As a restaurant owner, you need to look at tax from two angles. One where you need to pay state and federal taxes on businesses’ net income and any wages you pay yourself. The other perspective is where you need to charge your customers a sales tax and remit it to the local or state government.
As much as we want, these taxes are not straightforward—particularly when it comes to earned income, which items are tax-deductible and which are not. The US tax code is complex and even confusing at times.
So we recommend that you focus on the more significant theme related to your business expenses; they must be “ordinary and necessary” expenses related to your business. For example, employee payroll is an ordinary and necessary expense to run your business, so by focusing on this theme, you can better guide your restaurant tax approach.
For sales tax, it is a bit more straightforward, but this varies by city, county, and state and by the type of product sold. The benefit is sales tax is a set it and forget it approach once you have it correctly set up. The confusing part is when we dive deeper.
For example, some services are taxable, while others are not. In some states, dining-out warrants a separate tax while go-to orders warrant a different rate. Some local authorities charge additional taxes in addition to state tax. These different layers and varying rules make it complicated and painful to understand tax.
If you find taxes annoying and confusing, so you keep procrastinating it, here are some reasons you should get on them immediately:
- Restaurants are popular targets for tax authorities. It is a business where violating laws are easy. Expansive inventory, cash transactions, differing tax brackets make it easy to break tax laws, and auditors are on the lookout for restaurant businesses that do just that.
- Restaurant business margins are always thin. Proper tax knowledge can help you understand avenues of tax exemption, saving you from overpaying taxes, particularly when you have little to no profit to show.
- Even if you have a tax consultant or an accountant that helps you file taxes, you, as the restaurant and business owner, must have the necessary knowledge. The basic understanding will help you strategize your business planning and be a better business operator.
This article will be your restaurant tax crash course. While every state and municipality could have different rules, this article will at least help you familiarize yourself with the general rules and concepts. We will cover the following topics:
- Tax Payments
- Tax Deductions
- Final tips and recommendations
Please note that this article is not a substitute for a CPA or certified tax professional guiding you through the tax preparation process. We recommend you read this article to get knowledgeable about the concepts and bring your tax preparer detailed and educated questions.
Table of Contents
Common Taxes Every Restaurant Needs to Pay
The National Restaurant Association states that a restaurant income tax rates can reach as high as the 30% range, depending on business structure (sole proprietor, LLC, S-Corp, etc.).
For an industry that operates with slim margins that are only getting slimmer due to increasing costs, getting your arms around tax preparation and planning is the difference between business success and failure.
There are a few different taxes that will affect your business; these taxes apply to different parts of your business. The one you are most familiar with is income tax and is where we start this tax lesson. All taxes these activities fall into specific broad categories explained below.
This tax is levied upon every business in every industry (and all earning that you may have from W-2 income). However, the rate depends on your legal structure and your income level. Let’s walk through these different scenarios.
As a business owner under sole proprietorship, which is when you own an unincorporated business, you pay taxes on your total income (net income, not gross sales). This net income is your gross receipts minus and business expenses such as wages, licensing, rent, insurance, and so on. Expenses that are “ordinary and necessary” to operate your restaurant or bar, as mentioned above.
This net income from your restaurant business, along with any other income sources, is taxed at your marginal rate, which varies depending on your income bracket. For example, the federal income tax has seven tax brackets (starting from 10% to up to 40%), and the rate applicable to you depends on your income level, marital status, and sources of income.
Partnerships or an LLC
If your restaurant is organized under the partnership or as a Limited Liability Company, taxes pass through to the individual level as they do for a sole proprietor. As a partnership or multi-member LLC, the business files a tax return but does not pay income taxes; the tax responsibility is passed directly through to the members.
Income tax reporting is done by each partner individually, and the rate ranges between 10% to 40% depending on their total income and sources of income. Also, individual states tax limited liability companies based on their assets or gross income, this is a relatively small set of states with a small percentage fee, but could easily add up to be a few thousand dollars a year for a burgeoning restaurant.
