Death, Taxes, and Senate Bill 1: Texas Legislative Restaurant Update

Sevy’s co-owner Amy Severson makes this claim: “A full-service, lunch-and-dinner- liquor-serving business generates more taxes per-square-foot than most industries.” Below she wonders why the Texas State Legislature continues to penalize small to mid-sized restaurant owners. Hear her roar.

Imagine if you were sitting down for coffee with Uncle Sam, and the conversation started like this:

Uncle Sam: “Hey, we’re having a little budget problem and we’re going to collect your next month’s taxes out of your next paycheck.”

You: “But I might not have a job next month, and this month I have a mortgage that needs to be paid, utilities, car payment, kids in college [the list goes on]. How can I pay you ahead of time if I haven’t earned the money yet?”

Uncle Sam: “Whatever.”

Certainly this scene would not be appetizing to any taxpayer – individual or business – especially in a state that touts its tax friendliness. So it was a surprise to read in the 2011 Legislative Update issued by Susan Combs Comptroller of Public Accounts, that the State of Texas has cooked their books with a recipe for disaster for small restaurants. They’ve added Senate Bill 1, an “advance tax payment” plan to balance their biannual budget.  This follows a revised state franchise tax that burdens restaurants with a very high effective-net-income rate. They are literally trying to kill us.

Gory details below.

I used the example above  because for most small to mid-sized restaurant owners their business income is their personal income.  They have landlords, employees, insurance, and vendors to pay. Few have access to any other kinds of business credit lines. If there is anything left over after the loan payments or investor withdrawals, they pay themselves wages for their blood, sweat and tears. If this advanced payment hits the industry at what is typically one of the slowest sales months of the year – it would be like asking an individual for a loan on December 15. Ho, Ho, Ho.

But there it is, in black and white. Senate Bill 1 requires remitters of sales tax and mixed beverage taxes to add an additional 25% of the tax due as a “prepayment” to their July 2013 tax bills (payable in August). Conveniently, the state’s fiscal year end is August 31. Credit is given for the advance in September, but for even the smallest of those in the industry who pay both taxes this would total in the thousands of dollars. The question is where will they get it from?

The Legislator’s previous effort to fix the state budget resulted in the revised Franchise Tax. Though not technically an “income tax,” it certainly is an income-based tax. Certain costs of business (costs that are positive for Texas and the economy in general) are penalized because they are not allowed to be deducted from the tax. Yet these expenses bring down the restaurants income – labor (waiters, hostesses and bussers), rent, insurance, marketing, and taxes are considered taxable. Yes, taxes are taxable. While 14% of every drink sale is sent to the state for Mixed Beverage taxes, it is not considered deductible from state Franchise tax calculation. Neither is a significant portion of property taxes paid to local governments, nor payroll taxes. Restaurants, while appearing to benefit from a lower rate of .5 percent, can end up with a franchise tax due equal to 100% or higher of their actual net income.

In an industry well known for its high rate of failures, an often overlooked fact is what strong tax generators successful restaurants are. A full-service, lunch-and-dinner, liquor-serving business generates more taxes per-square-foot than most industries. Payroll tax, mixed beverage tax, property tax, franchise tax, while very beneficial to the government, all carve away at an already slim margin for the business owner. Sales tax is collected from the guest and passed on to the state as well. It’s not an expense like the others, but definitely a byproduct of the restaurant’s hard work and efforts that goes back to taxpayers.

Typically the more high tax generators a city has, the stronger its budget (Addison hasn’t been complaining of any shortfalls lately), and the same is true for our state. Perhaps it was because of this successful generation of taxes that the Legislature felt compelled to double down on leveraging the restaurant industry. After all, the larger the numbers, the less effort it takes to make their budget balance. In the meantime we can only hope this recipe doesn’t become part of their regular political diet.

17 comments on “Death, Taxes, and Senate Bill 1: Texas Legislative Restaurant Update

  1. That is very interesting. Thank you for sharing. I certainly want to support small, local restaurants with my buying dollars. I will be happy to support them by contacting my local state senators and representatives too.

  2. I would like to add that the Texas Restaurant Association’s webpage regarding Franchise taxes indicates that the mixed beverage tax is deductible in calculating Franchise tax. This is not correct per the Comptroller’s 2010 tax letter ruling #201010997L, which specifically deals with deductible expenses for restaurants. Listed under costs not deductible from Cost of Goods Sold: mixed beverage gross receipts tax.

    They have been notified previously that this is incorrect information. A CPA knowledgable in the restaurant industry is one of the best investments a small owner can make.

  3. Mixed beverage taxes are flow-through funds and are not included in gross revenue, and therefore are not subject to franchise tax. You cannot “double deduct” by also including them in the cost of goods sold.
    TITLE 34 PUBLIC FINANCE
    PART 1 COMPTROLLER OF PUBLIC ACCOUNTS
    CHAPTER 3 TAX ADMINISTRATION
    SUBCHAPTER V FRANCHISE TAX

    RULE §3.587
    Margin: Total Revenue

    (5) Exclusions from total revenue.

    (A) Any expense excluded from total revenue (e.g. flow-through funds or the cost of uncompensated care allowed under subsection (e) of this section) may not be included in the determination of cost of goods sold (see §3.588 of this title) or the determination of compensation (see §3.589 of this title).

    (e) Exclusions from total revenue. Except as otherwise provided in this section and only to the extent included in the calculation of total revenue under subsection (d)(1) – (6) of this section, the following items shall be excluded from total revenue:

    (1) Flow-through funds mandated by law.

  4. Ummm, no. By the way, are you a CPA?

    Sales are revenue, the state does not allow you to exclude the expense from revenue either. Nor does your quote above from the code say that it can be.

    The mixed beverage tax is based on your total sales, as is the franchise tax. Same total sales amount.

