Today TaxMama hears from Bill in North Carolina, with this question. “What is the tax treatment of equipment that is included in the payment of franchise fee? Is it all considered amortizable start-up cost? Or is the equipment depreciated separately starting with the day it opens for business? I am concerned about local business property tax on assets. And what if the franchise contract does not specify equipment costs vs other fees?”
That’s an interesting question…or questions. How you handle the costs will depend on the franchise contract, how it breaks down the fees, and what the franchisee receives.
My feeling is that any franchise business worth getting into cares deeply about the welfare and success of its franchise partners. They will have done their research to come up with the most advantageous breakdown of costs for their franchisees.
Sometimes, the reason they don’t break down the costs is to give themselves better tax advantages. Frankly, in my opinion, any franchiser that has not bothered to look after the welfare of their franchisees isn’t worth buying into.
So…let’s look at the numbers, starting with start-up and organization costs. This is especially useful if no numbers are broken out.
1) Start-up costs – if the total cost of the franchise, plus other start-up costs are less than $50,000, the new owner can deduct $5,000 as start-up costs – and amortize the rest over 15 years. https://www.taxquips.com/?id=690 (See all the links to other Start-Up discussions in the Resource Box.)
2) Separate out organization costs – the legal structure of the business and the arrangement with the franchiser. As long as they are under $50,000 – you can do the same as above.
This gives you only intangible expenses, not subject to property taxes. But, except for, perhaps $10,000, the rest of the costs are spread over 15 years.
Another thing you can do if no numbers are specified, is to look at the franchiser’s price list for replacement costs of equipment, supplies and inventory. Also, look at the segment of the monthly fee that covers advertising and promotion. (Keep a copy of these lists in the tax return file for the year when you pick up these costs.)
Use those catalogs to place prices on the depreciable assets received as part of the franchise. You can depreciate those costs, using the technique most useful to you. These will be subject to local property taxes.
The cost for inventory goes on the books as a current asset, to be adjusted to cost of goods sold as the inventory sells. This may be subject to local property taxes, as well, if inventory is taxed.
Look at the cost of advertising and promotion – and see if there is a breakdown for extra costs to introduce a franchise unit to the area. Also look at the costs of banners and flyers, etc. Treat those as current expenses for advertising. However, when it comes to signs – those get depreciated.
Naturally, if there is a building purchase, be sure to get a separate appraisal on that, whether it is lumped into the total purchase price or not. If it’s just a lease – pick up an expense for the number of months the building was used during the year. The months before the franchise was open for business are added to the start-up costs.
As to consumable supplies, things with logos on them that are used by the business, those are current expenses.
And remember, you can find answers to all kinds of questions about franchising and other tax issues, free. Where? Where else? At TaxMama.com.[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]
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- Taxquip #690 :: Start Up Costs (see links in Resource Box, too)