Restaurants rarely come unstuck in a CDTFA audit because they misunderstood the tax rules. They come unstuck because they cannot document what they sold. Where the records are thin, the tax gets assessed on the sales you cannot account for, and the burden of showing otherwise sits with you.
The basic rules
Dine-in
Food and beverages served for consumption at your place of business are taxable, whether sold à la carte or as part of a meal. If you have tables, chairs, counters or tableware, that is a place where consumption occurs.
To-go
Here it depends on what is being sold:
- Hot prepared food: taxable
- Cold food products alone: generally not taxable
- Carbonated and alcoholic beverages: always taxable
- Combination packages containing a hot item: taxable
The cold-food exclusion is where most of the complexity and most of the audit risk lives, because it requires you to distinguish those sales at the register and prove it afterwards.
The 80-80 rule
Two conditions, both of which must be met:
- More than 80% of gross receipts come from sales of food products, and
- More than 80% of retail food sales are taxable — meals, hot prepared foods or drive-in sales
Where both apply, special accounting rules govern how cold to-go items are treated, and a qualifying business may elect to account separately for certain of those sales. The election is only as good as the records behind it.
Gratuities: the distinction that costs money
This one catches Fresno restaurants regularly, particularly those doing banquets and private events.
Voluntary tips are not taxable. Payments of tips, gratuities and service charges are outside the tax where they are paid entirely at the customer’s option and retained by employees.
Mandatory service charges are taxable. A required charge agreed to in advance — the classic case being a banquet contract with a fixed service charge — is part of taxable gross receipts.
The same 20% is treated completely differently depending on whether the customer could have declined to pay it. If your banquet contracts specify a service charge and you have been treating it as a tip, that is an exposure that compounds every event.
It also matters for payroll: a mandatory service charge is generally not a tip for tip reporting purposes either, which affects both your reporting and your employees’ ability to claim the tips deduction.
What CDTFA asks to see
The records that decide an audit:
- Guest checks and register tapes that distinguish cold to-go sales from taxable sales
- A written complimentary merchandise policy — what gets comped, to whom, and on whose authority
- Price change documentation with dates, so reported sales can be tested against menu prices
- Happy hour records evidencing discounted pricing periods
- Segregated bar and restaurant purchase and sales records
- Inventory control documentation tracing purchases through to sale
That last one is the basis of the markup analysis an auditor will run. They take what you purchased, apply expected yields and menu prices, and compare the result to your reported sales. Where the two diverge and you cannot explain the gap with documented comps, waste and staff meals, the difference is treated as unreported taxable sales.
What to do about it now
None of this requires new systems, only consistent use of the ones you have:
- Configure the POS so cold to-go items ring differently from dine-in, rather than relying on staff to remember
- Write down the comp policy, even briefly, and have management approve comps in the system
- Keep dated menus, including happy hour and limited-time pricing
- Code mandatory service charges as taxable revenue and voluntary tips as tips, in both the POS and the books
- Take a monthly inventory count, however rough
Every one of those is cheap to do prospectively and expensive to reconstruct three years later.
Talk it through with a Fresno CPA
We prepare California sales tax returns for Fresno restaurants and set the books up so the taxable and non-taxable split is documented the way CDTFA expects. See our restaurant accounting page.
Schedule a meeting or call 559-372-9213.
This post is general information, not advice for your specific situation. Tax figures are current for the year stated and many are indexed annually. Talk to a CPA before acting on any of it.
