When you start a franchise business, you pay a fee to the franchisor for the use of its products, brand and marketing. A franchise business starts off with the advantage of a proven business model, as well as very detailed instructions on how to set up and run the operation. Because these fees can be substantial, it's important to account for them and other business expenses correctly with the IRS.

Franchise Fees and Capital Costs

The IRS considers franchise fees part of the cost of establishing a business. Under the tax law, the fee is a "Section 197 Intangible," not a deductible business expense. The IRS allows amortization of such costs, meaning the business may recover the fee through depreciation over a period of 15 years. This allows for an annual deduction from income and a reduction in tax liability.

Deductible Fees

Ongoing, regular fees paid to a franchisor are, under certain conditions, deductible. If a franchise business pays a royalty based on sales or productivity, at least annually and in substantially equal amounts, then the business can claim that fee as a business expense. Franchisors commonly require a monthly or quarterly payment of a percentage of gross revenue, which is simply an ongoing cost of doing business under the franchise name.

Other Fees

Franchise businesses may have other costs required by their agreement with the franchisor. One of the most common is an advertising fee, which is a regular contribution to the parent company for its marketing and ad budget. The franchisor may levy a training fee for staff, or require purchases of products from a specified supplier. These would be legitimate business expenses and deductible from gross income for tax purposes.

Franchise Nondeductibles

The Section 197 Intangible family also includes several other costs a new franchise owner may face. If you are buying a going concern, for example, the price you pay is a capital cost, not a deductible. This also goes for business information systems; licenses and permits; "goodwill" (the amount paid over and above the value of tangible assets); patents, trademarks and formulas; and any operating manuals or training costs.