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 New York Department of Taxation and Finance, are under significant pressure to collect sales tax, as it represents about 17% of New York’s total revenue. To maximize their efficiency, the NY Dept. of Taxation and Finance has considerably increased audits of restaurants, bars, gas stations convenience stores, and even car dealers, as these industries historically have the highest levels of underreporting. These industries are also among the easiest to audit thanks to third-party reporting.
This article focuses on the rules relating to restaurant and bar audits, as well as common sales tax audit tactics used by the NY Department of Taxation and some solutions you definitely want to know about if you are in the restaurant industry in New York.
New York Sales Tax Basics for Restaurateurs
Generally, the sale of tangible personal property is subject to sales tax unless specifically exempt. Food sold in a restaurant is considered ‘tangible personal property’ because it can be seen, weighed, measured, felt, or touched. However, New York State further narrows and divides the taxability of food based on how it is prepared and where it will be consumed. Specifically, NYS taxes the sale of “Restaurant-type food,” or food and beverage that is ready for consumption when sold, with few exceptions. Grocery store food, or items that are not altered by the restaurant and are taken home for consumption, are exempt from New York sales tax. To provide some clarity, the table below categorizes common sales as taxable or non-taxable in NY:
New York 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, so it deserves a bit more detail. The taxability of food sold to-go and for delivery is in line with the table above, but what about the delivery fee itself?
In New York, If your restaurant charges for food delivery, the delivery fee is only subject to sales tax if the food order is subject to sales tax. If an order includes a combination of taxable and nontaxable items, the entire delivery charge should be taxed. While you could technically list everything separately on the bill and only charge tax on the portion of the delivery fee that is for the taxable items, that would be a lot of work with no real benefit, so it’s not recommended.
A non-taxable sale: A bagel shop that sells a dozen bagels is not taxable because the bagels are sold in the same way they would be by a grocery store, and the customer is taking them home to prepare them as they desire before consumption. If the same order were placed for delivery, the delivery fee would not be subject to tax.
A taxable sale: If the bagel shop sells a bagel (hot or cold) with cream cheese on it to the next customer, the charge is subject to sales tax because the food is prepared for immediate consumption. If the same order were placed for delivery, the delivery fee would be subject to tax.
A non-taxable sale: A deli sells a pound of turkey-pastrami and a half-pound of swiss cheese to a customer to take home. This sale is not taxable because the products are cold and not prepared for immediate consumption. If the same order were placed for delivery, the delivery fee would not be subject to tax.
A mixed sale: The deli sells an Italian sub and a bag of chips, to-go, to the next customer. In this case, the sub is taxable because it was prepared by the restaurant, but the bag of chips is not taxed because the restaurant didn’t prepare it and it was sold in the same packaging and condition that it would be at the grocery store. However, if the sub and chips are sold as a combo for a single price, then it would all be subject to sales tax. In this case, the easiest solution is to list a single delivery fee on the bill and treat it as taxable.
Are Discounts and Tips Subject to New York Sales Tax?
Taxability of tips and discounts are also common issues that come up in the restaurant industry. In New York, voluntary tips are not taxable so long as they are distributed to the employees. Mandatory tips are not taxable so long as they meet the following conditions:
- The charge is separately stated on the bill and identified as a gratuity or tip, and
- all the money collected is given to the employees.
If these conditions are not met, the mandatory tip is subject to sales tax. More detail on the taxability of tips in New York can be found here.
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 New York Sales Tax Auditors
New York sales tax restaurant audits generally start with the auditor having an advantage in that they have your 1099-k report from the IRS. Your 1099-K shows all credit card sales which give the auditor an idea of what your approximate sales are. To supplement this information, the New York sales tax auditor will usually request bank statements, POS reports and any other documentation that shows sales. If the sales figure is less than the 1099-K, they will use the 1099-K as a basis for your total sales. If the 1099-K report plus a reasonable amount of cash sales are higher, that will be your total sales figure. Once the NY Department of Taxation auditor has a figure for your “sales” (aka the highest number they can reasonably achieve), they will compare it to your sales and use tax return and write up the difference as taxable. From there, you are guilty unless you can prove your innocence.
Combating a ‘guilty until proven innocent’ audit can be difficult, but not impossible. For starters, the 1099-K report relied upon by the auditor only has credit card sales. Therefore, if you can assure the auditor that the cash sales are lower than they projected, it will reduce the total estimated sales, and subsequently, your assessment. Another point to help your case is that your 1099-K likely includes sales of nontaxable items such as tips, possibly exempt delivery charges, and third-party service fees, such as Uber eats. 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 a CA Sales Tax Assessment or Prevent an Audit
There are a few ways to reduce the audit assessment or possibly prevent the audit in the first place:
- Compare third-party data against your New York Sales and Use Tax Return. Since you know the auditor is going to access and rely upon your federal income tax return and your 1099-k report, you should pull it yourself and review for accuracy. Assuming the IRS report is accurate, compare it against your sales and use tax return, better yet, have our sales tax experts do it for you. If there are incongruities, we can help you clean up your act going forward and reduce past exposure by amending returns or filing a voluntary disclosure.
- Consider a voluntary disclosure. If you review your 1099-K’s and your federal income tax return, and it greatly exceeds your sales tax returns, you should consider a voluntary disclosure. For starters, the VDA takes penalty off the table. In addition, because VDA’s are seldom audited, you can more aggressively disclose your true sales figure, rather than having the auditor overestimate your sales for you. If you enter into a VDA, the odds of being audited by the state dramatically decreases, but remember you are ineligible if New York contacts you first.
- Do your homework before the audit. If you are unlucky enough to have already received an audit notice, you should do your homework immediately. You now know that the auditor is going to compare your federal income tax return, your 1099-k’s, and your POS reports to your sales tax returns for the same period. Therefore, if the auditor requests documentation that you know is going to result in higher sales amounts, you should consider not producing or if you produce, have an explanation prepared.
- Carefully Account for Nontaxable Sales. The number one nontaxable item, which is likely included in your 1099-k, is tips. The 1099-k simply reports total dollars you received via credit card from a particular bank. If you do not have a breakdown for the tips included in total dollars received, the auditor will treat it as taxable. Having a breakdown as to the money received that is nontaxable, like tip revenue, is critical to reduce your assessment. If you cannot easily account for it, usually the IRS W-3 report will show tips paid to employees.
- Be Stingy on Providing Documentation. Generally, less is more in a sales tax audit. Provide documentation that reasonably shows your sales and nothing more. Every day we see restaurants who over provide documentation to the NY Department of Taxation sales tax auditor. The more that is provided, the more likely they will have an extravagant number to show as your taxable sales figure. You should be careful and know the answers before providing documentation. Alternatively, you should get a sales tax professional on your side who can evaluate what to and what not to provide to the auditor.
As the NY Department of Taxation gains access to more third-party reporting, the easier it becomes to efficiently perform audits on industries like restaurants and bars. Knowing how they will perform the audit is incredibly powerful because you can anticipate what they will do with the information you provide. Sometimes, no matter what is provided, a substantial assessment is inevitable. For those businesses, it makes even more sense to get out in front of the problem and amend returns or file a voluntary disclosure, so you control the narrative, instead of the NY Department of Taxation auditor. Of course, if you receive that audit notice, it is imperative to have the sales tax professional on your side to handle the audit or appeal the overinflated assessment.