Restaurant taxes: What owners need to know

Restaurant business structure

In the United States, businesses are taxed differently depending on their legal structure.

Sole proprietorship

Sole proprietorships are pass-through entities that pass on all tax liability to the individual. With this structure, you don’t pay business tax. Instead, the owner pays personal income tax on all restaurant profits.

Forming a sole proprietorship is the simplest structure for new restaurant owners. However, you don’t have any liability protection should you be sued by a customer or creditor.

Partnership

It’s not uncommon for restaurants to start as partnerships. A partnership has multiple owners with a pre-agreed-upon ownership structure. In either case, all taxes are passed to the owners on their individual tax returns.

Limited Liability Company

An LLC can be single-member or multi-member, meaning it has one owner or multiple owners. In either case, all taxes are passed to the owners on their individual tax returns. The IRS doesn’t recognize LLCs, so it treats them as disregarded entities for tax purposes. LLCs with only one member are treated as sole proprietorships. LLCs with multiple members are treated as partnerships.

Forming an LLC is the simplest business structure if you’re new to the restaurant business.

• Taxes are more straightforward for LLCs than for C corporations
• You benefit from liability protection, which protects your assets from lawsuits and creditors.
• Unless the articles of organization specify differently, a limited liability company has perpetual existence. The company can continue to operate in the event of the owner’s death, retirement, or withdrawal from the company.
• There’s less management required to keep your status as an LLC compared to a C corporation
• LLCs enjoy a flexible management structure. State law rests the management structure fully with the owners.

S Corporation

Many restaurants switch to an S corp entity after becoming profitable. With this structure, you don’t own the restaurant directly, as it’s considered a separate entity. Choosing an S Corp gets around the double-taxation problem of a C corp and makes it a pass-through entity. S corp owners can avoid the 15.3% self-employment on the portion of their income through distributions.

C Corporation

Restaurants organized as a C corporation file a corporate tax return. C corporations are the only business structure that pays taxes on the business level. The federal government charges a flat business income tax rate of 21% for C corporations. In addition, forty-four states levy a corporate income tax.

As a C corp owner, you must be a W-2 employee of your business if you’re involved in the day-to-day operation. You can then pay yourself what the IRS deems a reasonable salary and have taxes withheld.

After paying taxes on business profits, C corps can distribute earnings to owners as dividends. The IRS then taxes these distributions again on their personal tax returns.

If you plan to open multiple chains, seek investment, and operate in multiple states, consider forming a C corp. You can always restructure your LLC or other business entity into a C corp in the future.

What taxes do restaurants pay?

Income tax

Your business won't pay income tax on its profits if it’s a pass-through entity (sole proprietorship, LLC, partnership, or S corp). Instead, those profits are passed to your personal tax return.

Payroll tax

Payroll taxes are paid to the government to cover social security, Medicare, and unemployment tax. Employers are responsible for withholding payroll taxes from employee wages and paying the required share of payroll taxes.

You’re responsible for making payroll tax payments to the IRS monthly or biweekly. In addition, you need to file a payroll tax form with the IRS yearly or quarterly, depending on your business’s size.

The schedule can be monthly schedule, bi-weekly, or --if your business has enough employees to withhold $100,000 in taxes within a day --you have to deposit that money the next day. Employers have a separate portal online to deposit this money.

Here are the typical deadlines for filing quarterly:

• First Quarter, January – March: Filing due April 30, 
• Second Quarter, April – June: Filing due July 31
• Third Quarter, July – September: Filing due October 31
• Fourth Quarter, October – December: Filing due January 31 of the following year

Property tax

If your business owns the building and land it operates on, you’re responsible for paying property tax. The tax is administered locally, typically by the county or city where the business operates.

In addition to your business’s real estate or land, you may be responsible for paying business personal property tax. Business personal property tax, or BPP, is a tax assessed on physical or tangible things that a business owns.

A restaurant owner may be responsible for paying BPP tax on their eatery’s dining tables, point-of-sale systems, kitchen appliances, paper supplies, and more. 

A few more examples of tangible personal property include:

• Cars
• Phones
• Computers
• Furniture
• Tools
• Supplies
• Machinery
• Business equipment

Don't guess if business personal property tax applies to you. Our business personal property tax guide is a good starting point.

Taxes on tips

Tips are taxable income, so the IRS requires you to report them. The tax rate is the same as regular income, including withholdings for payroll taxes. Your employees are responsible for reporting their tips as taxable income. This includes cash tips and non-cash tips like tickets, gifts, and other valuable items.

