4 types of restaurant taxes (and deductions to take)

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Although “tax” and “relax” rhyme, they’re about as opposite as concepts can be. We know how it goes—no small business owners look forward to tax season. This is especially true for restaurant owners, since tax laws are thoroughly complex and often changing. Restaurant taxes are their own little world, and restaurateurs will need to stay on top of their game to keep the Internal Revenue Service (IRS) at bay. So, let’s look at taxes for restaurants, including tips to maximize deductions and minimize paperwork.

Before we get into anything serious, please keep this in mind: We are not tax professionals. We highly recommend hiring either a tax lawyer, an accountant, or both to make sure you remain compliant with tax laws in your area. Since local tax requirements can all vary due to county, city, and state laws, there is no one-size-fits all answer. So, while we’re happy to provide information regarding taxes, do yourself a favor and make a professional partnership that will keep you on the right side of the tax authorities.

We’ll start by looking at common taxes for restaurants and then cover deductions so you can minimize the total amount of taxes you pay.

4 types of taxes applicable to restaurants

Because tax authorities get a kick out of making life complicated for taxpayers, restaurateurs have to be aware of all sorts of different taxes they may or may not be subjected to. Failure to accurately comply with tax regulations can lead to penalties, which are a silly way to damage your bottom line. Let’s have a closer look.

1. Sales tax for restaurants

Most states as well as the District of Columbia require state sales taxes, though the amount of tax varies. For example, some states and local jurisdictions have different sales tax or use tax requirements for food consumed off-premise or for unprepared food.

Generally, most states require sales taxes on prepared food to be consumed on-premises, i.e., at the restaurant or for takeout, though sales tax rates vary widely. Fortunately, you only need to know the specific regulations in your area to remain compliant.

Five states do not charge sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon.

Be sure to register cash purchases in your POS system since cash purchases are just as subject to sales tax as any other kind. Bookkeeping software or a solid front-of-house (FOH) management system can help keep track of sales.

2. Income tax for restaurant owners

As a restaurant owner, you’re responsible for reporting and paying taxes on the profits your restaurant generates. This income tax can vary depending on your business structure and the amount of income you earn. Consider, for example, whether your structure is a sole proprietorship, an LLC, a partnership, or a corporation.

You’ll need to document absolutely everything in order to accurately file your tax returns and maximize your tax deductions. You’ll want to maintain income statements, business expense receipts, and payroll records. Because all of this is complicated, we again highly recommend working with a tax professional to make sure things don’t fall through the cracks.

3. Payroll taxes

Employers have specific payroll tax obligations related to their restaurant employees. These obligations include state and federal income tax withholding, Social Security and Medicare taxes, and Federal Unemployment Tax Act taxes.

Make sure your employees are correctly classified as either W-2 employees or independent contractors. Failing to accurately classify workers can result in penalties from the IRS. It may be tempting to classify some employees as independent contractors since your tax burden is limited, but we recommend seeking a tax professional’s advice before doing so.

Of course, you’ll need to keep accurate records of wages, taxes withheld, and payments made to tax authorities.

4. Tips and gratuity taxes

Naturally, tips and gratuities are a large part of restaurant workers’ incomes. As a restaurant owner, you need to understand the local and federal regulations regarding tips. This has long been a legal gray area, but it’s becoming less gray as cash tips are often being phased out for electronically transferred tips like those via credit card. When tips were often paid with cash, it was much easier to not claim them as income. But those days are fleeting, and servers’ income tax returns are being increasingly scrutinized.

All tips—cash, credit, or otherwise—have to be reported to the employer. In this case, that’d be the restaurateur. As that employer, you’re responsible for withholding taxes on reporting tips and ensuring tax compliance.

5 tax deductions for restaurants

Fortunately for restaurateurs, the tax system is not entirely predatory. There are plenty of tax-deductible expenses that can save you a bundle come tax season. So, you should absolutely max out your tax deductions in order to keep your profit margins healthy. Let’s look at some of these most important deductions and how they can work in your favor.

1. Labor costs

Labor costs are entirely tax deductible for all restaurant staff. That includes employee wages for chefs, managers, wait staff, bussers, and the whole restaurant crew. The only person whose labor is not tax deductible is that of the owner. Since labor costs often hover around 30% of sales in the restaurant industry, this tax deduction alone can be a huge benefit for restaurant owners and cut down significantly on tax outlays. Benefits like insurance, retirement, bonuses, and vacation pay also are included in labor costs.

2. Operating costs

Operating costs, including property rent, utilities, office supplies, and other basics are tax deductible. This includes business meals with staff or third parties. If a meal costs upwards of $75, you’ll need to keep the receipt for proof. Employee meals consumed on premises are also tax-deductible, so it’s wise to keep track of meal expenses provided to your employees.

Transportation costs are also tax deductible, which can be valuable for restaurants that do a lot of deliveries. Commuting miles can be tax deductible but things get complicated here, so we recommend checking out the IRS website for further details.

Restaurant advertising expenses are also tax deductible, as they can broadly be considered part of operating costs. So, keep track of any money spent on social media advertising, print advertising, Yelp Ads, or any other kind. Advertising being tax deductible should encourage restaurant owners to up their advertising game, since it’s one of the best investments a restaurant can make.

3. Food costs

Food costs are a large part of a restaurant’s expenditures, so you’ll be happy to know they’re fully tax deductible. Keep track of your cost of goods sold (COGS), since this will represent the food cost you’re able to deduct from your overall taxes. Note that “food costs” include alcoholic beverages. We recommend keeping weekly, monthly, and yearly COGS logs to have a good idea of how much you’re spending on food as well as how much you can expect to deduct from your taxes.

4. Asset purchases, improvements, and repairs

Things that a restaurant has to have to operate, like ovens, furniture, dishwashers, and so on are tax-deductible purchases. Similarly, upgrading old restaurant equipment is tax exempt, as are repairs on these items. Maintenance, including machine maintenance and cleaning services, falls under the same category. Renovations are also included in deductible improvements, and while depreciation used to complicate the matter, the tax code is constantly evolving. But hey, even napkins are tax deductible, so keep records of everything you purchase.

5. Insurance and professional fees

Remember how we keep pointing out that you’ll most likely want to work with a tax professional? Good news! The fees you pay to them will be tax deductible as well, so there’s no reason to be scared off by those fees. Hiring lawyers and accountants fall under the same category, so you’ll save money in two ways: By remaining compliant and by getting to deduct those professional service charges. Win-win!

And finally, restaurants are required to have insurance, but insurance premiums are also tax-deductible.

Don’t tax yourself too hard

With all the bewildering information about taxes, restaurateurs from California to New York and everywhere in between can take comfort in the fact that they don’t have to know everything. You only need to be aware of the tax requirements in your specific area. Again, a tax professional will help you get squared away and hey, their fees are fully tax deductible.

You know what else is both tax deductible and able to help you stay on top of your tax liabilities? Excellent FOH software like Yelp Guest Manager. It’s considered restaurant equipment, so the low fees are fully tax deductible. What’s more, Guest Manager is excellent at helping restaurateurs keep track of taxable income, taxable sales, and anything else that has to do with bookkeeping. Combine that with fully customizable FOH solutions, third-party integrations with point of sale (POS) systems and other third-party apps, and world-class customer interactions, and you’ve got a winner on your hands.

Curious if it’s right for you? Reach out to us for a free demo and we’ll get started.