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Give Franchisees a Head Start on Success
December 2007 Franchising World
Having a successful franchise depends a lot on whether the owner knows how to run the business. Knowing the rules is part of what helps franchisees to be successful. By Derek Ganter and Sharon Sanders Topping the list of rules for running a successful small business is the U.S. Internal Revenue Service Tax Rule: pay what should be paid, when it should be paid. This could be easier said than done. Knowing which taxes a franchise is responsible for, and when those taxes should be paid is a key part of being successful. Estimated taxes on income from self-employment and self-employment taxes are just some of the most common type of taxes franchises may be responsible for paying. And naturally, smart business owners want to take advantage of all the available tax deductions, so knowing what to deduct is also a key to success.
Keep Good Records
Monitor the Progress of the Franchise
Identify sources of income
Keep track of deductible expenses
Make tax return preparation easier
Support items reported on tax returns
Estimated Taxes
For franchises whose tax year does not start on Jan. 1, the estimated tax payment due dates are:
Self-Employment Taxes
Self-employment tax is computed by using Schedule SE (Form 1040). Tax Tip: one-half of the SE tax computed can be deducted from figuring adjusted gross income when filing the 1040 return. This deduction neither affects net earnings from self-employment nor the SE tax. This deduction only affects income tax.
How to Pay Self-Employment Tax
Obtaining an Individual Taxpayer Identification Number.
Deducting Business Expenses for the Franchise
Cost of Goods Sold
Capital Expenses
Personal versus Business Expenses
Business Use of the Home
Business Use of Your Car
Other Types of Business Expenses
Retirement Plans - Retirement plans are savings plans that offer tax advantages to set aside money for the franchise owner’s, and for their employees’ retirement. Rent Expense - Rent is any amount that is paid for the use of property not owned by the franchisee. Generally, rent can be deducted as an expense only if the rent is for property used in the franchise trade or business. If the franchisee has, or will receive equity in or title to the property, the rent is not deductible. Interest - Business interest expense is an amount charged for the use of money the franchisee borrows for business activities. Taxes - Various federal, state, local and foreign taxes can be deducted if they are directly attributable to the franchise as business expenses. This list does not cover all the types of business expenses that can be deducted. For additional information, refer to the IRS Publication 535 on Business Expenses.
An Extra Bonus: Establish an IRS Tax Center
Derek Ganter and Sharon Sanders, senior stakeholder liaison specialists, are employed by the IRS’ Small Business/Self-Employed Division in Los Angeles. They can be reached at 213-576-3629.
This article includes some basic tax information to give current franchisees a head start on success. Keeping good records, knowing which taxes to pay, and what kinds of expenses to deduct will go a long way toward achieving stated goals.
Everyone in business must keep records. Keeping good records is very important to having a successful franchise. Good records will help: • monitor the progress of the franchise,
• prepare the franchise’s financial statements,
• identify sources of income,
• keep track of tax-deductible expenses,
• make tax return preparation easier, and
• support the income and expenses reported on tax returns.
Good records are needed to monitor the progress of the franchise. Records can show whether the franchise is improving, which items are selling, or what changes need to be made. Good records can increase the likelihood of a franchise’s success.
Prepare the Franchise’s Financial Statements
Good records are needed to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help when dealing with the bank or creditors, and can help manage the franchise more effectively.
• An income statement shows the income and expenses of the business for a given period of time.
• A balance sheet shows the assets, liabilities and the equity in the business on a given date.
A franchise can receive money or property from many sources. Accurate records can identify the source of this income. This information will be needed to separate business from non-business receipts and taxable from nontaxable income.
When tax preparation time comes, expenses can be forgotten unless they are recorded when they occur.
Good records are needed to prepare accurate tax returns for the franchise business. These records must support the income, expenses and credits reported on the tax return. Generally, these are the same records that are used to monitor the franchise business and to prepare a financial statement.
Business records must be kept available at all times for inspection by the IRS. If the IRS examines, or audits, any of the franchise’s tax returns, it may ask for an explanation of the items reported. A complete set of records will speed up the audit process.
How long should records be kept?
The length of time a document should be kept depends on the action, expense, or event that the document records. Records that support an item of income or deductions on a tax return must be kept until the period of limitations for that return runs out. In general, the period of limitations is three years from the due date of the tax return, or when it was filed, whichever date is later.
Federal income tax is a pay-as-you-go tax. The tax must be paid on income as it is earned or received during the year. Generally, estimated tax payments must be made if $1,000 or more in taxes is owed, including self-employment tax, when the return is filed. There are two ways to pay as you go: withholding and estimated taxes. A franchise owner is a self-employed individual and does not have income tax withheld, thus she must make estimated tax payments.
Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. Estimated tax may also be paid if the amount of income tax being withheld from a salary, pension or other sources income is not enough.
