Due to the COVID-19 State of Emergency, many states have announced tax relief programs and tax filing extensions. The deadline to file and pay federal taxes has been extended to July 15 , while the deadline to file and pay California state taxes has been extended to July 31. For California businesses, please visit the COVID-19 page on CDTFA’s website to learn more.
In this world nothing can be said to be certain, except death and taxes.
— Benjamin Franklin
Taxes are an inevitable part of life — which wouldn’t be much of an issue if they weren’t also so complicated.
As a restaurant owner, you’ve likely discovered that the world of restaurant sales tax is especially complex. You have to account for variables such as to-go vs dine-in orders, mandatory service charges vs optional tips, inventory spillage and spoilage, etc. Even worse, restaurants are prime targets for tax audits.
It’s vital that you calculate, collect, and pay sales tax correctly. Failing to do so puts your business at risk of hefty fines. Even small miscalculations can quickly add up to a serious issue. Ignorance of tax law is also no excuse.
A restaurant POS in place can keep you compliant. It helps simplify the process of both calculating and collecting sales tax. You can also track inventory spoilage, cash transactions, online to-go orders, and more. These are all vital records to have on hand in the case of an audit.
Let’s break down restaurant sales tax into a bit more detail.
The Basics of Restaurant Sales Tax
All businesses are responsible for calculating and paying federal tax. As an employer, you are also responsible for calculating and paying employee payroll tax. This includes Medicare, Unemployment, and Social Security.
For most restaurants though, the focus is on sales tax.
There is no federal sales tax, but each state sets its own sales tax rate and regulations. Unfortunately, state-level sales tax can be incredibly confusing. This is especially true of California’s sales tax laws.
But First – What Is Sales Tax?
Sales tax is a tax on the sale of goods or services.
As a business owner, you are responsible for:
- Calculating the correct sales tax on the items you sell
- Collecting that tax from your customers
- Passing it onto the tax authorities in your state
In addition, you must be able to prove the accuracy of your sales tax returns in the case of an audit.
Using California as an example — nearly all goods and services sold in the state are taxable. However, the exact rules are much more complicated. As a restaurant business, there are a lot of variables you must consider including where you are located, what you sell, and whether orders are dine-in or to-go.
Sales Tax By State, County, and City
Your restaurant’s location is a significant factor in how you calculate sales tax.
California has state-level sales tax guidelines that apply to restaurants throughout the state. The state-level sales tax rate is currently 7.25%. This breaks down into 6% that goes to the state and 1.25% that is passed onto city- and county-level tax officials. However, not all food items in restaurants are taxable at the state level.
Moving to the county level, you might have to add additional tax to your sales tax calculation. Out of the 58 counties in California, only 7 impose no additional sales tax. The rest impose extra sales tax ranging from just above 7.25% to as high as 10.50%.
Most cities in California have passed additional sales tax laws to bring in city revenue. These are even more complicated as they are often imposed in very specific cases. For example, Berkeley, California was the first US city to impose a penny-per-ounce “sugar tax” which specifically targeted sodas and sugary drinks. This tax is very unusual, but as a restaurant owner, it is your responsibility to make sure you are following all sales tax regulations, no matter how new or novel.
Sales Tax on Dine-In vs To-Go Orders
Not all restaurant orders are treated equal under state sales tax laws. In fact, as a restaurant owner, you will often be required to track and tax sales differently depending on whether they were for dine-in, delivery, or to-go.
In California, a dine-in order is almost always considered taxable. Dine-in refers to any restaurant food that is sold for consumption at the restaurant location. This could mean you have your own restaurant dining room or it could apply to a communal dining area, such as a food court.
In California, food sold to-go is a bit more complicated. Cold foods — such as sandwiches, smoothies, cold salads, and similar items — are not taxable if they are sold individually as a to-go order. On the contrary, hot prepared food sold to-go is taxable unless it is a “hot baked good.” Even more complicated is when you have an order with a combination of hot and cold foods. In this case, the whole order may be taxable if the items are sold as a package, or not taxable if sold individually.
To-go orders that involve drinks also have their own sales tax regulations in California. Hot beverages such as coffee and tea are not taxable. Soda and alcoholic drinks are taxable, even if ordered to-go.
Sales Tax on Online Orders and Deliveries
Many restaurants now offer online ordering and delivery options. Sales tax collected on these orders must also account for state sales tax regulations.
In general, deliveries are considered the same as to-go orders under California law. If the order is only cold foods, you don’t have to collect sales tax. If the order includes hot, prepared food however, the same tax will apply as if the order was to-go from your restaurant. The delivery fee is taxable if the order is taxable, but not taxable if the order is of untaxed cold foods.
Taking online orders directly from your customers does not change sales tax regulations. However, if you use a third-party company for online ordering and delivery, sales tax collection will depend on the legal business agreement.
If the online ordering service provider is acting as your restaurant’s agent, you are responsible for collecting tax. If the agreement does not establish an agent relationship, then the online ordering service provider is seen as a retailer reselling your food items to the public. In this case, they are responsible for collecting sales tax.
Restaurant Sales Tax Is Confusing!
As you can see, collecting sales tax as a restaurant is incredibly complicated — and we haven’t even covered all the sales tax exceptions and exemptions your restaurant might encounter.
Even worse, sales tax regulations are constantly being updated at both the state and local level. As a restaurant owner, it is your responsibility to keep yourself informed of new regulations and to implement them in your restaurant.
The Risk of a Sales Tax Audit
If all the complications of sales tax weren’t bad enough, restaurants are also prime targets for sales tax audits. As a restaurant owner, you will face increased scrutiny — which makes it that much more important to correctly calculate, collect, and report sales tax.
In 2014, the California State Board of Equalization reported that 1 in every 4 food service establishments were noncompliant when it came to sales tax. This is not that surprising when you look at the business model and regulations placed on restaurants.
Lots of Cash Transactions
Restaurants often have a particularly large amount of cash transactions. This doesn’t apply to all restaurants, but customers — especially at small cafes and coffee shops — are much more likely to use cash.
Cash transactions are harder to track and are more prone to reporting mistakes. This could be due to employees giving incorrect change or simply pocketing some cash transactions without reporting them at all. In both cases, it’s easy for sales tax calculations to be off when you are dealing with lots of cash.
Cash is also a red flag to tax authorities as it is often involved in business fraud.
High Employee Turnover
Another issue for restaurants is the high employee turnover rate. When you have new employees working your register, it is much easier for sales tax issues to arise. New employees are more likely to inaccurately report cash transactions if they are unfamiliar with your POS.
Disgruntled ex-employees can also cause you problems when it comes to sales tax. Sometimes the issue is a false report to the tax authorities, leading to an audit. Without restrictions on POS access though, this can sometimes be an issue of deliberate sabotage of your system by a disgruntled employee.
Inventory Spillage and Spoilage
As a restaurant, you also face increased tax scrutiny and a higher chance of an audit simply because of what you sell. Unlike many retail businesses, a restaurant’s inventory is highly unstable and volatile. Spillage and spoilage is part of the business. However, if you report above-average numbers, that is a major red flag to tax authorities.
Being able to prove you really did have spoilage or spillage is vital. If you can’t, tax authorities may assume you are underreporting sales to reduce your tax obligation. In this case, an inventory management system is essential.