Employees use Form 4070A to keep track of the tips they receive from customers. They’re responsible for reporting the total to their employer each month. The employer will then withhold the employee’s share of income, social security, and Medicare tax.

Sales tax

Restaurants are required to collect sales tax on all transactions. This includes food and beverage sales through catering, merchandise, and space rental income. Your city and state will set their own sales tax rates if they have any.

Sales tax rates by state

Estimated taxes for restaurants

All self-employed individuals are required to pay estimated taxes throughout the year. Restaurant owners are no exception. This means you have to pay taxes at regular intervals throughout the year to the federal and state governments.

The IRS defines estimated tax as the method used to pay tax on income that is not subject to withholding. This income includes earnings from self-employment, interest, dividends, and rent. This payment usually gets made to federal and state governments (except in states with no income tax).

Tax incentives for restaurants

Restaurants operate on thin profit margins, so paying taxes can add an extra burden. Filing taxes correctly and on time is just the start of a proper tax planning strategy. Taking advantage of tax incentives like deductions and credits will help you save on taxes.

We’ll start with the nine deductions every restaurant owner should take advantage of.

Operating expenses

Operating expenses are all the costs and fees of running and managing your business. You can deduct all expenses related to food and beverage purchases, rent, utilities, advertising, and software costs. Keep accurate records of these expenses to ensure proper documentation during tax filing.

Operating expense deductions can also account for wasted, spoiled, or otherwise discarded food, beverages, and supplies. Write off food costs as they’re incurred, not as the food is consumed.

Marketing & advertising expenses

Any expense your restaurant incurs promoting itself is deductible. These expenses include paid ads on Facebook or Google, billboards, website hosting, and marketing subscriptions. This expense is also deductible if you pay an independent contractor or marketing company to perform marketing on your behalf.

Vehicle expenses

You can expense your purchased or leased vehicle. This applies if you or an employee drives a business vehicle for work purposes at least 50% of the time. You can expense mileage for business activities like deliveries, picking up supplies, or catering. To do this, keep track of the mileage of a personal vehicle used for business purposes with an app like MileIQ.

Expenses incurred on vehicles like food trucks are also deductible. Keep track of repairs, fees, fuel costs, and servicing.

Staffing costs

• Pay: Employee wages are the main staffing benefit you can and should deduct. Labor expenses typically hang around 25-35% of sales.
• Benefits: Most benefits paid to employees are deductible. Contributions made towards employee benefit plans like health insurance and retirement are typically tax deductible. You can deduct that if you offer paid sick leave or vacation pay.
• Employee meals: You can deduct every meal you provide your wait staff and kitchen crew. Typically, employees eat within the physical premises of the restaurant before or after service or on their break. You can record employee meals as separate expenses or include them within the operating costs.
• Payroll taxes: Besides employee salaries, you can deduct the employer portion of payroll taxes. Restaurants pay state unemployment, federal unemployment (FUTA), social security, and Medicare (FICA).

Capital investments and depreciation

The U.S. Tax Code covers what expenses you can deduct and in what year you can deduct them. Some expenditures are deductible in full the year they're incurred. While others, you’ll have to deduct over their projected useful life.

Section 179 of the U.S. internal revenue code is an immediate expense deduction. Business owners can now fully deduct the cost of capital expenses like business equipment. Before, businesses could only deduct an asset’s value over the course of several years. Section 179 allows businesses to take the entire depreciation deduction in a single year, a practice known as first-year expensing of capitalizing and depreciating the asset over a period of time. 

In 2023, business owners can deduct up to $1,160,000 of qualifying equipment or property purchased during the tax year. This deduction is designed to help small to medium-sized restaurants ease the financial burden of acquiring equipment. 

Some assets don't qualify for this deduction:

• Real estate (Buildings and land)
• Inventory bought for resale
• Intangible assets like patents or copyrights
• Property purchased from a close relative.

Repairs and maintenance

Repairs and maintenance are tax deductible if you don’t capitalize the expenses. The IRS states that routine maintenance keeps your property in good condition without increasing its value or prolonging its useful life. Thus, you can deduct these expenses in the year they occur. 

Here are examples of routine maintenance and repairs that don’t increase the useful life of your assets:

• Changing the oil in your catering vehicle
• Calling a plumber to fix a leaking faucet
• Replacing a glass door that’s chipped
• Weekly window cleaning or gardening
• Nightly janitorial services to clean your restaurant

Charitable donations

If you’re giving cash to non-profits or giving away food, track those expenses to deduct them from your taxes. Aligning your business with charitable causes can improve your public image and exposure.

