Business owners who buy assets that have useful lives longer than one year usually cannot immediately deduct the costs of these assets. The costs have to be deducted over a number of years through depreciation.
Luckily for restaurant owners, there is an exception that allows restaurant owners to immediately deduct the costs of smallwares in the year they are purchased and used.
What Are Smallwares?
Smallwares include the following items:
- Pots and pans
- Table top items
- Bar supplies
- Food preparation utensils and tools
- Storage supplies
- Service supplies
- Small appliances that cost $500 or less individually
This Provision Helps Other Food Services Businesses, Too…
This provision applies to corporations engaged in the business of preparing food and beverages to customer order for immediate on-premises or off-premises consumption. In addition to restaurants and cafeterias, this provision also applies to caterers, mobile food servers, bars and taverns, and food or beverage services located in grocery stores, hotels and motels, amusement parks, theaters, casinos, country clubs, and similar social or recreational facilities.
Watch Out for These Traps
There are two situations where an immediate deduction will not be available and the business owner will have to deduct the costs of smallwares over a number of years. The situations are:
- When the smallwares are purchased before the business begins operations. In this situation, the smallwares are treated as start-up expenses. Start-up expenses of up to $5,000 can be deducted the year business operations begin. Excess start-up expenses are deducted over 15 years.
- When the smallwares are purchased and stored, rather than put to immediate use. In this situation, the smallwares are treated as inventory and become deductible when they are put to use.
Example: Janson Family Restaurant will open to the public in July 2013. Prior to its opening, it buys $10,000 of smallwares. Later during 2013, it buys $5,000 of additional smallwares. During 2014, it buys an additional $4,000 of smallwares. Finally, during the last week of 2015, it buys $10,000 of smallwares, but keeps them in storage until 2016.
Janson Family Restaurant can deduct the costs of smallwares as follows:
- The $10,000 of smallwares purchased before opening are treated as start-up expenses. It can immediately deduct $5,000 and deduct the remaining $5,000 over 15 years.
- The $5,000 of additional smallware purchased in 2013 after the restaurant opened are fully deductible in the year of purchase
- The $4,000 of smallwares purchased during 2014 are fully deductible in the year of purchase
- The $10,000 of smallwares purchased during 2015 must be recorded as inventory in 2015 since the smallwares aren’t being used. The $10,000 will be fully deductible in 2016 once they are used.
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Restaurants have fairly tight profit margins. How they price their menu items can have a large impact on its profits. This post will describe three ways to price your menu items profitably.
The Prime Cost Method
A restaurant’s prime costs are its food, beverage, and labor costs. These costs are referred to as prime costs because, in the short term, they are the only costs a restaurant owner can manage. The Prime Cost method is based on the menu item’s cost and the desired food cost percentage of the restaurant. On average, restaurants have a 38% to 42% food cost margin—for example, a restaurant with $10 in sales will have a $3.80 to $4.20 food cost.
Under the Prime Cost method, the food cost of the item is divided by the desired food cost percentage.
Pomo D’oro Bros wants to price an entrée consisting of 4oz of chicken, a baked potato, green beans, and a salad. The total food cost of the items is $6. If Pomo D’oro Bros is aiming for a 40% food cost, it would divide the food cost of $6 by 0.4 and come up with a $15.00 menu price for the entrée.
The Peanut Butter Method
This method takes a restaurant’s projected labor, non-food expenses, and desired profit and divides the amount by the number of meals the restaurant estimates it will serve during a year. It then adds this amount to the cost of each food item.
This method only works if a restaurant has menu items that are similar in cost, otherwise each menu item will have the same markup.
Projected Labor Costs $60,000
General Expenses $40,000
Desired Profit $10,000
Total $110,000 (1)
Meals to be Served during the year 30,000 (2)
Required Markup Per Meal $3.67 [divide (1) by (2)]
The restaurant owner adds $3.67 to the cost of each menu item to determine the menu price.
Again, this method works best when all menu items have a similar cost. Under this method, a hamburger with a cost of $2 with have a $5.67 price for a 35% food cost (good) and a steak with a cost of $6 will have a $9.67 price for a 62% food cost (not so good).
Multiply Food Costs by 3
This method is the same as the Prime Cost method above if the target food cost is 33%. If your menu items cost $4 and you multiply this by 3, you would get a $12 menu price. This is a 33% food cost ($4 cost divided by $12 price).
A few points to consider:
- If you have menus printed only once a year, you may want to increase the menu prices for inflation over the next year. For example, if you come up with a $15 menu price, you may want to figure in a 3% (give or take) inflation rate and increase the menu price to $15.45
- The price you come up with must be compared with what your competitors are charging. If your competitor’s prices are slightly less than the amount you came up with, you may want to beat her price. If your competitor has substantial cost advantages like a low-cost lease you may not be able to beat her prices. In this case, you may want to stick with the higher price and focus on differentiating your restaurant from the competition.
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In 2010, Congress passed a law favorable to restaurants that allowed restaurants to more quickly deduct the costs of buildings and improvements to buildings. This was done in three ways:
- The costs of qualified restaurant property was allowed to be depreciated (deducted) over 15 years rather than the normal 39 years
- Additionally, up to $250,000 of the costs of qualified restaurant property was allowed to be deducted in the year of purchase under the increased Section 179 deduction
- Finally, if qualified restaurant property also qualified as qualified leasehold improvement property it would qualify for 50% bonus depreciation
The law expired on December 31, 2011; however, as part of the Taxpayer Relief Act of 2012 passed at the beginning of 2013, the law has been reinstated for 2012 and is extended through 2013.
