In California, restaurants are responsible for paying sales tax to the state on taxable items. What makes a transaction taxable? The answer gets a little complicated for restaurants. The key distinctions are whether the food is hot or cold, and whether it is intended to be consumed on the premises. Here’s how to calculate California restaurant tax:

• Hot food (whether eaten in the restaurant or taken to go or delivered) is taxable
• Cold food is not taxable if taken to go, but is taxable if consumed in the restaurant
• Deliveries are taxable (including the delivery fee) if the food is hot, but not if cold. If the delivery contains both hot and cold items, the tax including the delivery charge should be pro-rated to distinguish between the two. If the delivery also contains non-food articles like alcohol and convenience items, those items are taxable.

An added complication to the above is the 80/80 rule. If 80% or more of your sales are food, and 80% or more of the food sales are taxable, then you owe California food tax (aka sales tax) on 100% of sales.

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Calculating California Restaurant Tax

The California state sales tax (sometimes referred to as the California restaurant tax) is 7.25%. Additional sales tax may be owed to your county and city, depending on your location. County sales tax rates vary widely: Los Angeles charges 2.25% while Orange County assesses only 0.5%.

Tips for Streamlining Your Restaurant Tax Calculation Process

In order to accurately and efficiently collect California restaurant sales tax, you should program your POS system to charge sales tax on those items on which it is due. However, if you’re subject to the 80/80 rule, all your sales are taxable, regardless of whether the food is hot or cold. Beyond your POS, a modern restaurant accounting software suite will save you considerable time when you’re examining the books at tax time. Even the best software requires human oversight, so it’s well worth the expense to hire a tax professional to review your numbers. California sales tax can be complicated, and you want to get it right.

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The restaurant industry has specific conditions that complicate its taxation such as tipped employees and a bevy of state and local laws that regulate sales and payroll taxes. As a restaurant owner, it’s critical that you, and not just your accountant, understand the taxes on restaurants. This knowledge will enable you to reduce risk to your business and minimize your tax burden. 

IRS Tax Regulations for Restaurant Businesses

In the United States, businesses are taxed differently depending on their legal structure. We’ll explore what that means for sole proprietors, C corps and more in the next section. In short, some types of businesses function as pass-through entities, meaning that taxes on the business are passed on to the owners, who are taxed individually. Other types of businesses must pay taxes as an entity in their own right. 

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The exact IRS Forms needed to properly pay taxes on a restaurant business will depend on the business entity type. 

Individuals and pass through entities will be using some combination of:

• 941, Employer’s Quarterly Federal Tax Return
• 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
• W-2, Wage and Tax Statement
• Schedule C (Form 1040), Profit or Loss from Business
• Schedule C-EZ (Form 1040), Net Profit from Business
• Schedule SE (Form 1040), Self-Employment Tax
• 1040, U.S. Individual Income Tax Return

Partnerships will use:

• 944, Employer’s Annual Federal Tax Return
• 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
• 1065, U.S. Return of Partnership Income
• Schedule E (Form 1040), Supplemental Income and Loss
• Schedule SE (Form 1040), Self-Employment Tax
• 1040-ES, Estimated Tax for Individuals
• 1040, U.S. Individual Income Tax Return

A corporation will engage with:

• 941, Employer’s Quarterly Federal Tax Return
• 940, Employer’s Annual Federal Unemployment (FUTA) Tax return
• Schedule E (Form 1040), Supplemental Income and Loss
• Schedule SE (Form 1040), Self-Employment Tax
• 1120, U.S. Corporation Income Tax Return
• 1120-W Estimated Tax for Corporations

Corporate Taxation by Entity Type

Sole Proprietorships

A sole proprietorship passes on all tax liability to the individual. No corporate tax rate is paid, instead the owner pays personal income tax on all restaurant profits. While this legal structure is the simplest, it limits ownership to a single person (you can’t have partners) and in the event of a tax dispute, full legal liability falls on the individual—there is no legal distinction between personal assets and business assets.

LLCs and Partnerships

An LLC, or Limited Liability Corporation, can be single member or multi-member, meaning it has one owner or multiple owners. In either case, all taxes are passed through to the owners, who are assessed taxes at the individual rate. Partnerships work the same way. Note that for both LLCs and Partnerships the businesses are required for file “informational tax returns” that show their profit and loss for the year. This informational return does not entail actual payment of any taxes it shows as due, rather those are paid individually by the owner(s).

Corporations

Restaurants organized as corporations file a corporate tax return and then separately, all shareholders must pay tax on dividends received. This means Corporate profits are taxed doubly—first at the corporate level, and again when profits are distributed. Despite this disadvantage, many restaurants will choose to operate as a corporation in order to have a large ownership group (i.e. shareholders) and for robust liability protection.

Understanding Restaurant Taxes

Sales Tax

Restaurants are responsible for collecting sales tax on all transactions. This requirement encompasses not just food and beverage sales but also catering, merchandise and space rental income. Your city and state typically set their own sales tax rates, though some jurisdictions are notable for not having any sales tax at all. To properly collect sales tax, research your local laws and set the appropriate rate on your POS to make sales tax application automatic. Retain your transaction records to be prepared in the event of a sales tax audit by local authorities. 

