Midsize restaurant franchisors could be denied a tax cut provided by the reform legislation currently before Congress if lawmakers fail to tweak the proposed changes for pass-through companies.
The provision in question is an exception to a rate rollback for the owners of small and medium-sized companies whose profits are taxed as personal income for the stakeholders, not at the corporate level. The tax reform bill passed last weekend by the Senate would allow the owners to deduct 23% of the income, but with several qualifications.
One of those is an exception intended to prevent professional service companies such as law firms and medical practices from taking advantage of the break. The bill specifies that the deduction would be capped at half the amount that’s paid in salaries by a pass-through company. The measure is intended to prevent high-pay businesses from hiding compensation to partners who are also on the payroll by shifting money into the passed-along income rather than raising their salaries.
“The 23% deduction is a huge, huge win for franchisees and franchisors who are pass-throughs—it’s basically a tax cut,” says Matt Haller, SVP of government relations and public affairs for the International Franchise Association. But the salary exception undercuts the benefits for franchisors or franchisees of a certain size.
“The companies that this really impacts are franchisors that have 75 or more locations and are pass-throughs,” Haller explains. Such concerns typically see profits grow much faster than salaries, since a small executive team can adequately service a sizable franchise network.
The salary stipulation could also be a discouragement to growth-minded franchising newcomers, says Darrell Johnson, CEO of the franchise research concern Frandata. The firm has found that about 300 new brands start franchising in any given year. "Almost all of them start out as pass-throughs," says Johnson. "The typical way they start out is they have a few people, they wear multiple hats, and they add people over time." The goal is usually to expand the fledgling chain quickly, but with the wage stipulation, "the more successful the new franchisor is in creating businesses and jobs, the quicker the wage cap becomes an impediment to them. Yet the very goal of the tax plan is to create businesses and jobs."
Large franchisees could also possibly be denied the benefits, Haller adds.
About half the 1,500 franchise brands represented by the IFA are pass-through companies, he notes.
IFA members are pressing lawmakers to exempt franchise businesses from the salary exemption in whatever final bill emerges from a House-Senate committee. The committee has the task of combining measures passed separately by each chamber into a single piece of legislation that would then have to be approved before being passed along to President Trump. The president has left little doubt that he would sign a bill into law, possibly as soon as next week.
Mike Ferretti has computed what effects each scenario would have on his business, the 228-unit Great Harvest bakery-cafe chain, which has only one company-run store.
“If the Senate bill is retained as is, then things are status quo for us, which means we’re at a significant disadvantage,” he says. If a provision is included in the final bill to exempt businesses like his from the salary test, “we will grow our workforce by 10% within a year. It’s that much of a big deal.”
A stipulation that would shield businesses such as Great Harvest from the salary provision was raised during the scramble to pass the Senate bill. The suggested amendment, drafted by Sen. Steve Daines (R-Mont.), was aired during the frenetic rush to pass the full measure. It was not put to a vote. Rather, typical of such situations, the proposal was in effect shelved for consideration during the reconciliation-committee process.
“We don’t really have any opponents” on the measure, says Haller. “It’s really more a matter of whether this can become a priority for the people on the Hill. They’re doing a tremendous piece of legislation.”
The Daines amendment is far from the only concession that lobbyists will be seeking from the reconciliation committee.
Exempting franchisors and franchisees from the wage cap should be a no-brainer, says Frandata's Johnson. "The tax bill was not intended to constrain that type of model," he says. " The simplest thing would be to exempt franchise businesses."
He sees the committee stage as being the industry's lone shot because partisan bickering will likely thwart a fix after the bill becomes law. "If it’s not fixed now, it might not get fixed, period," he says.
“If the Senate version goes through as is, we will be treated much differently than General Electric and franchisees,” says Ferretti, a constituent of Daines. “I don’t find a whole lot of equity in that. Franchisors are treated differently, and I don’t see why franchisors should be treated differently if they’re the same legal form of entity.
“In general, I am supportive of tax reform and the tax bill,” he says. “I don’t think it’s perfect, but I don’t think anything from Washington these days is perfect. So I’ll take good.
“With a few tweaks, it will better.”
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