Buying a franchise usually comes with a structural requirement most first-time franchisees don’t expect: the franchise agreement itself often dictates that the franchisee operate through a specific type of entity, not simply as an individual signing a contract.
Why Franchisors Require a Separate Entity
Most franchise agreements require the franchisee to form a standalone legal entity — typically an LLC — before signing, both to give the franchisor a cleaner counterparty (a business entity rather than an individual, which simplifies enforcement of the franchise agreement’s operational standards) and to keep the franchisee’s personal assets separately identifiable if the franchise relationship ever ends in dispute or termination. Forming the LLC isn’t optional in these cases; it’s a condition of the franchise agreement itself, checked before the franchisor will countersign.
Why LLCs Have Become the Default Franchise Structure
Over the past two decades, LLCs have become the dominant entity choice among franchisors and franchisees alike, largely because they offer more flexibility in internal governance (fewer required formalities than a corporation), more flexible income allocation among multiple owners, and simpler mechanics if a franchise location is later sold or transferred to a new owner. A corporation remains an option and is sometimes required by specific franchisors, but it’s now the less common default.
One Entity Per Location Is a Common, Not Universal, Requirement
Multi-unit franchisees — owners of more than one location of the same or different franchise brands — often set up a separate LLC for each individual location rather than running all locations through one entity. This isolates one location’s liability (a slip-and-fall lawsuit, an employment dispute) from the assets of the owner’s other locations, functioning similarly to how a holding company structure separates subsidiaries, though franchise agreements themselves sometimes specify whether this structure is required, permitted, or restricted.
The QBI Deduction Applies the Same Way It Does to Any Pass-Through
Franchise income run through an LLC (taxed as a sole proprietorship, partnership, or with an S-corp election) is eligible for the same 20% Qualified Business Income deduction under Section 199A that applies to any other pass-through business, made permanent by OBBBA starting in 2026 — there’s no franchise-specific carve-out or restriction, but the same entity-choice tradeoffs (self-employment tax exposure on a default LLC vs. the reasonable-salary requirement on an S-corp election) apply just as they would to any other business with comparable profit.
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Related reading: LLC vs. S-Corp vs. C-Corp Tax Tradeoffs and Holding Company Structures.
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