  5. The law does not require a business to report as income passed-through 3rd party payments to a government taxing authority, which would be sales tax.

    Liquor taxes are not passed-through nor 3rd party payments. As much as I wish they would be changed to such.

  6. the TX restaurant association is not an advocate for restaurants of the size discussed. They represent chili’s, joe’s crab shack etc…and they lose regularly. It is time for a new organization to represent small and midsize restaurants!

  7. UPDATE: Per the Comptroller’s office – this very morning – Mixed Beverage taxes are NOT flow-through and do NOT get deducted from gross revenue.

    I’m happy to do the follow up due diligence to make sure my information is correct, even though I consulted with two CPA’s prior to writing this. If I was wrong it would have meant many years of refunds in overpayments for me, which is better than being right.

    TRA….back to you.

  8. I am an attorney and personally worked on this issue with the Comptroller when the franchise tax was first passed. The statute reads as follows:

    “(f) A taxable entity shall exclude from its total revenue, to the extent included under Subsection (c)(1)(A), (c)(2)(A), or (c)(3), flow-through funds that are mandated by law or fiduciary duty to be distributed to other entities, including taxes collected from a third party by the taxable entity and remitted by the taxable entity to a taxing authority.”

    The mixed beverage tax is mandated by law and is paid to the state. Please contact me directly if you would like to explore this issue further or need assistance in recovering the over payment you made on your taxes.

    Incidentally, in regard to your comment that we only represent “chili’s, joe’s crab shack etc…and … lose regularly. We represent the entire industry with 4/5’s of our Board made up of small operators. As for losing regularly, if TRA had not been working for you at the Capitol when the franchise tax was first adopted all restaurants would have been paying at twice the current rate.

    The ½ percent tax rate is not have available to businesses that manufacture more than 50% of their goods. We inserted an exception just for our industry (SIC 58)that allows us to pay at the ½ percent rate. Here is the statutory provision:

    (c) A taxable entity is primarily engaged in retail or wholesale trade only if:
    (1) the total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than the retail and wholesale trades;
    (2) except as provided by Subsection (c-1), less than 50 percent of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs; and
    (3) the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas.
    (c-1) Subsection (c)(2) does not apply to total revenue from activities in a retail trade described by Major Group 58 of the Standard Industrial Classification Manual published by the federal Office of Management and Budget.

  9. Amy, I neglected to put our contact number in the prior post. Please call me and I’ll help you resolve this with the Comptroller’s office. 800-395-2872.

  10. The August 2013 tax prepayment that was the genesis of this article was a means for the legislature to balance the current biannual budget. It was originally drafted as a permanent fixture and we would be making this “pre-payment” forever. We succeeded in limiting it to this budget period.

    Our aim is to eliminate it during the next session for 2013 so we never make the prepayment at all. This will depend on the state’s fiscal shape during that year, but sales tax receipts are up so there is a chance we can get this done.

  11. @Glen – First I want to point out that the comment about the board did NOT come from me. However I hear from many small owners that they are dissatisfied with the TRA. Just something to consider.

    I realize the law as written may have been intended differently. For the smallest of us it matters what the Comptroller’s view is on it, because they are the ones who are going to audit, and assess taxes and penalties if we err.

    We don’t have legal stockpiles to fight an opinion or audit results. So the best thing we can do is follow how the Comptroller reads the law. And in their opinion, as expressed in a letter, is that Mixed Beverage tax is NOT flow-through.

    My CPA has been on the phone with the Comptroller’s office, he has the letter of their opinion on Revenue and flow-through. And having spent many years working in CPA offices myself, I’m going with my CPA’s (and the Comptroller’s office) opinion on the tax. Unless lawyers work for free fighting this, which would be a pleasant surprise.

  12. And regards to the July prepayment, I wonder how many legislators will be eating out that month, really. Maybe they should reconsider.

  13. Amy,

    My job is to represent our members when we have issues with the Comptroller, or any other government agency. The whole point of a trade association like TRA is to fight for the little guy because it is too expensive to do it alone.

    I am familiar with the letter opinion you have referenced and it applies to calculating the cost of goods sold. When you are speaking with your CPA, be sure to make it clear that the mixed beverage tax should be excluded from the calculation of total revenue before you begin to calculate the cost of goods sold.

    If you are unable to resolve the situation, my offer to help stands if you need it.

    Glen Garey
    General Counsel
    Texas Restaurant Association
    800-395-2872

  14. Hi Glen,

    I work with a lot of restaurant owners and have reviewed the topic of Mixed Beverage Taxes and the franchise tax calculation with the state multiple times. On July 14, 2008, I received the below response from Martha Preston with the State Comptrollers office:

    This is an excerpt from the letter she sent me:
    (1) You ask if the TABC tax must be netted with gross revenue on the federal income tax return or can it be shown as an expense in order to be deductible for the COGS deduction.
    The Texas Mixed Beverage Gross Receipts tax is not one of the taxes that fits the definition of a flow‐through fund
    mandated by law under Tax Rule Section 3.587(e)(1). Also since it is a tax imposed on the amount received from the sale or service of a mixed beverage, it pertains to the sale of an item, not to its acquisition or production; thus, it is not in
    the COGS deduction either.

    Her response clearly states that the Mixed Beverage Gross Receipts tax does not fit the definition of a flow-through fund. Just to further verify this fact, I called the state comptrollers office this morning and they reiterated this fact.

    In an effort to clear up any confusion on this publically, I have also requested a formal letter ruling on this topic and will forward it to you as soon as it is issued.

    If for whatever reason they change their position on this topic, I will be more than happy to communicate this to the many restaurant owners who have relied on their prior guidance.

    Greg Williams
    Restaurant CFO Partners
    972-633-8999