Today, we're going to be discussing one of the two avoidable parts of life.
No, not death – taxes. Specifically, the processing fees restaurants have to pay on sales tax despite not receiving that tax money themselves.
A restaurant's finances are the foundation of your whole operation. Without a great payroll system, it's tough to keep your employees paid and happy, and if you're not on top of your tax obligations, you can risk losing your whole business.
While many states don’t charge sales tax on groceries, tax usually applies to meals prepared by restaurants, food trucks, and other food service businesses. When your guests pay for their meal with a credit card, you pay processing fees on the total amount, including the tip and sales tax.
Let’s look at what that means for your restaurant's bottom line and how to minimize the impact.
Why Are Processing Fees Paid on Sales Tax?
Even though the customer’s receipt shows items and sales tax separately, the two aren’t split when the transaction is actually processed. Fees are charged on the total amount of the transaction – including tax. The logistics of applying credit card processing fees to only the items purchased are too tedious and inefficient to implement.
Additionally, if transactions were split into the customers’ purchase and the sales tax, restaurants would end up paying more up front to process those transactions. Since processing fees include a per-transaction charge, you would end up paying that fee twice – once for the food, once for the tax.
It’s more effective to simply allow businesses to deduct the fees paid on sales tax from their taxes.
Avoid Losing Money on Processing Fees
Businesses that handle their own taxes are the most at risk of losing money paid from processing fees on sales tax. These businesses may not be aware of how to properly deduct those fees. Tax professionals can offer assistance to ensure that your deductions are handled correctly and you don’t pay more than you need to.
Since it’s not possible to separate sales tax from the total transaction, any time you accept a credit card to pay for a transaction that includes sales tax, you’re paying processing fees on that sales tax.
The only way to avoid losing that money is to properly deduct it from your business taxes.
Alternate Methods to Reduce Processing Fees
You’ll only pay processing fees on sales tax when your customer pays with a credit card. Since credit card processing costs account for a sizable portion of expenses for many restaurants, it’s important to manage those fees. In addition to ensuring that you properly deduct the fees paid on sales tax from your taxes, you can consider other methods to reduce your overall processing fees. Two popular options are surcharging and cash discounts.
Surcharging refers to charging customers a small fee for using a credit card. While the practice is prohibited in some states, it can be beneficial to lowering your out-of-pocket costs where permitted. Be sure to familiarize yourself with the rules for surcharging credit cards before implementing a surcharge at your restaurant.
Cash discounts are the flip side of surcharging. Instead of charging more for using a credit card, you offer a discount on the regular price if customers pay with cash. If your customer doesn’t use a card, you don’t have processing fees, and you’re passing some (or all) of that savings on to your customer. Cash discounts are legal in all 50 states.
Who Pays for Processing Fees on Tips?
Federally, there is no law against passing processing fees off to servers for their tips. Ergo, servers can be charged a processing fee on their gratuities the same way restaurant owners are for their food. However, the only deductions that can be made are those for the tip amount, not the entire bill.
For example, if the meal costs $80, a $20 tip is left, and the processing fee totals 3%, servers would only be asked to pay 60 cents, or 3% of the $20 tip. While the processing charge for the entire bill in this situation would be $3 (3% of the $100 total), employers cannot charge servers the entire $3 processing fee. Charging any more would be a violation of the Fair Labor Standards Act.
State-wise, this practice is not always legal. This map by CardFellow outlines the legality in each state.
States Without Sales Tax on Prepared Food
It’s important to note that while almost all states charge sales tax on prepared food, there are exceptions on specific types of prepared food in a few states. TaxJar provides thorough explanation of each state’s laws. The notable exceptions to the prepared food tax include the following.
Most prepared food in California is taxable, but exceptions include coffee or tea sold to-go and certain cold food items like sandwiches, milkshakes, and ice cream that are intended as takeout. However, if you don’t track these sales separately, tax may be owed on them anyway.
In Ohio, food sold to be eaten off-site (such as drive-through meals or takeout) is not taxable. Other prepared food is taxable. If you run a restaurant that has both dine-in and drive-through options, you’ll need to account for collecting sales tax from your dine-in customers and not from your drive-through customers.
In Texas, prepared food is taxable except bakery items sold by a bakery or bakery items sold by a non-bakery if the seller doesn’t include plates or eating utensils.
Whichever method you use, you’ll still have some customers that pay with credit cards and therefore you’ll pay processing fees on the sales tax of those transactions. Enlisting the assistance of a licensed tax professional can help ensure that you properly deduct those fees and keep more of your money.
This article is intended for educational purposes only and does not constitute tax or legal advice. Be sure to consult a licensed CPA or other tax professional for specific questions regarding your business taxes.