Q: I'm all set to buy my first
franchise, but I'm not sure what type of company I should have.
Should I incorporate or do something else? What are the pros and
cons, and how can I determine what's best for me?
A: This is one of those wonderful
questions that can best be answered with the phrase "it
depends." There is simply no right or wrong answer to the form
of entity you should use unless and until you consider a few
factors that relate to your own personal situation.
There are three basic forms of business entity: sole
proprietorship, partnership and corporation. The basic differences
between these forms relate to how income is treated for tax
purposes and which assets are exposed to your potential liability
(based on the operation of the business).
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If you use a properly formed and maintained corporation
structure for your business, the income from your franchise will be
taxed in your corporation rather than on your personal return, and
you may create a liability barrier between your personal assets and
any claims made against the business. A partnership or sole
proprietorship form of entity does not typically provide either of
these characteristics.
There is another form of entity that is coming into fairly
common usage--a LLC or limited liability corporation. In this
entity form, you report any income on your personal return, but you
do create a liability barrier to potentially protect your personal
assets from business-related claims.
One caveat you need to be aware of: Using a corporate structure
in a small business typically doesn't protect your personal
assets from business liability in relation to contracts you
execute. This is because most contracts require you to personally
guarantee performance as a condition of doing business.
This is especially true, in your example, with contracts like
your franchise agreement, your lease for the site of your franchise
business and probably the contracts you have with the major
suppliers of your franchise. Though it probably goes without
saying, this will also most certainly apply to any loan you use to
get your business started.
For this reason, many new franchisees are more interested in the
corporate form for its tax differences than for its potential
liability protection. The advantage they see is the potential that
corporate income will be subject to tax rates lower than personal
income. There are also possible benefits related to increased
options for retirement accounts and different treatment of certain
income tax deductions.
The flip side of these potential benefits is the double taxation
whammy you're exposed to if you have excess funds in the
corporation that you want to get into your pocket. You've
already paid income taxes on these dollars at the corporate level,
but you're almost certainly going to have to pay personal taxes
on the dollars as well to get them into your personal accounts.
This isn't a pleasant prospect for most franchisees.
As you can see, there are a number of variables for you to
consider before making the decision on what legal entity makes the
most sense for you as a franchisee. There is no right or wrong
answer, since it all comes down to your individual situation.
Though you might get lucky and guess the right answer, you should
definitely get professional advice from your accountant and/or
attorney about which form would be most beneficial for you.
Jeff Elgin has almost 20 years of experience in franchising,
both as a franchisee and senior franchise company executive. He is
currently the CEO of FranChoice Inc., a company that provides free
consulting to consumers looking for a franchise that best matches
their needs. He can be reached at jelgin@FranChoice.com.
The opinions expressed in this column are
those of the author, not of Entrepreneur.com. All answers are
intended to be general in nature, without regard to specific
geographical areas or circumstances, and should only be relied upon
after consulting an appropriate expert, such as an attorney or
accountant.