Restaurant tax guide: Tax types, deductions, and pitfalls
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While taxes may be as inevitable as death, they don’t have to be as final or dramatic. Restaurants that find a way to make peace with the tax authorities and pay the correct amount of tax—without overpaying—will find taxes are just a part of doing business and don’t have to be excruciating.
From the outset, we recommend working with a qualified CPA who knows what they’re doing, including knowing all the tax laws relevant to your local department of revenue.
For some practical help now, let’s jump into our restaurant tax guide. You’ll walk away knowing the main types of restaurant taxes, six tax deductions you can take, and common tax mistakes restaurateurs make.
8 types of restaurant taxes
Below are the most notable forms of restaurant taxes to pay attention to. Be sure to tap into your local tax laws for additional information, but this is a good start.
1. Income tax
Like any business, restaurants have to pay federal and, in most cases, state income taxes on their profits. The federal tax rate depends on the business structure—sole proprietorship, partnership, or corporation—while the state income tax rate varies by location.
You’ll need to understand your state’s income tax rates and keep abreast of any changes. Be sure also to clarify just how you want your business to be classified. Restaurants that are a sole proprietorship, partnership, or S corporation have profits “pass through” to the owners’ personal income tax. C corporations are treated as true corporations and will need a different tax structure.
Some states, like Nevada, South Dakota, and Wyoming, have corporate income tax rates of 0%. Other states can be much higher, with a flat tax like California or a tax gradient like New Jersey. The federal corporate tax rate is set at a flat 21%.
2. Sales tax
Restaurants in most states collect sales taxes from customers on food, beverages, and other taxable items sold. Sales tax rates vary, and some localities like Los Angeles County have additional sales taxes. The nature of sales tax varies by state as well, with some states taxing the sales of food prepared on-site, including takeout, differently than unprepared items. Some states like New York apply a use tax, which is most frequently applied to items that aren’t part of sales taxes, like items for resale.
3. Payroll taxes
Payroll taxes include federal and state taxes withheld from employees’ wages, including Social Security, Medicare, and income tax withholdings. Employers also contribute a matching portion for Social Security and Medicare for employees. Currently, the tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, while Medicare is taxed at 1.45% for the employer and 1.45% for the employee.
4. Tip taxes
Gratuities reported by employees, by credit card and cash, for example, are subject to income tax withholding, Social Security, and Medicare taxes. Restaurants may need to ensure compliance with tip reporting rules, like from IRS Form 8027 for large restaurants.
There are rumblings of the Trump administration cancelling tip taxes, but as of this writing it has not happened yet. Keep informed on changes to ensure your employees get their fair share should this policy change.
5. Property tax
If a restaurant owner owns the restaurant’s building or land, the property is subject to local property taxes based on the assessed value (which can change rapidly). Even leased spaces might indirectly involve property tax costs passed on by landlords. Make sure you’re up to date on the current valuation of your property so you don’t get blindsided by any increases in property taxes, as they usually trend upward instead of down.
6. Excise and inventory taxes
Restaurants will need to pay taxes on certain segments of their inventory, notably liquor. Alcoholic beverage taxes vary widely by state, and can include simple excise taxes on wholesale liquor prices or locally enforced mixed drink taxes, like Texas has. As these taxes can be part of your COGS in some cases, you’ll want to review your specific case with a CPA to ensure you’re ticking all the boxes while not overpaying in taxes.
7. Franchise tax
Some states, like Texas and California, may require restaurants structured as corporate franchises to pay a franchise-based additional tax on revenue or net worth, regardless of profitability. In Texas, for example, this tax is generally less than 1%, but can still add up if sales are high and profit margins low.
8. Meals tax
Certain states and jurisdictions impose a specific local tax on prepared food and beverages, separate from or in addition to sales tax. For example, Virginia has a meals tax in some areas that restaurants must collect. Know the tax laws in your specific county and city, since the taxes can vary between locations.
6 key tax deductions
Fortunately, business owners can make significant use of tax deductions. The restaurant industry already operates on thin margins, and keeping tax filings to a minimum can mean the difference between profitability and failure. Keep track of every expenditure so you can claim tax credits when the time comes for a tax return.
1. Labor costs
Good news: Labor costs are entirely deductible for all restaurant staff. Managers, wait staff, bussers, cooks, everyone—all employee wages are tax deductible. Labor costs are a significant portion of any restaurant’s expenditures, often around 30%, so this means there are significant savings involved for restaurant owners. The only labor that’s not tax-free is that of the owner.
2. Operating costs
Operating costs include property rent, utilities, office supplies, and other must-haves for your business. Operating costs also include employee meals and transport costs, including deliveries. While commuting miles can be deductible in some cases, make sure you understand the IRS rules on commuting.
