Lance E. Rothenberg, Esq., LL.M., is a tax attorney with Tenenbaum Law P.C., focusing on state and federal tax controversies and disputes. This article does not necessarily reflect the opinions of the editors or management of Restaurant Hospitality.
Successfully operating a restaurant takes grit and passion. We don’t have to tell you that it’s hard work. But rather than focus on the myriad challenges, let’s talk about taxes: Specifically, who must pay restaurant trust fund taxes?
Many operators don’t understand until it’s too late that sales-and-use taxes and payroll taxes are trust fund taxes, which carry personal liability. That means owners and operators can be personally liable for the company’s improper sales-and-use and payroll tax reporting and compliance.
If the restaurant doesn’t pay taxes, the Internal Revenue Service and state tax authority can come after individuals involved with the business. This is true regardless of the type of entity. A corporation or LLC does not offer protection against these types of tax liabilities.1
Here are five key points that every restaurant owner, operator and investor should know:
1. Restaurants are frequent targets for tax audits.
The restaurant industry is a frequent target for audits. Restaurants, bars, taverns, delis, pizzerias and other establishments, from fine dining to dive bars, are all five stars on the tax man’s audit rating scale. At the same time, cash flow issues, low profit margins, and other challenges often lead to periodic crunches for restaurants where choices must be made: pay the landlord; repair the walk-in freezer; upgrade the website and menus; pay the liquor vendor; or pay the sales tax this month. Sound familiar? But tax payments should always be prioritized.
2. Restaurant taxes are complex.
Tax laws applicable to the restaurant industry are complex. For example, sales of food and food products are subject to complicated sales tax rules. Generally, most foods sold by grocery stores are exempt from sales taxes, while prepared foods sold by restaurants are taxable. Employee meals may have special rules. Coupons, Groupons, discounts and gift cards can have special rules. Complimentary meals, by definition, may be offered free of charge, but they are still likely subject to use taxes payable by the restaurant.
What about tip income? Tips employees receive from customers are generally subject to withholding. Employers must withhold income tax, employee Social Security tax and employee Medicare tax on tips reported by employees, as well as upon wages paid. Further, wages subject to withholding generally include all pay given to an employee, including salaries, vacation allowances, bonuses, commissions and certain fringe benefits.
With all of these dizzying tax rules, let alone the task of actually running the restaurant, it’s not hard to see that mistakes can easily be made. And those mistakes can be costly.
3. Certain individuals may be personally liable for sales-and-use taxes and payroll taxes owed by the business.
State sales-and-use taxes and payroll taxes, both federal and state, are considered trust fund taxes. Sales taxes are collected (or should be collected) from customers by the restaurant as a fiduciary for the state. Likewise, payroll taxes are withheld (or should be withheld) from employee wages by the restaurant as a fiduciary for the Internal Revenue Service and states, respectively. Not only is the restaurant responsible, but certain individuals (owners, officers, directors, employees, partners or members) who are active in the restaurant’s management may be deemed “responsible persons” and can be, and often are, held personally liable for taxes owed by the business.
As a general matter, owners, operators and key employees should ask themselves: Are you actively involved in managing the business on a daily basis? Are you involved in deciding which financial obligations are paid? Are you involved in hiring or firing employees? Do you have check signing authority? Are you involved in preparing tax returns? Do you have authority over financial decisions? Are you aware of mismanagement? Are you aware that the business is paying other business expenses instead of trust fund taxes? Each of these can be a factor in determining whether you qualify as a “responsible person” and could have personal liability for business tax debts.
As for payroll taxes, have you outsourced your payroll reporting to a third-party payroll company? Good, but you may still be responsible and liable for any improper withholding.
4. Accurate record-keeping is critical.
What can you do to minimize your exposure? As with all things, the best defense is a good offense. In the tax world, that means maintaining good books and records. Not only do inaccurate or incomplete records make it impossible to know how your business is doing, it’s lethal in a tax audit. Accurate records are essential in tracking deductible expenses, verifying sales, recording purchases and validating proper withholding.
Poor record-keeping can make it difficult to challenge an audit, and can lead to serious financial consequences to both the restaurant and its owners and operators. Furthermore, states and the Internal Revenue Service impose statutory record-keeping obligations upon businesses that require records to be made available to an auditor for inspection. Failure to maintain proper records can lead to audit methodologies that may produce wildly different findings than the actual books and records would have otherwise shown.
5. The consequences of improper tax compliance are severe.
A trust fund tax problem could lead to financial ruin. Penalties and interest can be imposed on the business, as well as any responsible persons, for failing to pay sales tax or properly withhold. A business may also have its sales tax license revoked or, in egregious cases, could face criminal prosecution.
Taxing authorities may use a combination of enforcement methods, such as liens, bank levies, income executions and business seizures, to collect what is owed. Some states have additional methods. For example, New York can suspend a taxpayer’s in-state driver’s license if he or she owes more than $10,000 in taxes, penalties and interest. Similarly, the Internal Revenue Service can suspend a taxpayer’s U.S. Passport if he or she owes more than $50,000 in taxes, penalties and interest.
If you have a tax compliance problem, many tax authorities offer relief in the form of voluntary disclosure programs, where a taxpayer can voluntarily come forward before an audit and agree to pay back taxes in exchange for the state agreeing to waive penalties and criminal charges.
Restaurants have many tax and accounting obligations from local, state and federal governments. It is essential that owners and operators develop a basic understanding of these requirements, or hire competent and trustworthy advisors to act for them. Taxes are a cost of doing business. While there are lawful ways to minimize them, there is simply no way to avoid them.
1This discussion is general in nature. Sales-and-use taxes are administered separately by each of the 45 states that impose a sales tax. Further, payroll withholding taxes are also separately administered by the states, as well as the Internal Revenue Service. For specifics for your state or issue, please contact a tax professional to discuss proper compliance and how to resolve a tax dispute.
Lance E. Rothenberg is a tax attorney with Tenenbaum Law P.C. in Melville, N.Y. Rothenberg focuses on state and federal tax controversies and disputes, and has experience assisting a wide range of businesses and owners facing federal, state, local and multistate tax issues, including sales-and-use taxes, corporate income taxes, personal income taxes and excise taxes. You can reach him at [email protected], and at (631) 465-5000.