Tax for Restaurant Owners

Tip Reporting and the FICA Tip Credit (IRC Section 45B)

Restaurant employers face dual obligations on tips: ensuring employees report tip income accurately, and filing Form 8027 (Employer's Annual Information Return of Tip Income and Allocated Tips) if the establishment normally employs more than 10 employees on a typical business day.

Form 8027 compares reported tips to a threshold of 8% of the establishment's gross receipts. If reported tips fall below 8%, the employer must allocate the shortfall among tipped employees. Allocated tips are reported on employee W-2s but the employer does NOT pay FICA on allocated tips — only on reported tips. The allocation is a reporting mechanism, not a tax assessment.

The IRC Section 45B FICA tip credit is the most valuable restaurant-specific tax benefit. The credit equals the employer's share of FICA taxes (7.65%) paid on tips that exceed the federal minimum wage ($7.25/hour as of 2026). For each tipped employee, you calculate: total reported tips minus (hours worked x federal minimum wage x tip credit percentage). The employer's FICA tax on that excess amount becomes a dollar-for-dollar tax credit on the employer's return.

For a restaurant with 15 tipped servers averaging $150/day in tips each, the annual Section 45B credit can exceed $15,000-$20,000. The credit directly reduces federal tax liability — it is not a deduction, it is a credit. However, claiming the credit means you cannot also deduct the same FICA taxes as a business expense (no double benefit). For most restaurants, the credit is more valuable than the deduction because credits reduce tax dollar-for-dollar while deductions only reduce taxable income.

The employer FICA tip credit under Section 45B provides a dollar-for-dollar tax credit for the employer's share of FICA taxes paid on employee tips exceeding the federal minimum wage. (IRC Section 45B; IRC Section 6053 (tip reporting requirements); IRS Form 8027; IRS Form 8846 (Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips))

No-Tax-on-Tips Employee Deduction (OBBBA 2025-2028)

The One Big Beautiful Bill Act (OBBBA) introduced a temporary above-the-line deduction for tipped employees effective 2025-2028. Qualifying employees can deduct up to $25,000 of tip income from their adjusted gross income, effectively making that portion of their tips tax-free at the federal level.

This deduction benefits the EMPLOYEE, not the employer directly. However, restaurant owners benefit indirectly through reduced reporting friction, improved employee retention, and the ability to position tip-earning jobs as more financially attractive. In a labor market where restaurants compete intensely for servers and bartenders, the effective after-tax increase in take-home pay is a genuine recruiting advantage.

The deduction applies to cash tips, credit card tips, and tips reported on Form 4070. It phases out for employees with AGI above $160,000 and is not available for business owners receiving tips from their own establishment. The deduction is temporary — it expires after the 2028 tax year unless extended.

For employers, the operational impact is minimal: tip reporting obligations under Section 6053 and Form 8027 remain unchanged, FICA obligations on reported tips remain unchanged, and the Section 45B credit calculation is unaffected. The deduction sits entirely on the employee's personal return. The employer's role is communicating the benefit to employees and ensuring accurate tip reporting so employees can claim the full deduction.

Tipped employees may deduct up to $25,000 of tip income above-the-line for 2025-2028, reducing their federal tax on tips; the employer's tip reporting and FICA obligations remain unchanged. (One Big Beautiful Bill Act (OBBBA) Division D — No Tax on Tips provision; IRC Section 6053 (tip reporting unchanged))

Food Costs, COGS, and Inventory Accounting

Food and beverage costs are the largest single expense for most restaurants, typically 28-35% of revenue. These costs flow through cost of goods sold (COGS) on Schedule C Part III (or the corporate equivalent), not as ordinary deductions.

Proper inventory accounting requires tracking beginning inventory, purchases during the year, and ending inventory to compute COGS. For restaurants, this means regular physical inventory counts — monthly at minimum, weekly for high-volume operations. The IRS benchmarks food cost percentages by restaurant type, and significant deviations from industry norms (e.g., a full-service restaurant claiming 50% food costs) trigger scrutiny.

The small business inventory exception under Section 471(c) allows qualifying restaurants (average annual gross receipts of $30 million or less) to use their financial accounting method for inventory instead of traditional GAAP inventory rules. Most independent restaurants qualify. This simplifies accounting but does not change the fundamental requirement to track food purchases and compute COGS accurately.

Liquor costs are tracked separately from food and carry different industry benchmarks (typically 18-24% of liquor revenue). Spoilage, breakage, and waste should be documented and included in COGS. Employee meals provided for the employer's convenience (on-premises, during shifts, for business reasons) are deductible at cost and excluded from employee income under Section 119 if provided on the employer's premises for the employer's convenience.

Food cost control is both a tax compliance issue and an operational survival issue — restaurants that cannot accurately track food costs typically cannot manage profitability. The IRS knows this, which is why food cost anomalies are a primary audit trigger.

Restaurant food and beverage costs are computed as COGS (not deductions) and must be supported by inventory records; the IRS benchmarks food cost percentages by restaurant type and flags significant deviations. (IRC Section 471 (inventory accounting); IRC Section 471(c) (small business exception); IRC Section 119 (meals for the convenience of the employer); IRS Pub 334 (Tax Guide for Small Business))

Leasehold Improvements and Equipment Under Section 179

Restaurant build-outs are capital-intensive. Leasehold improvements — kitchen buildout, dining room construction, HVAC, plumbing, electrical, walk-in coolers, and interior finishes installed in a leased space — are classified as qualified improvement property (QIP) with a 15-year recovery period under MACRS and qualify for 100% bonus depreciation under OBBBA.

This means a $200,000 restaurant build-out in a leased space can be fully written off in year one through bonus depreciation, rather than spreading the deduction over 15 years. This is a significant change from pre-2018 treatment and was made permanent by OBBBA's restoration of 100% bonus depreciation.

Section 179 expensing also applies to restaurant equipment: commercial ovens, refrigeration, dishwashers, POS systems, bar equipment, furniture, and fixtures. The $2,560,000 Section 179 limit for 2026 covers even the most expensive restaurant equipment purchases. Restaurant furniture and fixtures are 7-year MACRS property; most kitchen equipment is 5-year or 7-year property.

Liquor licenses present a unique depreciation question. In most jurisdictions, a liquor license is an intangible asset with an indefinite useful life — it does not depreciate and is not amortizable under Section 197 unless purchased as part of an asset acquisition of an existing business (in which case it is a Section 197 intangible amortized over 15 years). Annual renewal fees are currently deductible expenses.

Qualified improvement property (restaurant build-outs in leased spaces) has a 15-year MACRS life and qualifies for 100% bonus depreciation; restaurant equipment qualifies for Section 179 expensing. (IRC Section 168(e)(6) (qualified improvement property); IRC Section 179; IRC Section 197 (intangible amortization — liquor licenses in asset acquisitions); OBBBA §70301 (bonus depreciation restoration))