Successfully operating a restaurant takes grit and passion. We do not need to tell you that it is hard work. Rather than focus on the daily challenges, let’s talk about taxes, specifically “indirect taxes.” After all, the restaurant industry is a frequent target for audits, and since indirect taxes have become a crucial revenue source, governments are stepping up enforcement, intently focused on indirect tax collections. Restaurants, bars, taverns, delis, pizzerias, and other establishments, from fine dining to dive bars, are all five stars on the state auditor’s audit rating scale. With the numerous dizzying indirect tax rules that apply to restaurants in particular, let alone the task of actually running the restaurant, it’s not hard to see how mistakes can easily be made. And those mistakes can be costly.
Here are several key points every restaurant owner, operator, and investor should understand about indirect taxes:
What exactly are indirect taxes?
Unlike direct taxes such as corporate income tax paid directly to the government, consumers pay indirect taxes when they buy goods and services. Intermediaries such as restaurants have a “fiduciary duty,” which many deem the highest duty recognized by law, to collect indirect taxes from consumers on behalf of the taxing jurisdiction and timely remit those taxes to the appropriate authority. Sales tax and certain excise taxes are examples of indirect taxes applied to the sale of goods and services.
Many operators don’t know until it’s too late that indirect taxes are “trust fund taxes” which carry personal liability. Trust fund taxes are those collected by a business as a result of its activity, i.e., indirect taxes, and then held in trust until the taxes must be paid to a government entity. Trust fund taxes have the unique characteristic of holding owners and operators personally liable for a company’s improper reporting and compliance with these taxes. Thus, if the restaurant doesn’t pay the tax, the relevant taxing authority can go after individuals involved with the business. This is true regardless of the type of entity; a corporation or LLC does not offer protection against these types of tax liabilities.
Indirect taxes directed at the restaurant industry are myriad and not always obvious
It’s no longer the case that restaurants are only responsible for collecting and remitting the obvious, i.e., sales tax. While greatly accelerating the pace of all their tax legislation, state governments continue to rely heavily on indirect taxes as an invaluable source of revenue. As a result, there is an increased risk taxpayers will be caught unprepared. Year after year, new indirect tax laws go into effect shaking up businesses around the country. What’s more, it often seems like it’s not long after businesses settle into a new law that more disruptive ones are enacted. Many of these laws have a huge impact on the restaurant industry, from special excise taxes on alcoholic beverages to special meals taxes. To make matters worse, even these special taxes can be broken down further. For example, some states impose sales and use tax on all sales of alcoholic beverages (e.g., beer, wine, or liquor) but restaurants that sell such items also must account for special excise taxes that apply to beer, wine, liquor, and ciders differently.
This underscores one of the most significant indirect tax issues faced by the restaurant industry: indirect tax duties are not always obvious. The restaurant must be agile enough to implement new obligations as they arise, typically at the mercy of a jurisdiction’s proactive notification, but often by snail mail. This leaves considerable room for error. Rather than wait until they’ve had a chance to negatively affect your business in some way, it’s important to understand what resources you have available to prepare for any changes.
Accurate recordkeeping is critical
What can you do to minimize your exposure? The best defense is a good offense. This means maintaining good books and records. Inaccurate or incomplete records are lethal in a tax audit. Accurate records are essential in tracking deductible expenses, verifying sales, recording purchases, and proving that special excise taxes are accounted for when these taxes are passed on directly to the consumer in the form of raised alcohol prices, for example. Poor recordkeeping can make it difficult to challenge an audit and can lead to serious financial consequences for both the restaurant and its owners and operators. Furthermore, states impose statutory recordkeeping obligations upon businesses that require records to be made available to an auditor for inspection. Failure to maintain proper records can lead to audit methodologies that may produce wildly different findings than the actual books and records would have otherwise shown.
The consequences of improper tax compliance are severe
A trust fund tax problem could lead to financial ruin. Penalties and interest can be imposed on the restaurant, as well as any responsible persons, for failing to pay sales tax or properly withhold. A restaurant may also have tax licenses revoked or, in egregious cases, face criminal prosecution. Taxing authorities may use a combination of enforcement methods, such as liens, bank levies, income executions, and business seizures, to collect what is owed. Some states employ additional, more obscure methods.
If you have a tax compliance problem, many tax authorities offer relief in the form of voluntary disclosure programs. Taxpayers can voluntarily come forward before an audit and agree to pay back taxes in exchange for the state agreeing to waive penalties.
Restaurants have many indirect tax and accounting obligations from state and local governments. It is essential owners and operators develop a basic understanding of these requirements, or hire competent and trustworthy advisors to act for them. Indirect taxes are simply a part of doing business. While there are lawful ways to minimize them, there is simply no way to avoid them.
Article written by:
Judd Ballard, CPA
Senior Manager, State & Local Tax Services