SELECTED TAX TIPS FOR RESTAURANT OWNERS
By R. David Marchetti
Wells Marble & Hurst, PLLC
www.wellsmarble.com
In this article, you will find some “tax tips” that will, hopefully, be helpful to you
as a restaurant or franchise owner.
Choice of Entity- First, briefly outlined are the advantages and disadvantages of various
forms of business entities. The choice for the vast majority of our clients will come down
to three entities. The C corporation, the S corporation or the limited liability company
(LLC). We rarely recommend C corporations except in the case of high-income
individuals needing or desiring self-provided employment benefits. For this reason we
have limited our discussion of C corporations. We typically recommend the S
Corporation for actively managed businesses that are expected to produce substantial
ordinary income, but with little likelihood that the value of the entity’s assets will
increase in value, and we generally recommend the LLC (taxed as a partnership or a sole
proprietorship) for passive investments, especially rental real estate, and where the assets
are likely to appreciate in value.
Based on the foregoing comparison, we conclude the LLC is best in asset-based entities
where the assets are expected to increase in value and generate rent and or capital gains.
S corporations are generally best for active businesses where the value of the business’s
assets are not expected to increase in value and where self-employment tax will likely be
an issue. C corporations should be used cautiously in the limited situations described
above.
Lease vs. Own Your Building- Liability protection concerns would indicate that you
should not own your building inside your operating entity. Generally we DO NOT
ADVISE that corporations own real estate. On the other hand, passive loss rules and the
"self-rental" rule may kill your real estate deductions. You may not be able to adjust the
rent to maximize use of losses. This can be solved by owning the building in the
operating entity and just buying additional liability insurance. Section 469 “Grouping” or
Aggregation Rules can let you have your cake and eat it, too! If you own the building
and rent it to your business, you can elect to treat them as one activity. This tax-favored
treatment allows tax deductions for your rental property losses. You must own both
businesses in the same proportion, but husband and wife filing jointly qualify as one
taxpayer for this purpose. Also works if an LLC or S Corporation owns the building, so
long as ownership of the operating and real estate entities proportion.
Example- Harvey and Wilma are married and file a joint return. Harvey owns an S
Corporation that operates a restaurant. Wilma owns an S Corporation that owns the
building and rents it to Harvey’s restaurant. Because Harvey and Wilma file a joint
return, they are treated as one taxpayer for purposes of the passive loss rules. Thus,
Harvey is deemed to own 100% of both the restaurant and the rental property, and Wilma
owns 100% of the restaurant and the rental property.
Suppose Harvey and Wilma make the election when the restaurant earns $300,000 after
paying salaries of $200,000 and rent of $100,000. The rental property shows a $50,000
loss. Actual rental expenses were $150,000.
With no grouping, the loss cannot be used because of the passive loss rules. With
grouping, you get the following result:
Restaurant Corp.:
Taxable income before grouping
Add back rental
Less: Rental expenses
Adjusted taxable income
$300,000
$100,000
(150,000)
$250,000
Compare taxable income of $300,000 to $250,000 because of the ability to use the
$50,000 loss.
CAVEAT 1: You may not group personal property and real property rental operations.
CAVEAT 2: You may NOT group a rental with a C Corporation, except to determine
“material participation.”
Sales and Use Tax- Use Tax is imposed on purchase of item from out-of-state vendor for
use in Mississippi if the vendor does not collect Mississippi sales tax. Don’t ignore use
tax. There is a tendency for your accounts payable clerk to just pay the invoice as billed
and ignore the fact that sales tax was not collected by the out of state vendor. Over time,
this liability can accrue to significant sum, and penalties and interest will be imposed
when finally audited.
Responsible Party Rules. Corporate officers and 10% owners can be held liable for
payment of tax in the event the business fails to properly remit the tax. Never prefer
another creditor over money owed to the Department of Revenue for sales or use tax.
Most other creditors can be dismissed in bankruptcy but the Department of Revenue will
simply look to the officers and directors to pay this amount.