What is Qualified Restaurant Property?
Qualified restaurant property includes:
- a building, or
- improvements to a building
- if more than 50% of the building’s square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals.
Shorter Depreciation Period
Qualified restaurant property is the only category where Section 179 expense is allowed on the building itself, rather than solely on the improvements.
Example: Tomato Brothers Restaurant buys a building for $300,000. Under old law, the building would be deducted over 39 years at $7,692.31 per year. Since a restaurant building is qualified restaurant property, it can be deducted over 15 years at $20,000 per year.
This favorable provision also allows costs of leasehold improvements to be deducted over 15 years rather than over 39 years.
Increased Year of Purchase $250,000 Section 179 Deduction
Restaurant buildings and leasehold improvements also qualify for the increased $250,000 Section 179 deduction. A major drawback of the Section 179 deduction is that it is limited to the restaurant’s taxable income for the year. Any disallowed Section 179 expense is carried forward. A second drawback of this special provision is that the deduction cannot be carried forward after 2013. Any unused deduction is treated as placed into service on January 1, 2013 and is deducted over 15 years.
Example: In 2012, Paradise Coney Island incurs $200,000 in qualified restaurant improvement expenses. Before taking in account the $200,000 Section 179 expense, Paradise Coney Island has $150,000 of taxable income. Paradise Coney Island’s allowable Section 179 expense is limited to its taxable income of $150,000. The remaining $50,000 of Section 179 expense is carried forward to the next year. If Paradise Coney Island has at least $50,000 of taxable income in 2013 it can deduct the remaining $50,000 in 2013. If Paradise Coney Island does not have income in 2013, the $50,000 unused loss is treated as placed in service on January 1, 2013 and is deducted over 15 years.
Qualified Restaurant Property May Qualify for 50% Bonus Depreciation
If qualified restaurant property also meets the definition of qualified leasehold improvement property, it will qualify for 50% bonus depreciation. Since the building itself will not qualify as leasehold improvement property, only the improvements to a restaurant building (and not the building itself) may qualify as qualified leasehold improvement property.
What is Qualified Leasehold Improvement Property?
Qualified leasehold improvement property means any improvement to an interior portion of a nonresidential building if
- such improvement is made pursuant to a lease by the lessee, sublessee, or lessor of such improved portion
- such portion is to be occupied exclusively by the lessee or sublessee
- such improvement is placed in service more than 3 years after the date the building was first placed in service
Qualified leasehold improvement property does NOT include:
- an enlargement of a building
- any elevator or escalator
- any structural component benefiting a common area
- the internal structural framework of the building
A lease between related persons (e.g., a lease between a taxpayer and his 80% owned business) does not qualify.
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There is a tax credit available to restaurants that have tipped employees. The credit is based on the FICA taxes paid by the restaurant on reported tips. Although this credit has been available to restaurants for years, many tax professionals fail to inform their clients that the credit is available. If you’re a restaurant owner, keep reading.
Restaurants must pay FICA taxes on any tips reported by tipped employees. This requirement has been criticized by the restaurant industry since 1987 because reported tips in excess of the minimum wage are not counted as wages under the Fair Labor Standards Act (FLSA). Since tips in excess of minimum wage are not counted as wages under the FLSA, it is argued that it is not appropriate to require restaurants to pay FICA taxes on these tips.
As a result of lobbying by the restaurant industry, Congress created a tax credit in 1993 to offset some of the FICA taxes paid by restaurants on excess tips (tips that get the employee over minimum wage). The credit is named the Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips. They tried, but couldn’t come up with a longer name.
How it Works
The credit is calculated as 7.65% of tips in excess of the federal minimum wage. For purposes of this tax credit, the federal minimum wage is capped at $5.15, and not at the normal $7.25 federal minimum wage. Michigan’s minimum wage of $7.40 is not relevant to this credit; however, under Michigan law the employee’s base wage plus tips must be at least $7.40.
Example: JoJo’s Restaurant has a tipped employee who earns $2.65 per hour. The employee worked 1,500 hours during 2012 and had tips of $8,000.
The tip tax credit is calculated as follows:
Hourly Tip Rate: $5.33 ($8,000 tips divided by 1,500 hours)
Tips Deemed Wages: $2.50 ($5.15 federal minimum wage less $2.65 wage)
Excess Tips per Hour: $2.83 ($5.33 total tips less $2.50 tips treated as wages)
Total Excess Tips: $4,245 ($2.83 excess tips per hour times 1,500 hours worked)
Tip Tax Credit $325 ($4,245 times 7.65% FICA rate)
The tip tax credit for this single employee is $325.
The tip tax credit is calculated for each individual employee. Modern payroll software makes it much easier to determine how much of each employee’s tips are deemed wages and how much are excess tips.
There has been some confusion as to whether restaurant owners could claim the credit on unreported tips discovered during an IRS audit. The answer is yes—restaurant owners can claim the tip tax credit on unreported tips discovered during an audit (good news if you’re looking for a silver lining during an audit.)
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