Restaurants can donate and deduct:

• Food
• Staff time and services (such as catering or delivery)
• Money
• A percentage of a particular day/evening’s food sales
• The profits from a specific dish

Insurance

Restaurant owners can claim depreciation on insurance premiums:

• Property insurance
• Liability insurance
• Workers compensation insurance
• Fire and casualty insurance
• Term life insurance 

Interest expenses

To build a successful restaurant, you may seek outside investment. You can deduct the interest paid on business loans and credit cards. You can only deduct these expenses from the percentage of the balance you generated through business purchases.

Employee Retention Credit (ERC)

If your restaurant was open in 2020 and 2021, you likely received the Employee Retention Credit (ERC) in 2021. If you didn’t receive an ERC payment, contact your tax advisor. This credit is highly beneficial, and almost every restaurant qualifies.

FICA Tip Credit

The FICA tip credit is a general business tax credit available to food and beverage establishments. The premise of this credit is that it’s common for tipped employees to earn less than the minimum wage. The FICA tip credit equals the employer’s portion of FICA taxes paid on tip income over the federal minimum wage.

In an ideal world, the customers leaving the tips would pay the employers half of the employment taxes due on tip income. Since this isn’t possible, the law assigns the employer portion (7.65%) of employment taxes on tip income to the employer. The credit reduces the federal income tax based on the employer’s share of employment taxes paid on a portion of reported tips.

Work opportunity tax credit

The Work Opportunity Tax Credit (WOTC) and Employment Zone Credits (EZ) are wage-based credits for employees who meet specific criteria.

• The formerly incarcerated or those previously convicted of a felony;
• Recipients of state assistance under part A of Title IV of the Social Security Act (SSA);
• veterans
• Residents in areas designated as empowerment zones or rural renewal counties;
• Individuals referred to an employer following the completion of a rehabilitation plan or program
• Individuals whose families are recipients of supplemental nutrition assistance under the Food and Nutrition Act of 2008
• Recipients of supplemental security income benefits under Title XVI of the SSA
• Individuals whose families are recipients of state assistance under part A of Title IV of the SSA
• Individuals experiencing long-term unemployment

This tax credit is helpful to restaurants and employees who qualify. Historically, restaurants have provided equal employment opportunities to individuals while other industries pushed them out. 

The amount is driven by the amount of wages paid to eligible employees. It equals 40% of the employee's first-year wages up to $6,000. This tax credit will expire on December 31, 2025. 

Tax tips for new restaurants

The general advice in this restaurant taxes guide applies to all restaurants, including new ones. New businesses can use a few tax strategies in their first few months or years of operation.

• All the licenses, permits, trademarks, and legal counsel is deductible.
• Startup costs like market research and scouting locations are deductible.
• You can amortize some startup costs instead of taking the entire deduction in the year you open. Do this if you want to receive the tax break in a future year when your business is more profitable.
• Nothing is stopping you from classifying your LLC as an S-corp to lower your self-employment tax obligation and receive corporate benefits.
• You can donate inventory and tools purchased solely for your business opening. You can deduct these donations if they meet the qualifying criteria.
• Resist the temptation to hire temporary workers and classify them as independent contractors to save on payroll taxes and benefits. The consequences for misclassifying workers as contractors when they should be employees are steep.

According to a survey from Restaurant Owner, restaurant startup costs can range between $175,500 and $750,500.

Budgeting for taxes and other expenses

The best way to pay taxes and manage your budget is to have three separate bank accounts.

1. Operations
2. Tax
3. Profits

Take 10% of your weekly sales and put it into your tax account. Since you’re likely obligated to collect sales tax on behalf of your state, you don’t even own that money. Next, take 10% and put it into your profits account. You deserve to make money for your hard work as a restaurant owner. The last 80% should go toward your operation expenses. 

Understand restaurant taxes

As a new restaurant owner, you’ll find yourself spending less and less time in the kitchen and more time in the office. You need a solid plan for your restaurant taxes to operate a successful business. 

Working with a tax professional to help you develop a tax planning strategy is worth the investment. This is not only so you can save money on taxes, but so you can save time too. The last thing you want is to get hit with a surprise tax bill or need to file an extension.

Are you on a tight budget or want to go the extra mile with your tax budgeting and savings? Then consider a tool like ComplYant.