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Every franchise owner will eventually leave their business. Whether that happens in two years or 20, planning today for an exit can minimize the tax burden of selling or gifting a business. This article covers five tax strategies every franchise owner should consider for their exit plan.
Franchise owners wishing to transfer ownership of their business to their children or other designated individuals may consider gifting tranches of stock over several years. With the annual federal gift tax exclusion, individuals may gift up to $19,000 per recipient each year without triggering any gift taxes. For married couples, that amount is doubled.
When gifts are made over several years and to multiple recipients, the amount that can be transferred tax-free can be significant. At the time the franchise owner exits the business, their Gen 2 owners will already have a large stake in the company.
The unified tax credit represents the amount an individual can gift during their lifetime or after death without triggering gift or estate taxes. The lifetime unified tax credit for 2026 sits at $15 million for an individual or $30 million for a married couple, indexed for inflation. An individual can leave an estate of $15 million without triggering estate taxes, but that amount will be lowered by any previous gifts made that exceed the federal annual gift tax exemption.
A franchise owner may also use part of this lifetime exemption before death by transferring business interests into a dynasty trust. A dynasty trust is an irrevocable trust designed to benefit multiple generations, such as children and grandchildren. If properly structured, the assets transferred to the trust, and future appreciation on those assets, may be excluded from the owner's taxable estate.
To understand how the unified tax credit works, consider this scenario. A franchise owner gifts each of their three children $25,000 per year for 10 years. Those gifts exceed the annual gift tax exemption by $6,000 per year ($25,000 – $19,000). Over 10 years and three children, the amount gifted beyond the annual federal tax-exempt limit would come to $180,000 ($6,000 x 10 years x 3 children). If the donor dies in year 11, the amount of their estate that can be passed on without estate taxes would be $14,820,000 ($15 million minus the $180,000 annual gift overage).
Another option for transferring ownership to children is the family limited partnership (FLP). In this arrangement, the franchise owner creates an FLP and moves the assets of the business into it, retaining a 99% interest in the limited partnership and a 1% general partnership interest (which allows them to maintain control over the business).
Over time, the owner can transfer shares of the partnership to family members. However, because limited partnership interests may lack control and marketability, a qualified valuation may support discounts from pro rata enterprise value. These discounts are highly fact-specific and subject to IRS scrutiny. Because of the lower value per share, more of the limited partnership shares can be transferred each year before hitting the federal annual gift exemption cap. When the owner is ready to exit, they can transfer their general partnership shares, thus allowing the new generation of owners to control the business.
The purpose of a GRAT is to transfer the appreciation of assets to other individuals while reducing or eliminating the amount of gift taxes owed on that increase in value. A GRAT is established as an irrevocable trust with a limited term, often two to 10 years. The individual wishing to transfer value (the grantor) puts assets into the trust and cannot withdraw them until the trust expires. The grantor receives annuity payments from the trust representing the total value of assets put into the trust plus interest calculated based on the IRS Section 7520 rate, or hurdle rate.
At the end of the term, beneficiaries of the trust (e.g., family members of the grantor) receive the amount that the assets appreciated, less the interest paid to the grantor according to Section 7520. These types of trusts, therefore, are well suited to assets that are likely to increase significantly in value over the life of the trust, such as stock in startup companies.
For franchisees considering transferring ownership to employees or family members, an employee stock ownership plan (ESOP) may offer a tax-efficient exit strategy. In an ESOP, the company provides stock to employees as part of a qualified retirement plan. Depending on the structure of the plan, employees may sell back their shares when they leave employment, retire, become disabled, or pass away.
A key advantage of an ESOP is that it gives the current owner a way to gradually transition ownership and withdraw money over time, as opposed to receiving the full value in a single lump sum. In certain C corporation ESOP transactions, Section 1042 may allow selling shareholders to defer capital gains tax by reinvesting proceeds in qualified replacement property, provided strict statutory requirements are met.
It's crucial to discuss any tax strategies with a qualified accountant or other tax professional to ensure proper documentation and compliance measures are met. But it's never too early to start having those conversations, as decisions made today could result in significant tax savings down the road.
Rick Dennen is CEO of Indianapolis-based First Franchise Capital Corporation, a First Financial Bank company, which provides customized financial solutions for multi-unit quick-serve restaurant franchisees of best-in-class concepts nationwide.