Coming out of the COVID-19 pandemic, states are predictably desperate for cash as their revenue streams have been cutoff while their spending has skyrocketed in 2020. To help solve this problem, state revenue agencies, like the Illinois Department of Revenue (IDOR), are under significant pressure to collect sales tax, as it represents about 19% of Illinois’ total revenue. In fact, as of Jan 1, 2021, Illinois has the highest combined sales tax rate in the United States, coming in a whopping 9.76%. To maximize their revenue collection, the IDOR has substantially increased audits of restaurants, bars, and convenience stores, as these industries historically have the high levels of underreporting. These industries are also among the easiest to audit thanks to third-party reporting.
This article discusses the rules relating to the restaurant industry audits, as well as common sales tax audit tactics used by the IDOR and some solutions you definitely want to know about if you are in the restaurant industry in Illinois.
Illinois Sales Tax Basics for Restaurateurs
Generally, the sale of tangible personal property is subject to sales tax (called “retailers' occupation tax” in Illinois), unless there is a specific exemption that removes it from Illinois taxation. Food is tangible personal property because it can be seen, weighed, measured, felt, or touched. So, unless an exemption applies, it’s generally taxable. While most states provide a sales tax exemption for grocery store food items that are taken home for consumption, Illinois does not. Rather, Illinois imposes a 1% sales tax rate on these items. Additionally, Illinois imposes it’s statewide sales tax rate of 6.25%, plus applicable local sales taxes, on all sales of food that are “prepared for immediate consumption.”
So, the tax rate to be charged on a given food sale depends on whether Illinois considers it to be prepared for immediate consumption. The answer can generally be broken down as follows.
Illinois state and local sales tax applies to food if:
- The food is sold hot or heated.
- The food is sold for on-premises consumption.
- The food is prepared or sold ready to be consumed without delay (i.e., sandwiches, salads, coffee, etc.).
- The establishment making the sale has an area for patrons to consume food (like a dining area with tables and chairs). If an area to consume food is provided the IDOR automatically assumes that all sales of food by that retailer are prepared for immediate consumption. However, if both of the following conditions are met, the IDOR will not default to this assumption:
- The dining area is physically separated or clearly distinct from the area where food not for immediate consumption is sold; and,
- The business records and accounts for receipts from sales of food prepared for immediate consumption completely separately from the rest.
- Different rules apply to soft drinks, candy, and alcoholic beverages.
- Depending on business location, you may also need to collect MPEA Food and Beverage Tax.
Illinois Sales Tax on Food Orders for Takeout and Delivery
While selling food To-Go or for delivery isn’t a new concept, it has become the only way to survive for most restaurants this past year, which makes the taxation around the subject that much more important. While the taxability of food sold to-go and for delivery is in line with what we previously discussed, what about the delivery fee itself?
Illinois taxes delivery charges if:
- The delivery charge is not separately stated on the bill; or
- The customer does not have the option to pick up the order (delivery is mandatory).
If your restaurant makes sales through a service that is considered to be a marketplace facilitator by Illinois (like Uber Eats, DoorDash, etc.), they are required to collect and remit sales tax on the orders they facilitate for your business if the following conditions are met:
- The facilitating service lists or advertises your food or drink menu; and
- The facilitating service provider either directly or indirectly collects payment from the customer and provides it to you regardless of whether the service provider receives compensation for its services.
However, there are some exceptions for the Chicago area. Specifically, a facilitating service is liable for Chicago Home Rule Municipal Soft Drink ROT when the seller (restaurant) is located in Chicago.
Are Discounts and Tips Subject to Illinois Sales Tax?
Taxability of tips and discounts are also common issues that come up in the restaurant industry. In Illinois, tips are not taxable so long as they are not mandatory, and they are distributed to the employees.
Discounts offered by a restaurant, such as a happy hour, generally reduce the sales price of the food or beverage before the sales tax is applied. Therefore, sales tax is reduced because it is calculated as a percentage of the reduced sales price. This is logical as you wouldn’t collect sales tax on revenue you didn’t receive.
Where it gets more complicated is when a third-party coupon is applied to a bill. In this case, if the restaurant is accepting the third-party coupon as a partial payment, with the intention of being reimbursed by the third-party for the amount discounted, sales tax should be applied to the full amount before applying the coupon.
Common Tactics of Illinois Sales Tax Auditors
When the Illinois DOR audits a restaurant or bar, the audit usually begins with the auditor having an advantage right off the bat. That is, they can see all your credit card sales from the 1099-k report you submit to the IRS. Next, the auditor will request bank statements, point-of-sale reports, and other similar documentation from you. The actual ‘audit’ is quite simple once these documents are obtained:
If the total sales reported to the DOR on the sales and use tax return is less than what is shown on the 1099-K, the auditor will use the 1099-k as the basis for your total sales. Then, the auditor will assume some amount of cash sales and add that to your total sales figure.
