What Changes on Your Client’s Return After a Franchise Resale Closes

What Changes on Your Client’s Return After a Franchise Resale Closes

When a franchise resale closes, the return you build for the client may start from a price allocation that was agreed in the deal, long before the return existed. For a franchise resale tax return, three things in the primary text are worth knowing: a Form 8594 for each side, the franchise named among the intangibles, and a written allocation that can bind both parties. This is not guidance on how to file. It sets out where a franchise resale touches the return, drawn from the IRS and the statute, for you to check against your own research.

Does a franchise resale put a Form 8594 on my client's return?

Yes, if the sale meets the IRS's conditions, and those conditions are about the assets, not about franchises. The IRS page says: "Both the seller and purchaser of a group of assets that makes up a trade or business must use Form 8594" to report the sale when goodwill or going concern value attaches, or could attach, to the assets, and the purchaser's basis is determined only by the amount paid (IRS, About Form 8594).

The regulation under Section 1060 adds that the seller and the purchaser "each must file asset acquisition statements on Form 8594" with their returns for the taxable year that includes the first date assets are sold (26 CFR 1.1060-1(e)(1)(ii)(A)). Whether your client's sale meets the conditions is your call, from the documents.

Is the franchise itself an asset in the allocation?

Section 197 names it. Among the intangibles the section covers is "any franchise, trademark, or trade name", listed beside "goodwill" (26 U.S.C. 197(d)(1)(F) and (d)(1)(A)). Section 1060(b) has each side report the "amount of the consideration received for the assets which is allocated to section 197 intangibles" (26 U.S.C. 1060(b)).

So ask a plain question of the deal documents: does the allocation give the franchise its own line, or fold it into a wider group of intangibles? The answer can differ from one sale to the next.

Section 197 also has exceptions in subsection (e) and special rules in subsection (f), including a definition of "franchise" that points to another section. Check both before you apply the section to your client's franchise.

Where is the allocation actually decided?

In the purchase agreement, if the parties put it in writing. Section 1060(a) provides that when the transferee and transferor "agree in writing as to the allocation of any consideration", the agreement is "binding on both the transferee and transferor unless the Secretary determines" the allocation "is not appropriate" (26 U.S.C. 1060(a)). The regulation makes a written agreement binding "to the extent provided in this paragraph" (26 CFR 1.1060-1(c)(4)).

So a return built after closing may be working from an allocation fixed when the agreement was signed, not when the return was filed. The same allocation reaches both the buyer's side and the seller's side, which means the two may want it to cut differently. Which way it should cut is your analysis to make.

What happens to the return if the price changes after closing?

The regulation has a second statement for that. When an increase or decrease in consideration is taken into account after the close of the first taxable year that includes the first sale date, "the seller and the purchaser each must file a supplemental asset acquisition statement on Form 8594" with the return for the year in which the change "is properly taken into account" (26 CFR 1.1060-1(e)(1)(ii)(B)).

An earnout is one deal term that can add to the price after closing. Whether a given payment is such an increase, and for which year, is for you to decide. Our article on earnouts, seller notes, and escrow covers how those terms work in the deal. The tax bill at closing is the owner-facing list of questions to bring to a CPA.

What should I check before the return is built?

Five questions, all for the client's signed documents:

• Is there a written allocation agreement? If there is one, read it first. The statute and the regulation make it binding to the extent they provide.
• Does the franchise have its own line, or is it folded into a general intangibles group?
• Is there a covenant not to compete, and does the agreement price it? Section 197(d)(1)(E) lists a covenant entered into in connection with an acquisition of an interest in a trade or business. How it is treated on a return is your call.
• How many units were sold? A client who owns several units may have one franchise agreement per unit. Ask whether the allocation runs unit by unit or across the group.
• Is any part of the price payable after closing? If so, ask when later changes will be reported.

Where a document is unclear, go back to the signed transaction documents and your own firm's research. A general rule from us is not what governs.

When is it worth talking to a franchise specialist?

Before the client signs. The allocation, the payment terms and the franchisor's approval are all set while the deal can still change, and by the time of the return the allocation may already be fixed in writing. Franchisor approval is part of every franchise sale, and we deal only in franchises, so that is the part of the sale we work on. The books and the return are the part you know.

This page is background for your own practice, not an invitation to hand a client to us. You decide whether to mention us, to which client, and when. If a client of yours is weighing a franchise resale early enough that the terms can still be shaped, you can talk it through with us. Our piece on spotting an exit-ready franchisee covers the signs that a client is nearing that point.

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