What Are the Audit Risks for Franchise Businesses With Multiple Locations?

The businesses based on franchises, which occupy multiple premises in California or in any other state of the United States of America, are subjected to high levels of attention on the part of taxing authorities. Such businesses do not just need to deal with state and local tax laws, but with a super-complicated maze of state and local laws that they must deal with and manage, internal controls. So, what are the most pertinent questions related to the audit that come up, as far as such multi-unit operations are concerned?

Why Are Multi-Location Franchises More Likely to Face a Tax Audit?

Multi-location Franchise businesses have large transactions, diversified products/services, and decentralized accounting systems. Such factors cause red flags to the taxing authorities like the IRS and California Department of Tax and Fee Administration (CDTFA) because of:

• Reporting in various outlets is not uniform in terms of sales
• Improper or absent local sales tax applications
• Franchise royalty and management fee complicated systems

The more sophisticated your business is, the more likely it is to be subjected to an auditor who will seek discrepancies.

What Sales Tax Issues Trigger Franchise Audits in California?

One of the criminal activities that tends to attract audits at the state level is sales tax-related problems. Particular risks comprise:

• Misplaced charging or gathering of local territory sales tax
• The inability to appropriately implement tax on bundle goods and services
• Failure to adhere to varying tax levels in various administration areas

The franchises should have a well-documented history of sales tax procedures and the collection of sales taxes that help in ensuring a reduced occurrence of risks of audit.

How Do Inconsistencies in Franchise Fee Reporting Increase Audit Exposure?

Franchise contracts usually involve the use of royalties, advertising costs, and even technology charges. Failing to be reported or to be correctly distributed among various entities or jurisdictions, tax bodies can:

• Suspicious inflow
• Dedictibility of expenditure as a question
• Look at intercompany transactions for transfer pricing violations
• Mishandling these fees in tax returns indicates a red flag to audits.

Are Payroll Tax Errors Common in Multi-Unit Franchises?

Yes, at least in cases where the payroll is done at separate locations or is outsourced to different vendors. Areas of risk are:

• Employee vs contractor misclassification
• Late or unfiled Form 941 and state employment taxes
• Disparate wage reporting

Franchises are quite subject to scrutiny to detect payroll fraud, especially in big turnover businesses (such as food service or retail).       

Can Poor Record-Keeping at the Store Level Invite Audits?

Absolutely. Misdocumentation at the level of the point-of-sale may generate loopholes that may be used by auditors. Deterioration of relations with others inevitably arises:

• The absence of legible receipts of sale or digital records
• Absent stock reports
• Lack of backup of financial information for all sites

One non-compliant location is one weak spot that could also result in a complete audit of the franchise.

Do Cross-State Operations Pose Additional Audit Risks?

Yes. When your franchise stores are in more than one state, you are bound by nexus regulation and cross-state tax statutes. Risks include:

• This is either due to a process of non-compliance in secondary states or to being subject to double taxation.
• Failure to register for sales tax collection in new jurisdictions.
• Wrong allocation of income to the state corporate tax.

Such mistakes are frequently the cause of numerous audits of the various state taxes.