Once the IDOR auditor has a figure for “total sales” (aka the highest number feasible) they will compare it to your sales and use tax return and write up the difference as taxable, and that will be your tax liability unless you are able to prove to the IDOR that they are wrong. Unfortunately, in sales tax, you are guilty unless you can prove your innocence.
Combating a ‘guilty until proven innocent’ is not impossible but can be difficult. Some methods to support your case often look like this:
- The 1099-k report only has credit card sales, and the auditor most likely estimated your cash sales. So, any documentation that can show that their estimation of case sales was too high, will help reduce your liability.
- Your 1099-K likely includes nontaxable items such as tips, and possibly tax-exempt charges, like delivery some fees and third-party service fees, such as DoorDash.
If your restaurant is under audit, it is critical to determine your nontaxable sales and ensure they are backed out of your 1099-k report.
Strategies to Reduce an Illinois Sales Tax Assessment or Prevent an Audit
In addition to the strategies already discussed, these tactics shouldn’t be overlooked when defending your business against an Illinois sales tax assessment, or in some cases, prevent the audit in the first place:
- Compare your Illinois Sales Tax Return against third-party data. You know the auditor is going to rely upon the third-party data they have access to, like your federal income tax return and your 1099-k report, so it’s wise to proactively pull it and review for accuracy. Once you’re satisfied that the IRS report is accurate, compare it to your Illinois sales and use tax return, better yet, have our sales tax experts do it for you. If there are inconsistencies, we can help you clean up your records and procedures to keep you out of trouble going forward and reduce past exposure by amending returns or filing a voluntary disclosure.
- If your records are a mess or you find large discrepancies, consider the IDOR voluntary disclosure program. If your 1099-K’s and your federal income tax return greatly exceeds your sales tax returns, you should consider a voluntary disclosure. The voluntary disclosure program benefits your business by taking penalties off the table, and in most cases, the IDOR agrees not to audit the period(s) disclosed, allowing you to aggressively disclose your true sales figure without retribution, rather than having the auditor overestimate your sales for you. Additionally, entering into the VDA program dramatically decreases the odds of being audited by the state. The VDA program is only available if you contact the state first.
- Do your homework before the audit starts. Start doing your homework and audit preparations immediately after receiving an audit notice from the IDOR. Knowing what we discussed here, at a minimum, pull your 1099-k’s, POS reports, and Illinois sales tax returns for the period being audited. If the auditor requests documentation that you know is going to result in higher sales amounts, consider not producing or if you do produce, have an explanation prepared.
- Carefully account for nontaxable sales. Tips are the number one nontaxable item that is likely shown on your 1099-k. Remember, the 1099-k reports total dollars you received via credit card from a given bank. It’s critical that you have a breakdown to account for the portion that is tips, otherwise, the auditor will treat the entire report as taxable. In the absence of other documentation showing tips, pull your IRS W-3 report as it should show tips paid to employees.
- Carefully consider documentation provided to the auditor. Generally, less is more during a sales tax audit. While it’s important to work with your auditor professionally, and in good faith, they don’t necessarily need everything they ask for and you should consider potential consequences of providing unnecessary documentation. You should provide documentation that reasonably shows your sales, but anything beyond that should likely not be provided as it isn’t necessary. Our team sees restaurants that have over-provided documents to the IDOR on a daily basis and the results can be very damaging. The more documentation provided, the more likely it is that the IDOR will finish their audit with an extravagant sales tax assessment. Be careful, think ahead, and always know the answers and outcomes of the documentation provided to the state. Or, better yet, get a sales tax professional on your side who can evaluate what to and what not to provide to the auditor.
- Do not sign anything or make a payment on an assessment until you have talked with someone experienced in Illinois sales tax audit defense. In Illinois, making a payment or signing an audit report, waiver of restrictions, or form IL-870, among others, automatically waives your right to a review of your matter by the Informal Conference Board (ICB).
As the Illinois DOR increases its access to, and reliance on, third-party reporting, industries like restaurants and bars can expect to see an increase in the number of audits conducted. Knowing what info the Illinois DOR has access to and how they use it during a sales tax audit is the key to successfully managing the auditor and the outcome. For businesses that will inevitably have a hefty sales tax liability after an audit, it makes even more sense to be proactive and consider hiring a professional to help amend incorrect sales tax returns or file a voluntary disclosure.
Whether you’ve just received an audit notice or you’re losing sleep over how to limit your current sales tax liability, it makes sense to talk so a sales tax professional with a proven track record. Schedule a free 30-minute call with one of our sales tax experts. Whether you hire our firm or not, we offer a thorough and honest evaluation for free so you can decide how to proceed with knowledge and confidence.