A Simple Guide to Income Tax Preparation for Restaurants
By Brian Smith, EA
Director of Compliance, RASI
As a best practice, a restaurant owner’s income tax preparation should start at the beginning of the tax year. Those who begin preparation at the end of the tax year face the reality of lacking accurate and up-to-date financial statements, making year-end tax preparation a more painful process. Although most operators despise record keeping and accounting, that does not change the filing requirements. This article will discuss a simple guide to take even the most unkept of operators through a tax season, well-prepared and armed with best practices for a smooth tax journey.
The Importance of Accurate Financial Statements
Creating a streamlined method of recording income and expenses that can be easily adhered to is imperative for accurate and up-to-date financial statements. The first step to sure-fire record-keeping is automating your invoices and integrating your accounting system with your POS (Point of Sale). This technology will ease the burden of completing the mundane, daily accounting tasks on your own (or paying excessive money for a bookkeeper on staff to do it for you). Implementing technology to ease this process is a surefire stress reliever. The inaccuracy of human error and lack of consistency because operators are “too busy to perform accounting tasks” leads to inaccurate financial statements, ultimately costing you money through higher income taxes owed to the IRS (Internal Revenue Service). Suppose you do not take proper care to record accurately and timely. In that case, expenses can be understated, leading to higher taxes. Interest can be assessed for late or inaccurate filings with the IRS and higher financing costs because the business does not appear to be a worthy borrower. It’s important to note that Lenders charge higher interest rates to businesses deemed unworthy borrowers. Moreover, inaccurate financial statements lead to lengthy, expensive, arduous year-end tax processing.
The Power of The Balance Sheet
Many operators are probably wondering, “how do I even begin?” Accurate financial statements and tax returns start with an accurate balance sheet; the income and expenses (i.e., your P&L) are on point when the balance sheet is on point. Keeping the balance sheet accurate and up to date can be time-consuming, so having the fewest amount of balance sheet accounts for your financial activities is the easiest way to achieve an accurate balance sheet. Fewer accounts on the balance sheet provide fewer hiding places for items to be forgotten. Make a concerted effort only to add accounts to the balance sheet when necessary. For example, when the business purchases a large asset, takes out a loan, opens a line of credit with the bank, or needs to record expenses paid on the company credit card; these activities require a balance sheet account. Developing strong balance sheet management throughout the year will ease the pain of tax preparation. If something on your balance sheet looks off or does not make sense to you, ask your accountant immediately. Waiting will exacerbate the issue noticed and take much longer to fix when the issue you noticed could be as simple (and easily fixable) as miscoded expenses.
Reducing your Tax Liability
When preparing a business’ tax return, the goal is to lower your tax liability to the lowest legal amount – a taxpayer should not pay a penny more in tax than what is owed. Reducing your tax liability begins with ensuring all business expenses are recorded in the correct period and for the correct amount. Often operators ask, “can you claim appliances on taxes?” Under the Internal Revenue Code (IRC) Section 162, a deductible business expense includes any expense that is ordinary and necessary to run a restaurant. Common deductions in restaurant expense categories include: Cost of goods sold (COGS), restaurant and kitchen supplies, rent, utilities, labor, advertising, employee benefits, insurance, legal and professional fees, office/accounting, outside delivery services, credit card processing fees, repairs and maintenance, and interest are all examples of the most common deductible restaurant expenses.
- Purchases of small equipment like a fryer, griddle, flat top, or slicer can be deducted on the business tax return as an expense of small kitchen equipment. Small purchases of up to $2,500 for equipment that will last more than 1 year can be fully deducted as an expense in the year purchased.
- According to IRS rules and regulations, larger equipment purchases that are more than $2,500, like an industrial-size mixer or a pizza oven, need to be capitalized on the balance sheet and depreciated, i.e., expensed over several years in the future. However, through the tax year 2022, current tax law allows restaurants to deduct 100% of the purchase price of an asset costing more than $2,500 through bonus depreciation expense. This allows the restaurant to reduce taxable income by the total amount of large equipment purchases, even if a loss is created by deducting the total cost of a large asset.
- For tax years 2023 and after, a Section 179 election can allow a taxpayer to take a higher deduction for depreciation, with some limitations, in the year a large asset is purchased. However, total Section 179 deductions cannot be greater than taxable income and, therefore cannot generate a loss.
How Can Generating a Loss from Bonus Depreciation Help a Taxpayer?
A taxpayer that owns a restaurant and has other sources of income, for example, could offset taxable income from those alternate sources with a taxable loss from the restaurant in order to reduce the total tax owed by the taxpayer. Increasing depreciation expense through bonus depreciation is one way to reduce taxable income, but this only applies to a restaurant that made a large number of equipment purchases during the year or made improvements to the restaurant.
Restaurant Tax Credits vs. Restaurant Tax Deductions
A tax credit is another path a taxpayer can take to reduce the business’ tax liability. A tax credit does not reduce taxable income; it directly reduces the amount of tax owed. A $100 tax credit reduces your tax liability by $100; a $100 restaurant tax deduction (expense) reduces your tax liability by the amount of tax on $100, which would be $37 at the very most and in rare circumstances. Therefore, a tax credit is much more valuable than a restaurant tax deduction.
There are many tax credits that apply in rare circumstances and to very few taxpayers. However, the restaurant industry has a credit that applies to every restaurant that accepts tips. A credit can be claimed on the business’ tax return for the payroll tax (Social Security and Medicare tax) paid on eligible tips. The payroll tax paid on eligible tips can reduce the tax liability of the restaurant dollar for dollar. Example: A $100 tip-credit will reduce the tax liability of the restaurant by $100. This credit is claimed on IRS Form 8846; if the tax package you received from your tax preparer did not contain IRS Form 8846, it is time to find a tax preparer that specializes in restaurants!
Utilize a Hospitality-Specific Accountant!
A fair amount of complexity goes into tax preparation, ensuring your restaurant takes advantage of valuable credits and reduces tax liabilities correctly. A tax preparer familiar with server tip-outs, and daily discounts of credit card deposits for loan payments, will better serve your tax needs because they understand the restaurant industry and know the tax laws that apply and how those laws apply!
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