We keep you up-to-date on the latest tax changes and news in the industry.
Franchise investment can be a wonderful opportunity, but it also involves a completely unfamiliar set of rules when it comes to your taxes. Whether you are considering becoming a franchisee or are already involved, it’s important that you have the support of a knowledgeable tax planner to help ensure you understand your tax obligations and are preparing accordingly. Here are just a few of the things that you need to keep in mind:
Franchisees Pay Self-Employment Taxes
Even though you take direction from the franchise on marketing materials, training methods, employee rules and suppliers, you still are in charge of the business in ways that the IRS defines as being self-employed. You make your own schedule and establish your own community and business relationships, so the government puts you in the same category as a sole proprietor. That means you need to report your earnings on a Schedule C, just like single-member LLCs and sole proprietors do, and you need to pay the additional 15.3% tax that self-employed people are assessed.
Though this may feel excessive, if you were somebody’s employee they would be taking out payroll taxes on your behalf to cover Social Security and Medicare for your future. That is what the additional taxation is for. Unfortunately, as a franchisee you will have to pay that amount regardless of whether your income ended up in your pocket as take-home pay. Just as is the case for participants in a partnership, it doesn’t matter whether profits are reinvested in the organization or paid out as distributions, they still count as self-employment income and are taxed as such. Keeping this liability in mind is an important part of your financial planning that an experienced tax professional can ensure you have prepared for properly.
Are You an Active or Passive Participant?
One of the advantages of being a franchisee is that you can be either an active or passive participant. Making the decision about whether you are hands-on or simply purchasing the business and handing off day-to-day operational responsibilities to a partner has important tax ramifications. Establishing whether your earnings are passive or active will be one of the first tasks on your tax professional’s list, and they will do this by asking questions like the ones below, which are geared to learning exactly what you do, and to what extent.
The Benefits of Investing in Your Franchise
If you’re considering buying new equipment or furniture for your business, the Tax Cuts and Jobs Act (TCJA) passed in 2017 gives you a significant, but short-lived tax advantage. Your investment of capital into your business qualifies for a 100% bonus depreciation until the end of tax year 2022. After that, the bonus depreciation level will drop by 20% each year, lowering to 80% in 2023, 60% in 2024, and so on until it is completely gone at the end of 2026.
If you are purchasing a business structure rather than leasing one, other advantages can be realized by having a specialized professional conduct a cost segregation study to separate the cost of a building from expenditures on non-building components such as electrical components, drywall, ceilings, and interior doors. The Coronavirus Aid, Relief and Economic Securities (CARES) Act defined these components as 15-year property, which effectively provided a bonus depreciation period for these expenses. This allowed qualified improvements to the property (QIP) to be deducted over a shorter recovery period as long as their costs are separated from the cost of the building itself. Having a cost segregation study done in support of this depreciation can make a significant difference in your tax liability.
Be Aware of Specialized Tax Incentives You May be Eligible For
Different types of businesses are eligible for specialized tax incentives, and if you are new to franchising, you may not be fully aware of them. Here are a few that we may be able to identify for you:
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