Taxes are a part of any business, regardless of size or industry. However, every industry approaches taxes slightly differently, which is typically determined by federal, state, and local government requirements. Veteran restaurant owners and operators may already be quite familiar with the tax requirements for their business, but if you’re newer to the industry or opening a shop in a new state or city, understanding tax rules is a key to your restaurant’s success.
In this article, we’ll discuss the types of taxes that restaurants have to pay, specific restaurant taxes in certain states and cities, as well as some strategies regarding tax deductions.
Types of Taxes Restaurants Have To Pay
There are certain taxes that every U.S. restaurant has to pay, regardless of which state it’s located in. These taxes include federal income tax, payroll tax, service tip tax, and health taxes — each of which we'll explore in greater detail in the sections below.
Federal Income Tax
Federal income taxes are required by the federal government and are based on your restaurant’s net income. Your restaurant will fall into one of several graduated brackets accordingly: The more money your restaurant makes, the more you can expect to pay in federal income taxes.
The federal income tax rate your restaurant is required to pay also depends on how your business is set up — either a C corporation, otherwise known as a “regular corporation,” or an S corporation, which is also known as a “pass-through entity.” Consult a tax expert to understand exactly how much your restaurant may be required to pay in federal income tax.
Payroll taxes are required for every restaurant in the U.S. and are paid to the Internal Revenue Service (IRS). These taxes consist of the FICA tax, which includes the Social Security tax and Medicare tax, as well as the Federal Unemployment Tax (which appears on pay stubs as FUTA). The cost of payroll taxes is shared by both you (as the employer) and your employees. The amount you’ll pay as the employer is 6.2% for Social Security and 1.45% for Medicare and employees are required to pay the same percentages, according to Bench. Additionally, the FUTA tax is 6%, but certain U.S. states often have a credit of 5.4%, which means that employers usually only pay 0.6%!
While all of this may seem daunting for new and seasoned restaurant owners alike, it's worth noting that you can deduct staffing costs on your taxes, which can help reduce your taxes overall. (We’ll discuss deductions later on in this article, so keep reading to get the complete run-down!)
Service Tip Tax
If you’re new to the restaurant industry, it may surprise you to learn that you must pay taxes on tips. It’s a common, although extremely costly mistake to assume that tips are considered “off the books” — the IRS considers tips as taxable income.
It can be confusing and difficult to track just how much your staff is earning in gratuities as an owner or operator, and this process will involve collaboration between you and your employees. Employees are responsible for keeping a daily record of their tips and reporting them to the business. The only situation in which an employee wouldn’t need to report their tips would be if they earn less than $20 per month. When tax season comes, employees are also responsible for reporting all of their tips for the year on their personal income tax returns.
You’ll want to track both cash tips and tips that come in through credit card transactions, which is easy to do using your restaurant’s point-of-sale (POS) system.
You can make the process a little easier for your employees by providing them with Form 4070A, Employee’s Daily Record of Tips. This form serves as an easy, standardized way for employees to report their tips to their employer, and includes a separate column for cash tips, tips from other employees, and debit or credit card tips.
You may be wondering: What happens if an employee doesn’t report their tips? As the employer, you aren't liable for the employee’s share of Social Security and Medicare taxes on unreported tips until notice and demand for the taxes are made to the employer by the IRS, according to IRS.gov. However, as a business, you are required to file IRS form 8027 at the end of each year — which asks for your business’s total and charged sales, and charged and reported tips. In a perfect world, you or your tax accountant would notice a discrepancy on this form if employees aren’t reporting their tips.
Health Care Taxes
As a small business, it can sometimes be tough to offer health care benefits to your employees without costing you and your employees a lot of money. However, to help make healthcare more affordable for you and your employees, there are supports in place like the Small Business Health Care Tax Credit. According to Investopedia, if your business is eligible for this credit, it can offset the costs of providing health insurance to employees.
There are various options small businesses can tap into, which are provisions of the Affordable Care Act (ACA). A few of note include special insurance options for businesses with less than 50 employees, as well as an additional health care tax credit for businesses employing less than 25 people. Investopedia reports that “The maximum credit is 50% of premiums paid for small business employers or 35% of premiums paid for small tax-exempt employers.”
