In recent years we have noticed more states starting to impose a state income tax on franchisor royalties, even where the franchisor has no physical presence in that state. In 2011, the Supreme Court of Iowa, in KFC Corporation vs. Iowa Department of Revenue, held that Iowa was allowed to assess an income tax on the franchisor, on those royalties paid to the franchisor by KFC franchisees in Iowa. This decision was made despite the fact that KFC Corporation had no physical presence in the State of Iowa. The U.S. Supreme Court has declined to review the ruling.
This ruling, along with other recent court rulings in various states indicates that most states will likely begin, or continue, to aggressively pursue the collection of income taxes off of royalty income from franchisors, regardless of their physical presence in a state. Franchisors need to prepare for the possibility of having to pay income tax in various states. We suggest each franchisor with franchisees in multiple states begin working with an accountant to analyze taxable income with respect to these types of tax liabilities.