The restaurant industry is at the top of many state sales tax auditors target lists. With a history of underreporting cash sales, state auditors have developed many strategies to hit owners with underpayment assessments. These can include sitting by the front door for a day in order to count customers to using purchases of products to back into sales estimates. However, with the number of cash sales diminishing significantly over the past 10 years, auditors have found other ways to apply hefty sales tax assessments against the industry.
Resale vs. Consumption of Supplies
Many restaurant owners assume that everything a customer uses can be purchased sales for resale. However, most states have rules that define the difference between items purchased for resale compared to items purchased for consumption. For example, paper cups and takeout containers that are part of the sale to the customer are generally considered resale. However, napkins, forks, and knives used on premises are considered used by the customer on site and cannot be purchased for resale. Unfortunately, many owners purchase these items from the same vendor and many paper supply vendors rely on the customers to tell them which items should be tax exempt.
Capital Improvement vs Repair
As any restaurant owner knows, repairs and maintenance of restaurant equipment can be costly. But what is worse than getting hit with sales tax, interest, and penalties on purchases where sales tax was not charged? So why does this happen? Many states have very complicated rules on what constitutes an improvement to real property (generally exempt from sales tax) and what would be considered a repair or maintenance service (generally taxable). For example, in many states, the replacement of hardwood floor or ceramic tile is exempt as an improvement, but the replacement of carpet or vinyl tile is taxable. What about the partial replacement of a wooden floor? This can depend on many factors, such as state guidelines or the reason for the replacement. Next, the equipment and services (electric and plumbing) needs to be fixed. Well if all you need is to replace a stove burner, that will be taxable in most states. However, if you are installing a new fryer and you need to run a new gas line, that will be exempt. Of course, when the state auditors come in to review your purchases, they tend to focus on the items you underpaid sales tax while overlooking the items you overpaid on.
Non-Food Related Services
Catering can be a boost to many food establishments. However, it can also lead to sales tax nightmares. We recently assisted a client with a sales tax audit who had significant sales from catering. In addition to the food sales, the company would charge for the labor, rental of tables, chairs, and tents, and even a live DJ. The company separately charged for each item and only charged sales tax on the food and the rental of chairs, tables, and tents. Unfortunately for the company, the state had very clear rules that ALL services performed in conjunction with the catering event were subject to sales tax. This led to a sales tax assessment. However, with our assistance, the client was able to greatly reduce her final liability.
As you can see, sales tax issues can be complicated for restaurant owners. Companies should review these issues with their CPAs to ensure they are complying. PMBA works with restaurant owners and CPAs across the country to assist on sales tax audits and other complicated sales tax issues.