Coupons. A retailer’s coupon is considered a price adjustment that occurs at the time of
sale; therefore, the coupon is deducted before sales tax is calculated.
Employee Meals. If the restaurant gives the meals to his employees without charge, the
sale is exempt from sales tax. If the employees pay at a discounted rate, sales tax is
imposed at the price charged.
Withholding Taxes
1.
2.
A. Federal – Direct Deposit – Form 501.
Income Tax
FICA
1.
B. State – No Deposit. Remit to Department of Revenue.
Mississippi Income Tax
C. Federal Unemployment Tax (FUTA) – See “Circular E, the “Employer’s
Tax Guide.” Form 940 Due Jan 31
D. Mississippi Unemployment Compensation Insurance – Register and pay to
Mississippi Employment Security Commission.
E. Withholding on “Tip” Income.
1. Section 3121(q) – Tips are deemed to be paid by the employer for FICA purposes.
2. The remuneration is deemed paid at the time the employee provides a written
statement of the tip amount to the employer, but is not required if tips are less
than $20/month. Form 4070 may be used for this purpose. See, Pub. 1244
3. Employer must report and withhold income and FICA taxes on tip income
reported on Form 8027 “Employer’s Annual Information Return of Tip Incomes
and Allocated Tips.”
4. You do not have to withhold on unreported tips.
5. You do not have to pay the employer’s share until the IRS makes notice and
demand. Rev. Rul. 2012-18.
6. You are responsible for your share of FICA tax on all tip incomes, whether
reported or not.
7. “Aggregate Estimation Method” - In U.S. v. Fior d’Italia, Inc., the United States
Supreme Court approved this method of computing the employer’s FICA tax. In
this case, the IRS looked at the 8027 and noticed that “reported tips” were less
than “charge tips.” The IRS observed that average credit card tips were 14.49% in
1991 and 14.29% in 1992. The IRS applied those percentages to total receipts,
assuming cash customers tipped at the same rate, not necessarily accurate, but the
Court upheld it.
EDUCATE YOUR EMPLOYEES!
8. 8 % Rule for “Large” Restaurants
 Large" equals more than 80 hours per day worked by all employees.
 Tips must be allocated to employees if the total tips reported are less than 8% of
total sales (adjusted for carry-out sales, service charges, and sales taxes).
 Allocation can be based on each employee's share of gross receipts, hours
worked, or another method based on an argument with your employer. Most
restaurants use the gross receipts method. Remember, you only withhold on
income and FICA taxes on reported tips, not on allocated tips.
 Publication 1874 P "Tips on Tips - A Guide to Reporting for Employees in the
Food and Beverage Industry."
 IRS Pub. 531 “Reporting Tip Income”
 Have a tip reporting policy in your employee manual
 Distribute the two publications
 Remind them at staff meetings
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Employer’s Tip Credit (Section 45B)
Income tax credit for employer's FICA taxes paid on tip income.
Credit reduces the amount of income tax deduction for FICA taxes paid.
Only applies to tip income in excess of that needed to bring the employees' wages
up to $5.15/hr (minimum wage as of 1-01-07).
Example: Felix is a waiter in ABC restaurant. He is paid $2 an hour plus tips. During
the month, he works 160 hours for $320 and receives $2,000 in cash tips. Felix's $2 per
hour rate is below $5.15 minimum wage (as in effect 1-1-07) by $3.15/hr. Thus for 150
hours worked, he is below minimum rate by $504 (150 x $315). For Felix therefore, the
first $504 of tip income just brings him to the minimum rate. The rest of the tip income
is $1,496 ($2,000 - $504). Felix's employer pays social security taxes at the rate of
7.65%. The employer's credit is thus $114.44 for the month ($1,496 x 7.65%).
10. Agreements with the IRS
YOU ARE UNDER NO OBLIGATION TO ENTER INTO ANY
AGREEMENT WITH THE IRS AND MAY BE UNNECSSARY IF YOU ARE
OTHERWISE IN COMPLIANCE
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Tip Rate Determination Agreements (TROA)
Tip Reporting Alternative Commitment (TRAC)
Employer-designed Tip Reporting Alternative Commitment (EmTRAC)
Publication 1875, Tips on Tips – for employer
Publication 1872, Tips on Tips – for employees
11. Mississippi DOR says withholding not required on cash tips paid directly to the
employee. If employer distributes to employee, then they are subject to
withholding.