Popular City/State Sales Taxes for Restaurants
Beyond federal tax laws, every state has different tax implications as well, including sales tax rates — many of which have been updated in recent years due to the pandemic. Here are some specific city and state sales tax requirements you should be aware of as a successful restaurateur.
New York City Restaurant Tax
New York City has a total sales tax rate of 8.875%, which is the highest in the state of New York. This includes the New York City tax on service, which is 4.5%, New York state sales tax, which is 4%, and the Metropolitan Commuter Transportation District tax of 0.375%.
Chicago Restaurant Tax
Even more than New York City, Chicago’s sales tax is 10.25% in general and 10.75% for restaurants specifically. This is because there is a city restaurant tax of 0.5% in Chicago, which was established in 2020. However, if your restaurant is located within the MPEA Food and Beverage Tax zone in the city, you will see a total sales tax of 11.75%, according to the Illinois Restaurant Association.
California Restaurant Tax
California restaurant taxes vary depending on which county you are in, but can fall anywhere between 7.25% and 10.25%. If you’re operating in California, you can learn more about sales tax by jurisdiction here.
Virginia Restaurant Tax
The state of Virginia does see lower taxes compared to other areas in the country. Virginia has an average tax on prepared foods of 5% but can see higher taxes in some areas, with the highest being 6.5%.
Washington, D.C. Restaurant Tax
According to the Office of the Chief Financial Officer in the District of Columbia, Washington, D.C. charges a 10% tax on the sales of food, drink, and on-premise alcoholic beverage consumption for restaurants, bars, and similar businesses.
Massachusetts Restaurant Tax
On the lower side, if you open a restaurant in Massachusetts, you will see a sales tax on meals sold or bought from restaurants of 6.5%. Learn more on Massachusetts' government website.
6 Potential Tax Deductions for Restaurant Owners
Now that you have an expanded view of what restaurant taxes look like on federal, state, and local levels, you’re probably wondering how you can leverage tax deductions to your advantage. Luckily, there are many possible deductions that your restaurant may be eligible for that can save your business money. Let’s take a closer look at six of the most beneficial tax deductions for restaurants.
1) Marketing Expenses
Marketing and advertising are essentially required costs for any restaurant, so you’ll be happy to know that some of those expenses can be tax-deductible. This could include things like marketing flyers, coupons and other handouts, your website, social media ads, Google AdWords campaigns, and other paid promotions.
2) Staffing Costs
Staff wages often make up a large part of any restaurant’s budget. As mentioned briefly above, there are some staffing costs you can deduct from your restaurant’s taxes. This includes things like your employee wages, as well as the cost of meals that you provide employees during their shifts.
3) Food Expenses
As a restaurant owner, food will be one of your highest costs besides staffing. But to keep profit margins high, the general rule of thumb within the restaurant industry is to try to keep your food costs below 32%, according to Restaurant 365. In any case, writing off your food costs on your taxes can help keep your business's finances in a good place.
4) Certain Legal Fees
Starting a business in any industry is not a cheap endeavor. When it comes to starting up a restaurant, there are many fees to consider, like permit fees, trademark filings, legal fees and counsel, etc. Luckily, the IRS allows restaurant owners to deduct legal fees from their business’s taxes that are considered “ordinary and necessary” to running your business.
5) Certain Types of Insurance
The IRS considers various types of business insurance to be necessary costs of doing business. Therefore, you can often deduct your policy premiums from your business’s taxable income. This could include general liability insurance, property insurance, employee insurance (such as workers’ compensation), delivery vehicle insurance, and liquor liability insurance.
6) Table Items & Utensils
Anything in your restaurant that goes on your tables or bar tops can typically be deducted from your taxes. Think of things like tablecloths, dinnerware, silverware, cups and glasses, paper products, condiments, etc. If a restaurant patron uses it, you can likely write it off.
Optimize Your Restaurant With INFI
Navigating the world of taxes can be complex, but once you’ve got a handle on what taxes you’re expected to pay and what you can write off, it will be easier to streamline your processes and ensure your restaurant runs smoothly.
Another way you can support your business’s success is by using self-ordering kiosks, which can provide a seamless ordering experience for customers in-store and online — and keep your back-of-house operations running smoothly. INFI's self-service kiosks help small business owners optimize their ordering processes and provide valuable unified sales data in a single easy-to-use system. Learn more about what self-service solutions can do for your small business and sign up for a demo today!