Since COVID-19 invaded the U.S. earlier this year, businesses across America have struggled to connect with customers and keep their doors open. These private sector problems have, in turn, been felt by state and local sovereigns, which rely on the taxes levied on business income to fund vital government programs.
Given the budget deficits these state and local governments are now facing, its taxing authorities are likely to begin encountering increased pressure to collect more revenue. Consequently, restaurants can expect more aggressive sales tax enforcement in the near future.
By taking proactive measures and understanding the sale tax landscape, restaurants can set themselves up to successfully defend against costly tax assessments and civil penalties against the restaurant, limit such exposure to the restaurant itself and not its owners and officers as individuals, and protect against possible criminal prosecutions.
Maintaining “Auditable” Records
Many restaurants keep daily sales ledgers showing cash and credit totals. Often times, these records are broken down into taxable sales, non-taxable sales for items like alcohol, and tips. While this information may be enough for their accountants to prepare sales tax returns, state sales tax auditors often require more detail.
Many state taxing authorities require businesses to keep guest receipts or daily POS (point of sale) printouts detailing individual sales transactions. Without this information, they may deem your records inadequate and estimate your taxable sales using an alternative methodology.
A favorite alternative methodology for auditors these days is to compare the owner’s records against the “industry average” for ratios of credit cards receipts from IRS Forms 1099-K to gross sales. This average is typically compiled from confidential information reported by other restaurants in the area. In many instances, the restaurant’s ratio will exceed the “industry average.” This is because restaurants have different business models, serve different cuisines, and cater to different clientele. Nonetheless, to the extent a particular restaurant’s ratio exceeds this average, it can expect to find itself assessed with additional tax and penalties. Moreover, since these assessments will be based, not on the restaurant’s actual records, but on secret data compiled concerning other restaurants, they often outsize the restaurant’s ability to pay. Given these intricacies and ramifications, restaurant owners should seek advice from a tax attorney at the first hint of state taxing authorities considering such alternative methodologies.
Avoiding Personal Sales Tax Assessments
If the business has an assessed sales tax liability, a “responsible party assessment” against the owners is likely not far behind. Many owners—and some tax representatives—don’t know that when a business collects sales tax but doesn’t send it to the state, state taxing authorities typically impute the tax liability to the owners personally if they are considered to be “responsible parties.” This is true even if the business didn’t actually collect the tax, but simply has an audited sales tax liability.
Many state taxing authorities take the position that most active restaurant owners and officers are responsible parties. However, this is not necessarily true. A fact-specific analysis by knowledgeable professional might help avoid and/or reverse responsible-party determinations against owners and officers.
Keeping the Audit Civil
It is important that restaurant owners treat sales tax audits seriously because sales taxes are considered “trust taxes.” Because they are collected on behalf of the state, misuse of such funds is treated as theft. Accordingly, civil sales tax audits can and often do blossom into criminal prosecutions in egregious cases. To prevent misuse of sales tax funds, restaurants should maintain separate bank accounts for collected sales tax and avoid commingling these funds. As tempting as it may be, collected sales tax should always be timely paid over to the government even if the restaurant/owner needs the money for other purposes and fully intends to pay it back. To the extent a restaurant finds itself in the unfortunate position of being audited for sales tax that was collected but used for other purposes, a tax attorney specializing in civil and criminal tax audits should immediately be consulted to assess exposure and advise on how to favorably resolve the matter.
The Upshot
The best defense is often a good offense. By keeping detailed sales tax records and enlisting the assistance of competent tax professionals as early as possible, taxpayers can minimize the potential consequences of the next wave of aggressive state sales tax enforcement.
Kevin F. Sweeney is a shareholder at the law firm Chamberlain Hrdlicka in Philadelphia. He specializes in civil and criminal tax controversy and litigation matters and represents clients in civil tax audits, civil tax litigation, white-collar criminal defense matters, and whistleblower matters for business owners, corporate executives, and public and private companies worldwide. Reach him by email at ksweeney@chamberlainlaw.com or call (610) 772-2327.
