As you try to keep your operations going during this challenging period of health and economic crisis, you may be dreading tax season. But there’s actually an opportunity to save on taxes by finding deductions to decrease your business income. Here are some important expense deductions—and a tax credit—you can use to cut your tax bill.
Restaurants may deduct most business expenses, as long as they are “ordinary and necessary” for your business situation. Examples of these types of deductible business expenses include:
You may have been doing a lot more advertising to drive business in 2020, and you can deduct those advertising expenses, which include signage, social media advertising, and promotions. You can also deduct the cost of meals and entertainment at a local promotional event for your restaurant.
You can deduct driving expenses for your restaurant business, for yourself, and your employees, including:
- Trips to buy food and supplies
- Delivery to customers
You can take the deduction using either the IRS standard mileage deduction or actual car expenses, whichever the IRS allows, and that gives you the most deduction, but you can only deduct the business use, not personal use of the vehicle.
You can’t deduct costs for driving back and forth to your restaurant from home. That’s considered commuting, and it’s never deductible as a business expense.
Leasing or Buying a Car for Business Use
Did you buy a delivery vehicle for your restaurant this year? If you lease or buy a car to use for your business, you can deduct loan interest or lease payments if you deduct actual expenses. You can only deduct these expenses for the percentage of the expense that represents your business use of the car.
If you buy a car for business, you can depreciate the cost (spread deductions out over time). You must use the car more than 50% of the time for business to depreciate the car.
Employee Pay and Benefits
Employee pay and benefits are a big portion of your costs as a restaurant owner. Fortunately, you can deduct:
- Employee pay, including bonuses, commissions, sick pay, and vacation pay
- Employee benefits, like health plans and life insurance coverage
- Employment taxes you pay based on employee work and tips, like unemployment. Social Security, and Medicare taxes
Cost of Goods Sold
The cost of goods sold (COGS) is a critical deduction for your restaurant because it directly affects your gross profit each year. It’s also a tricky calculation for your tax return because the food and supplies in your inventory change daily.
To calculate cost of goods sold for tax purposes, you’ll need to know your beginning inventory at the start of the year, minus all your purchases for all the products you sell, and then your ending inventory. The calculation is:
In your calculation, don’t forget to include storage, delivery costs, takeout containers, and merchandise you buy for resale (like cookbooks or kitchen tools).
Improvements and Equipment
Upgrades and improvements to your restaurant (like adding a drive-through window or upgrades to your ventilation and air-conditioning systems) are considered capital improvements and they must be depreciated (deductions taken over several years). Equipment you buy for your restaurant also must be depreciated.
Depending on the cost of some restaurant property, you may be able to deduct all of the purchase costs in the first year. Check with your tax professional on this.
Repairs and Maintenance
Repairs and maintenance expenses that don’t improve the value of your property, such as painting or replacing a broken window, can be deducted in the year the work was done. Hiring a service to deep clean your restaurant is also deductible.
You can always donate food, gift cards, and other items to charities, but whether your business gets a tax deduction for your donation depends on your business type.
Restaurant owners who pay business taxes through their personal tax returns usually can’t deduct these charitable donations unless they itemize deductions. If your restaurant is a corporation or S corporation, the business can make charitable donations to qualified charities, with specific limits.
For 2020 taxes, the IRS allows individuals to take a $300 tax deduction for charitable giving to IRS-qualified organizations before December 31, 2020. The additional deduction is designed to help charities struggling with COVID-19-related drops in giving.
New Small Business Tax Deduction
Restaurant owners (not corporations) may qualify for an additional 20% deduction on their business net income for the year. You may be able to take the Qualified Business Income (QBI) Deduction in addition to your normal business income, and it’s deducted from your personal tax return. Learn how the QBI deduction works.
Deducting Operating Losses
If you had a loss from your business operations in 2018, 2019, or 2020, you may carry back that net operating loss (NOL) to previous tax returns, and you can take the loss to fully offset income. That means a potential refund for the year you carried back to. Corporations can also take deductions on NOL, but with different regulations. This is a complicated process, so check with your tax preparer.
Deducting Paycheck Protection Program (PPP) Loan Forgiveness
The IRS and the U.S. Treasury Department have issued guidance to explain that since businesses aren’t taxed on the proceeds of a forgiven Paycheck Protection Program (PPP) loan, the expenses are not deductible. If your loan was not forgiven, you will be able to deduct those expenses.
Bonus: The Work Opportunity Tax Credit
This tax-saving measure isn’t a deduction, but it may be even more beneficial. The Work Opportunity Tax Credit (WOTC) is a tax credit, which means it can create dollar-for-dollar savings off your business tax bill. You can get the credit for hiring individuals from certain qualified groups of people who face significant obstacles to employment, such as veterans or ex-felons. Read more about how the WOTC works, and the types of employees who are eligible for you to hire.
Keep Good Records to Prove Deductions
The burden of proof is on your business to prove your deductions. You don’t have to include your business records with your tax payments, but you must be able to show the documents an auditor or inspector as proof of the deductions. Keep especially good records for business driving expenses, gifts, and for depreciating property.
The Bottom Line
Tax season can be complicated for restaurant owners, with the many requirements, limitations, and exceptions involved. While this article only includes highlights, it can hopefully provide a foundation for identifying the applicable deductions that can help you save on taxes. However, because of the potentially complex nature of deductions, talk to your tax professional first about which ones you might be able to take before filing your tax return.