Growing franchises: Reducing your SALT intake

If you are like most, when you founded your company or opened your first franchise, your corporate presence was restricted to a single location or state. But now that your company has grown, you may be looking to add units or expand your sales efforts, both within your state as well as in other jurisdictions.

The expansion may take the form of physical stores or locations where products or services are sold to the public. Or the move may be sending sales people to a neighboring state to solicit new franchisees for your franchise.  

In either case, your state and local tax (SALT) exposure and liabilities may change, in some cases dramatically and unexpectedly. Even without a physical presence (office) in your neighboring state, you may have created a taxable presence there by virtue of your sales team’s presence. And in certain instances, you may find that you are taxed in excess of 100 percent of profits, no doubt an undesirable consequence and one that can (and should) factor into your growth strategy.

With myriad state apportionment rules and regulations that govern the percentage of income that is subject to a state’s tax laws, the impact on your company is far from predictable or even easily ascertained. Indeed, it takes a trained tax expert to wade through the complexities of SALT laws to ensure you are in full compliance.

Nexus determinations

As a first step to assessing tax liability, a determination of nexus must be made. Nexus is what a state considers to be a taxable presence within their state. For a franchisee opening a store or restaurant in a state, nexus is clear and state tax liability is well understood. However, take the case of a franchisor whose sole office is restricted to its home state. Other states may rule that nexus is established for that franchisor as long as it has franchisees in its state.

A multistate business may therefore unknowingly be exposed to tax liability, with substantial tax consequences. The statute of limitations will not begin to toll for a taxpayer that has established nexus but failed to file a tax return. In other words, the state has the right to reach back for all years in which a state filing was not made. In such an instance, a Voluntary Disclosure Agreement (VDA) may be available to allow the taxpayer to remit past due taxes without penalty. 

Apportionment considerations

Once a company has established nexus in another jurisdiction, it has the right to apportion income outside of its home state. As with nexus, each state applies its own apportionment rules. In some instances, the tax consequences may be favorable to the company, resulting in less than 100 percent of its activity within a state subject to tax (such cases apply apportionment rules to arrive at “nowhere” sales, or items excluded from a tax calculation). In other instances, income might be taxed above 100 percent.

Final considerations

Any franchisor or franchisee considering or taking part in multistate activity should review its operations to assess its tax exposure and potential liability, while considering opportunities for “nowhere” apportionment. With varying rules for nexus and apportionment in each state, it’s essential to understand the distinctions and build a growth strategy accordingly.