Payroll Tax

Payroll taxes are paid to the government to cover social security, medicare and unemployment tax. Part of payroll tax is the responsibility of the employee (and is deducted by you on their behalf from their paychecks). The other part is paid directly by the employer.

Property Tax

In the event that you own your restaurant’s building and land, you’re responsible for paying property tax. It’s also not uncommon for restaurants that lease their property to have a provision in the lease that makes them responsible for a percentage of property tax. Know your lease terms.

Income Tax

Income tax for restaurants is the same as for any other type of business. Employees are responsible for paying their share of income tax on W-2 Forms. Whether the business itself pays a tax on profits depends on whether its a pass-through entity such as an LLC or partnership. If the business is a corporation, it will need to pay a corporate tax rate on profits. Corporate distributions to owners are then taxed again at the individual level.

Restaurant Taxes on Tips

Tips are taxable income and must be reported as such. There’s space on the W-2 form for exactly this purpose. Tips get no special tax treatment—the tax rate is the same as regular income, and payroll taxes are assessed in the same manner. The only distinction is that employees are responsible for separately tracking and reporting tip income to their employers. If employees neglect to report this income to their employer (and so make it subject to regular payroll tax withholding), they must use Form 4137 to account for the tip income.

Employers are responsible for correctly withholding payroll taxes from employee wages, and paying the appropriate employer share of payroll taxes. As tips are included as part of total employee income, no special provision is necessary. Employers should use Form 941 to report all payroll taxes.

A tax credit is available to refund the amount of employer social security and medicare taxes paid on tip income that exceeds federal and local minimum wages. This is known as the FICA tip credit, which is calculated and paid via IRS form 8846. In short, the tax credit is equal to the amount of tip income per employee above the minimum wage times 7.65%.

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Strategies for Restaurant Tax Planning

As this guide to taxes on restaurants has illustrated, there are nuances to the tax treatment of restaurants. Here are some quick tactics to improve your grasp of restaurant taxes:

• It’s well worth the investment to work with a tax professional who can help you reduce your audit risk and maximize your deductions. A local accountant will also know the relevant state, county and city tax laws.
• Retain all records of sales transactions, purchases, and payroll. This information will be crucial in the event that you need to show proof of your accounting figures to the IRS or local tax authorities. 
• Save as much on your taxes as possible by maximizing your deductions. The details of how to go about this should be handled by a professional tax advisor, but the gist is that many of your daily expenses are deductible costs of doing business, and thus can reduce your tax liability. 
• Finally, remember that you’re responsible for paying estimated taxes at regular intervals throughout the year, not just in April. Research your required payment interval and keep to it.

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What is restaurant sales tax automation?

Your point of sale system likely offers integration with technology that enables you to automate every step of sales tax management – from calculating tax for each sale and setting the funds aside daily, to preparing, filing, and paying the tax owed to the State when due. DAVO by Avalara Sales Tax seamlessly integrates with the most popular POS systems to automate sales tax from start to finish. All you have to do is set up the service on your POS and DAVO takes it from there. Set up typically takes about 5 minutes and you never need to worry about sales tax again.

Why it’s important to set sales tax aside daily (sales tax impounding)

An important part of dealing with restaurant sales tax is cash management: ensuring you have the correct funds set aside when it comes time to pay your sales tax. If you aren’t setting those funds aside on a daily basis, you run the risk of mistakenly spending the money and coming up short when it is time to pay.

Sales Tax Impound Definition: In accounting, the practice of setting aside sales tax is also referred to as sales tax impounding.

DAVO uses data from your POS system to set aside the exact amount of sales tax you collect daily. The funds are then transferred to a secure tax holding account. With this automated cash management in place, you can rest easy knowing that the funds are accounted for every single day.

The benefits of restaurant sales tax automation

When you reduce the need for manual management of a complicated business process like sales tax, you save a lot of time – something that is in very short supply for many busy restaurant owners. Beyond the major benefit of time and resource savings, there are many other benefits of automating your restaurant’s sales tax:

• Eliminates missed payments and late payment penalties. Taxes are automatically filed and paid on time and in full so you will never have to think about a payment deadline again.
• Ensures you automatically receive discounts where available. If you operate in one of the 26 states that offer on-time filing discounts, your discounts are automatically calculated, collected, and refunded. *Note that restaurant sales tax by state varies – find specific sales tax information for your state.
• Sets sales tax funds aside daily (sales tax impounding) ensuring you have the correct funds set aside when it comes time to pay.
• Completely removes the burden of restaurant sales tax from your plate so you never have to worry about it again. More time to focus on food and grow your restaurant business!

 Author Bio:

Pete Murray

Pete oversees operations as the General Manager of DAVO by Avalara. He has decades of experience leading technology teams for a variety of companies, including Quantrix and IDBS.

The post What it Means to Automate Your Restaurant Sales Tax and How it Can Help Your Business appeared first on Restaurant Accounting Services, Inc..