items:
- Planning for retirement. Spending cash toward your future retirement is a great tax strategy for using excess business cash flow.
If you haven’t already, begin using HSA accounts as an additional retirement account option and setting up other individual retirement accounts. HSA accounts are one of the only retirement account options that offer the following triple tax avantages:
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- Tax-free contributions
- Tax-free investment growth
- Tax-free withdrawals for qualified health care expenses
- Setting up employee retirement plans. Offering employee retirement plans (e.g., a 401(k) plan or a SIMPLE IRA) can benefit both you and your employees. Recent tax law changes have introduced new tax credits (e.g., start-up credit and auto-enrollment credit) for setting up such plans.
- Business succession planning. What’s the plan for the future sale of your franchise? It’s important to:
- Understand the legal and tax planning issues (to structure the sale/transfer in the most tax-efficient way and minimize capital gains taxes)
- Explore what options are available (e.g., owner financing, sell to an employee, transfer to your children, etc.).
- Ultimately obtain an accurate business valuation. To do so, right now, it’s important that you ensure that your financials and tax returns are in good order so you get the best possible price in the end.
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With many years of experience serving franchises in various industries, our dedicated franchise team offers comprehensive accounting, management, and business advisory services that can change the trajectory for your business.
