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Tax Considerations and Franchise Payments

Freys, Inc., sells a 12-year franchise to Reynaldo. The franchise contains many restrictions on how Reynaldo may operate his store. For instance, Reynaldo cannot use less than Grade 10 Idaho potatoes, must fry the potatoes at a constant 410 degrees, dress store personnel in Freys-approved uniforms, and have a Frey's sign that meets detailed specifications on size, color and construction. When the franchise contract is signed Reynaldo makes a noncontingent $160,000 payment to Freys. During the same year, Reynaldo pays Freys $300,000?14% of Reynaldo's sales. How does Freys treat each of these payments? How does Reynaldo treat each of the payments?

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The franchise agreement sounds like a very typical franchise. The following article lists 10 common provisions in franchise agreements:

The Franchise Agreement is the legal document that governs the franchisee/franchisor relationship. There is no standard format for a Franchise Agreement because the terms and conditions and operations vary from franchise to franchise and industry to industry. In general, Franchise Agreements cover the following main provisions:

1. Training and/or ongoing support provided by the franchisor. Each franchisor has its own training program for franchisees and their staff, which can include training done at the franchisee's location or at the corporate headquarters or a combination. Most franchisors offer ongoing support including administrative and technical support.

2. ...

Solution Summary

The cited 488-word solution first presents an article explaining standard provisions in franchises. The last two paragraphs address the tax consequences of the initial payment: how to report it. The last paragraph explains the concept of the periodic payments and how to record the payments in the accounting records of both companies.