3. Food costs
Like labor costs, food costs are a significant portion of a restaurant’s expenditures. Fortunately, they, too, are tax deductible. Keeping track of your cost of goods sold (COGS) with restaurant management software and your point-of-sale (POS) system will make the approach to the tax due date that much smoother, and keep your tax burden down.
4. Asset purchases and improvements
Your equipment, including appliances, furniture, and supplies, is all tax deductible when it’s purchased, maintained, or upgraded. Cleaning services also land in this category, so keep that ice cream machine clean and operating. Renovations like remodeling are also included in tax deductible expenditures. Depreciation of assets does play a role in any asset deduction, so keep in mind the ever-changing tax code, but keep track of every single necessity you purchase for maximum deductions.
5. Insurance and professional costs
Professional services including insurance, legal advice, and accounting are all tax deductible. Think of it this way: If it’s necessary for your business, it’s likely tax deductible. Insurance premiums are necessary for a restaurant, but those premiums are deductible. Of course, you’ll want to check with your CPA to ensure you’re doing the right thing, but since hiring a CPA is tax deductible you’ve got no reason not to do so.
6. Charitable donations
Working with a local charity? Good news: All charitable donations are tax deductible. If you get the impression that a local charity is a better way to spend would-be tax dollars, donate away, and you can more or less control the flow of cash that otherwise would have gone to Uncle Sam.
Avoiding 8 common pitfalls
Restaurants can make several common mistakes when filing taxes due to their unique operations. Here are some pitfalls and ways to avoid them.
1. Underreporting cash sales
Restaurants often deal with cash tips and payments. Failing to report all cash income, intentionally or not, can trigger audits and penalties. Keep meticulous records of all transactions, both cash and credit card. Use POS systems to track sales daily and reconcile them with bank deposits. Train staff to log cash tips accurately.
2. Mishandling tip reporting
Tips are taxable income, though avoiding declaring tips is quite common in the restaurant industry. Restaurants can mess up by not reporting tips properly. Educating staff on reporting tips and using payroll software to track tips against credit card records helps mitigate this problem. Claim the FICA tip credit to offset Social Security and Medicare costs.
3. Misclassifying employees
It can be tempting to label workers as independent contractors instead of employees to dodge payroll taxes, but this can backfire if the IRS reclassifies them. This can be an issue with delivery drivers or part-time staff, for example. When in doubt, remember employees have set hours and use restaurant equipment, while contractors control their schedules and tools. Consult a tax pro to make sure you’re doing things correctly.
4. Neglecting sales tax compliance
Restaurants might collect sales tax but fail to remit it on time, miscalculate taxable items like prepared vs unprepared food, or overlook local add-ons via county or city. Penalties can add up. Set up your POS system to automatically calculate and separate sales tax. Additionally, double-check the taxability of items—for example, some states exempt takeout from sales tax but not dine-in.
5. Overlooking deductible expenses
Small things like food spoilage, uniforms, or repairs reduce taxable income. Small restaurants especially fail to log such small things since they may lack the capacity. Invest in high-quality accounting software and put your CPA on the job to maximize savings.
6. Ignoring inventory tracking
Poor inventory management may lead to inaccurate COGS calculations, skewing taxable income. Make sure you have your inventory thoroughly understood through menu engineering techniques. The IRS might question sudden COGS jumps or drops. Conduct regular inventory audits and match purchases to sales records to justify COGS on tax returns.
7. Failing to file on time
Taxpayers everywhere know that taxes are due on a specific date, but restaurant owners are especially busy people. It can be easy to miss a deadline if you’re not paying close attention. Penalties can rack up over time, up to 25%, so mark all deadlines on a calendar and keep in touch with your CPA. File for extensions if needed, but pay estimated taxes by the original due date to minimize penalties.
8. Ignoring state-specific rules
Tax rules that are state- and local-specific can be easy to overlook, especially if you’re new to an area. California and New York alone have plenty of specific taxes that people in other states are unaware of. For this reason, it’s best to work with a CPA who knows the ins and outs of all tax laws in your area so you can find out what state sales tax you need to know, what’s tax-exempt, and what’s a tax liability you can avoid.
Technology that helps with thorough recordkeeping
Restaurant tech can help you stay in the good graces of the IRS—and prevent headaches long before they occur. Use a software suite like Yelp Guest Manager to coordinate and centralize operations across your restaurant. Link up your POS systems and inventory management systems to keep track of data. Best of all? Guest Manager makes it easy.
Want to find out how it can work for you? Curious how it can boost your sales via online waitlists, reservations, and check-ins? Thinking about switching to customizable front-of-house software? Reach out to us for a free demo to see what it’s all about. Making taxes easier frees up time to focus on the more fun parts of the business.