What expense category is Franchise Fees?

Buying into a franchise can be an excellent way to start a business with an established brand and support system. However, the payments made to a franchisor come with a unique and often misunderstood tax treatment. The large initial franchise fee is handled very differently from the ongoing royalty payments.

For accountants and business owners, knowing how to categorize these distinct costs is essential for tax compliance. One is a capital expenditure recovered over 15 years, while the other is a currently deductible business expense. This guide clarifies the IRS rules for both types of franchise payments.

Franchise Fees Expense Category

The tax treatment of a franchise fee depends entirely on its purpose. There are two primary categories of payments, each with its own set of rules.

Initial Franchise Fee (A Capital Expenditure)

The one-time fee you pay to acquire a franchise is not a currently deductible expense. IRS Publication 535 classifies a franchise as a Section 197 Intangible. This means the initial fee must be capitalized and then amortized (deducted in equal amounts) over a 15-year period.

Ongoing Franchise/Royalty Fees

The recurring payments you make to the franchisor, typically calculated as a percentage of sales, are considered an ordinary and necessary business expense. These can be deducted in the year you pay or incur them.

Important Considerations When Classifying Franchise Fees

Correctly distinguishing between the initial investment and ongoing operational costs is the most critical step.

Amortization of the Initial Fee

The cost of acquiring a franchise must be amortized ratably over 180 months (15 years), beginning with the month you start your business. You cannot deduct this large upfront cost in a single year. This amortization is mandatory for Section 197 intangibles, such as franchises.

Deducting Ongoing Royalties

Ongoing royalty payments are handled differently. IRS Publication 535 explains that you can deduct payments for a franchise if they are contingent on the productivity, use, or disposition of the item. Most franchise royalty payments, which are based on a percentage of sales, fit this description and are therefore fully deductible as a current business expense.

Franchise Fees vs. Franchise Taxes

It is important not to confuse franchise fees (payments to a franchisor) with franchise taxes. As noted in IRS Publication 535, corporate franchise taxes are amounts paid to a state or local government and are deductible as a tax, not a royalty.

Examples of Franchise Fee Expenses

• To Be Capitalized and Amortized: A $50,000 initial fee paid to a franchisor to acquire the rights to open and operate a fast-food restaurant.
• Deductible as a Current Expense: A weekly royalty payment to the same franchisor equal to 5% of the restaurant's gross sales.
• Deductible as a Current Expense: A monthly fee paid to the franchisor that is designated for a national advertising fund.

Tax Implications and Recordkeeping

The reporting for franchise payments depends entirely on whether it is the initial fee or an ongoing royalty.

How to Report Franchise Payments

• Initial Fee: The annual amortization deduction is calculated and reported on Form 4562, Depreciation and Amortization. The total deduction from this form is then carried to your main business tax return (e.g., Schedule C, Line 13, Depreciation, and section 179 expense deduction).
• Ongoing Royalties: These are deducted on Schedule C (Form 1040), Part II, Expenses. They should be listed under Line 27a, Other expenses, and clearly labeled as Franchise Royalties or a similar title.

What Records to Keep

You must keep detailed records to substantiate all franchise-related payments. Supporting documents should include:

• The signed franchise agreement details the initial fee and the structure of ongoing payments.
• Proof of payment for the initial fee.
• Invoices and proof of payment (canceled checks, credit card statements) for every ongoing royalty payment.

How Fyle Can Automate Tracking for Franchise Fees

Fyle helps you manage both the large initial investment and the recurring royalty payments, ensuring every cost is captured, coded, and compliant.

• Track the Initial Investment: Easily capture the one-time payment for the initial franchise fee and attach the entire franchise agreement for documentation.
• Automate Recurring Royalties: Fyle’s real-time credit card feeds can instantly capture recurring royalty payments made on a business credit card.
• Centralize All Documents: Keep your franchise agreement, invoices, and payment proofs organized in one digital, audit-ready system.
• Automate Your Accounting: Fyle's integrations with QuickBooks, Xero, NetSuite, and Sage Intacct enable you to automatically sync the initial fee to the correct intangible asset account for amortization and the ongoing royalties to the proper expense account.