Estimated tax is used to pay both income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If not enough taxes are paid through withholding or estimated tax payments, the IRS may charge a penalty. The IRS may charge a penalty even if a refund is due when the tax return is filed, if enough is not paid by the due date of each payment period.
For example, if the franchise tax year begins Jan. 1 and ends Dec. 31, the estimated tax payments for 2008 are due as follows:
For the period: Estimated Tax Payment Due Date:
Jan. 1–March 31 April 15
April 1–May 31 June 16
June 1–Aug. 31 Sept. 15
Sept. 1–Dec. 31 Jan. 15
• The 15th day of the 4th month of the fiscal year,
• The 15th day of the 6th month of the fiscal year,
• The 15th day of the 9th month of the fiscal year, and
• The 15th day of the 1st month after the end of the fiscal year.
Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. Self-employment taxes must be paid and filed on Schedule SE (Form 1040) if the net earnings from self-employment were $400 or more.
To pay SE tax, one must have a Social Security number or an individual taxpayer identification number.
Obtaining a Social Security number. If you never had an SSN, apply for one using Form SS-5, Application for a Social Security Card. This form can be obtained from any Social Security office or by calling 800-772-1213. Download the form from the Social Security Online Web site.
The IRS will issue an ITIN if the applicant is a nonresident or resident alien, and they do not have and are not eligible to get an SSN. To apply for an ITIN , file IRS Form W-7, Application for IRS Individual Taxpayer Identification Number.
Business expenses are the costs of operating the franchise. These expenses are usually deductible if the franchise is operated with the intention of making a profit.
What is Deductible?
To be deductible, an expense for the franchise must be both ordinary and necessary. An ordinary expense is one that is common and accepted for the type of franchise being operated. A necessary expense is one that is helpful and appropriate for the franchise. An expense does not have to be indispensable to be considered necessary. It is important to separate business expenses from the following expenses:
• the expenses used to figure the cost of goods sold,
• capital expenses, and
• personal expenses
If the franchise manufactures products or purchases them for resale, generally, inventory must be valued at the beginning and end of each tax year to determine the cost of goods sold. Some of the expenses may be included in figuring the cost of goods sold. The cost of goods sold is deducted from the gross receipts of the franchise to figure the gross profit for the year. If an expense is included in the cost of goods sold, then it cannot be deducted again as a business expense.
The following are types of expenses that go into figuring the cost of goods sold:
• The cost of the product or raw materials, including freight, storage,
• Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products, factory overhead, and
• Under the IRS uniform capitalization rules the direct costs, and part of the indirect costs for certain production or resale activities must be capitalized. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.
For additional information, refer to the chapter on Cost of Goods Sold in IRS Publication 334 - Tax Guide for Small Businesses, and to the chapter on Inventories in IRS Publication 538 - Accounting Periods and Methods.
Some cost must be capitalized, rather than deducted. These costs are a part of the investment in the franchise, and are called capital expenses. Capital expenses are considered assets in the business. There are, in general, three types of costs that may be capitalized:
• business start-up cost (certain start-up costs can be elected to be deducted or amortized),
• business assets, and
• improvements
Generally, personal, living or family expenses cannot be deducted. However, if there is an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. Then the business part can be deducted. For example, if a franchisee borrows money and uses 70 percent of it for business and the other 30 percent for a family vacation, 70 percent of the interest can be deducted as a business expense. The remaining 30 percent is personal interest and is not deductible. For more information on deducting interest and the allocation rules, refer to Chapter 5 of the IRS Publication 535 on Business Expenses.
If part of the home is used for business, there may be a deduction available for some of the expenses in using the home for business. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to the IRS Publication 587, Business Use of Your Home.
Car or truck expenses can be deducted if the car or truck is used in the franchise business. If the car or truck is used for both business and personal purposes, the expenses must be divided between personal and business use based on actual mileage. Refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Employees’ Pay - Generally the salary given to employees for the services they perform for the franchise can be deducted.
Insurance - Generally, the ordinary and necessary cost of insurance can be deducted as a business expense, if it is for the franchise.
When franchisees need answers on taxes, an official IRS Tax Center on your Web site can take them directly to the source for the latest on business taxes. When current or potential franchisees cruise your Web site for information, they can quickly find out answers to tax questions from the people who know taxes best–the Internal Revenue Service.
Any franchisee who takes the time and effort to find out about their federal tax responsibilities automatically increases their probability for success. The IRS offers a one-stop resource section for small business and self-employed, with information on opening, operating, and closing a business, tax-related responsibilities for businesses with employees, online learning and education, tax forms, publications, and more.
Many industry organizations currently post IRS information on their Web sites to help their members find the tax information they need. The IRS Tax Center provides links to products and services tailored specifically for the needs of the business owners within the small business community. The tax center provides a way for Web masters to establish and maintain a professional-looking site, ensuring online visitors are directed to the products and services IRS has developed for their use. And, local stakeholder liaison specialists at the IRS can help customize the tax center even more for specific industries, like food and beverage.