12. Tip vs. Service Charge Rev. Rul 2012-18
In order to be a tip: (Rev. Rul 59-252)
1) The payment must be free from compulsion.
2) Customer must have unrestricted right to determine amount.
3) The payment should not be the subject of negotiation or dictated by employer
policy.
4) Generally, the customer must have the right to determine who receives the
payment. Otherwise, it’s a service charge and you must withhold whether
reported or not.
Franchise Tax1. Tax on corporations, not LLCs or partnerships, for privilege of doing business in
Mississippi.
2. Due annually as long as the corporation remains incorporated, domesticated, or
continues to do business in Mississippi.
3. Minimum due is $25.00
4. Rate is $2.50 per $1,000 of value of the capital employed or the assessed property
values in this state, whichever is greater, but not less than $25.00.
5. Return due March 15th if corporation is on calendar year.
 Employee Meals
If provided during working hours for the convenience of the employer, are not considered
taxable gross income to the employee and are 100% deductible by the employer.
 Gift Cards
 Section 451 - Income recognized when card sold, unless:
 One or two year deferral of recognition of income for accrual method
taxpayers who meet certain requirements. Rev. Proc. 2011-18.
 Payroll Tax Cut – 2012 Middle Class Tax Relief Act
 2% reduction in withholding deduction (6.2% to 4.2%).
 Extended to balance of 2012.
 Applies to self-employment income as well (rate reduced from 12.4% to
10.4%).
 Social Security Wage base is $110,100 for 2012.
 An employee making the maximum wage base will save $2,202.
 Other TIPS
1. If you are in a C Corporation, how can you get money out of the company
tax free?
1) Repayment of loan to the corporation.
2) Borrow money from the corporation.
3) “Reasonable” compensation.
4) Rent property to the corporation.
5) Fringe benefits.
6) Sell property to the corporation.
1. Employ your children as soon as they are of age (14).
1) Income shifting (income and FICA).
2) Income tax can be eliminated totally by child contributing to an
IRA.
3) “Kiddie tax” does not apply to wages.
4) Child must actually work and compensation must be “reasonable”.
Smallwares- A new IRS procedure allows restaurant and tavern owners to change
accounting methods and expose the cost of replacement dishes, glassware and other items
that previously had to be depreciated. The smallwares method of accounting allows
restaurants and taverns to deduct these replacement items in the year purchased.
Use Form 3115 to elect this method.
Rev. Proc. 2002-12.
 “Reasonable” Compensation
 What is reasonable?
 No simple formula.
 IRS tries to determine what similar companies would pay for comparable
services.
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TIP:
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“Reasonable” Compensation (Cont.)
Factors Include:
Duties of employee.
Time required to perform duties.
Employee's skill, ability and accomplishments.
Complexity of the job.
Gross and net income of the business.
Employee's compensation history.
Company's salary policy for all its employees.
Document reasons for compensation in minutes.
Avoid paying compensation in proposition to stock ownership.
Keep in line with similar businesses.
Be sure to pay at least some dividends.
 Section 179 Expense Deduction
 Immediate deduction (rather than capitalize and depreciate) for certain property
up to certain limits.
 Deduction limit is $139,000 for 2012.
 Phase out if more than $560,000 of qualifying property is placed in service during
2012.
 Qualifying Property - Must be "tangible personal" property (NOT real estate and
not intangibles).
 Up to $250,000 of leasehold improvements on restaurant property and off-theshelf computer software.
 Must be acquired by "Purchase".
 Beware of recapture if you dispose of the property before end of the cost recovery
period that otherwise would have been applicable.
OTHER TIPS
PUT IN PLACE A GOOD ESTATE PLAN AND A BUSINESS SUCCESSION PLAN
WHERE APPROPRIATE!