If your restaurant is registered as a corporation, then you must file a separate tax return for your restaurant. The profits of a corporation are, however, taxed double. When the corporation reports profits, it is taxed.
Next, when the corporations distribute to its shareholders (you) in the form of dividends – the shareholders are also taxed at the individual level. The range is between 15% to 35% just at the corporation level, depending on the profit level, with personal liability ranging from 10% to 40%.
Restaurants need to collect sales tax on all their products and services. Food, beverage, space renting, catering, private services, merchandise, all of the restaurant offerings are subject to tax (depending on the locality). The rate differs based on product or service, county, and state.
The average range is anywhere between 5% to 10% for all restaurants. Sales tax audits occur regularly, and even though you may undercharge your customer sales tax, in most states, it is the restaurant’s responsibility to pay the shortfall.
Pro tip: This also includes gift-cards that you might give out for your restaurant. When the gift cards are unused, they are treated as a liability for the restaurant. All the unclaimed money (gift-card example) needs to be reported.
Your restaurant is located on or in a property. On a college campus, inside a mall, off the highway, regardless of the specific location, you need to pay a tax on the property. Wait, you say, I don’t own the property!
Even if you lease the property, and do not own it, you need to pay some percentage of the property tax. This rate depends on your lease agreement. The rate differs from location and state. It also depends on your property value. Additionally, property tax rates fluctuate regularly. You should be aware of the rate, or at least the percentage of the annual amount you owe as the tenant.
As a restaurant owner, you are required to pay taxes on each employee’s salary (including social security, medicare, unemployment tax). Payroll taxes have two categories, one which you deduct from the wages, second which you pay as an employer on the salaries. As an employer, you also need to withhold a specific portion of the employee’s salary to ensure that they pay the taxes to the government.
Mostly, you have to be the adult in the room for your employees when it comes to taxes. This employee and employer contribution, schedule of payments, and so on can get very confusing quickly. That is why I recommend a full-service provider like Gusto: 5 Minute Payroll, who taxes the headaches out of payroll taxes.
Taxes on Tips
For the front of the house staff, hourly wages are a small portion of the income they receive every week or month. Their earned wages are mostly tips, which the team depend on, and are tied to their performance as waitstaff. Since the tips are not fixed, mainly in cash, and sometimes seasonal, it is difficult to report the exact amount—the waiters, on average, report less than 10% of their total tips as taxable income.
As an employer, however, it is your responsibility to ensure your employees report their earned wages. No one wants to help someone else commit tax fraud. Some easy ways to do this are to ensure you report all credit card tips received by employees, use a high-quality point of sale system that prompts employees to declare cash tips when they close their shifts and more.
Tax Deductions for Restaurants
Tax deductions are the amount you can reduce from your total gross income (taxable income). For instance, If you claimed $100 taxable income but claimed $30 in allowed deductions, then you only need to pay tax on the net income of $70. Some of the common tax deduction avenues for restaurants are listed below.
Menu Creation and Testing
All the expenses around menu engineering, printing, testing and designing is fully deductible.
These include significant expenses to the premise owned or operated by your restaurant—for instance, kitchen equipment purchase, tables, chairs. The rule is that these must be assets that have a lifetime of at least a year to be considered capital improvements. Those that have a lifetime of less than a year or treated as an expense during the current period.
Your restaurant should be insured. Some typical insurances are property insurance, liability insurance (in case your staff is injured on-premise), loss of business, workman’s comp insurance, and more.
Some restaurants even have food insurance, especially those that deal with expensive and large quantities of inventory that can go bad if there is a breakdown in the storage freezer or a loss of electricity. These insurances are deductible as business expenses.
Suppose your restaurant can own vehicles for food delivery, inventory purchase, catering, staff conveyance. A portion or all of the purchases and expenses related to the vehicles are deductible.
Food and Beverage Costs (Cost of Goods Sold)
This is one of your major expenses and includes your raw ingredients, packaged food, spices, condiments, and anything else that is consumable and related to the production of your food.
For beverages, this could include bottled water, spirits, alcohol, and sodas. Both the food and beverage that are consumed or wasted (spoiled or unsellable) are accounted for under the cost of goods.
Remember cost of goods and purchases are not the same thing: link out here
Employee salaries, including employee wages, insurance, sick-leaves, gifts (up to $25), vacation pay, and bonuses, are all fully deductible. Any meals and similar benefits provided to the employees are also included.
This bucket of expenses also includes fees that you might pay for contract-based workers like consultants, accountants, bookkeepers, guest chefs, entertainers, and lawyers.
Every restaurant has operating expenses. This group includes your rents, utilities, office supplies, and more. All of the other costs directly related to your restaurants are deductible.
Some examples include glassware, dinnerware, kitchen pans and pots, table decor items, small appliances, napkins, linens, tablecloths, hats and aprons, laundry bills, candles. You can also include your fees for licensing, music, payment processing under this category.
Maintenance and Repairs
Facility maintenance and repairs are fully deductible expenses.
Advertising and Marketing
You will also include items in this category like coupons, flyers, websites, online stores, social media ads, or any other form of paid advertisements.
Includes cloud-based, software-as-a-service (SaaS) applications.
The tax code’s sophisticated way of saying you can claim some or all of the costs of major purchases, like ovens and other large pieces of kitchen equipment. (Some of these costs may require you to split the expense of a set number of years, also known as the major purchases useful life).
Essentially, depreciation on your property, vehicles, equipment, and any other business asset (excluding land) can be deducted in small portions over the asset lifetime.
You can claim the interest on a vehicle you lease or have purchased for your business as well as the interest on your facility mortgage, lease payments business loans or business credit card payments.
Final Tax Tips and Recommendations
If you miss your tax payments or pay late, the penalties are steep. If such a situation arises when you are unable to pay on time, voluntarily file for an extension or pay at least a small amount. If you are a small restaurant, you could also negotiate with the IRS (for instance, if you have a real cash flow problem). They could give you an extension or some other measure of relief.
Maintain your documents from day one. Have a system in place where you have a record of your receipts, invoices, contracts, sales reports, insurances, and all other relevant documents. If you do get an audit or receive a notice to submit your documents, the record can save you a great deal of time and effort.
Be thorough about the taxes you need to charge. Tax codes, bases, definitions, exemptions, and rates – they vary from state to state and town to town. Here are some more factors that affect taxes:
- Taxable food and beverages, beverage sold with food and without food, beverage kind (soda/tea/carbonated drinks vs. wine/spirits/liquors).
- Business located in a particular business zone (like entertainment areas, historic districts).
- Even within a state, there can be many multiple rates plus local rates. Do not fall into the blanket rate trap.
Make sure you know about tax incentives that are relevant for your restaurant. Here are some examples:
- Expansion Write-Off: If your restaurant or franchise opens a new establishment or upgrades equipment, there will be an option to expense this new investment in the current year. This write-off is valid for all filing before 2023.
- Inheritance Tax: When you pass down a restaurant (and its related assets) to the next generation, it comes with a substantial tax rate. The government capped it at 40% (for all restaurants that are valued above $11.2 Million and $22.5 Million for married couples). This tax is valid for all filing before 2025.
To make your reporting, handling, and tax filing easy, there are many software’s available. These software’s also have by default state rates (dynamic) and all relevant taxes in the system, which can make your life much more comfortable.
Do your homework and find out which software best suits your current restaurant process and budget. You can also include your accountant or consultant in this decision as they will have insights, and they will be the user of this software.
Tax Ignorance Is Not Bliss
When it comes to taxes, you need to be on top of your numbers. Track all your information with a proper sales and accounting system or software. Sales, time-tracking, payrolls, inventory, accounting – they should work in sync and have error-free reporting.
In addition to this set-up, always seek help from a tax specialist (CPA). If you cannot afford to hire a full-time accountant or consultant, have contract-based freelancers. They can ensure that you are on the right track and help you with your question, answers, and optimization of your restaurant finance department.