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In recent years, the Pennsylvania Department of Revenue (“Department”) has become increasingly aggressive in auditing restaurants for the underpayment of sales tax. By taking proactive measures and understanding the audit landscape, restaurants can set themselves up to successfully defend against the potential consequences.

Keep “Auditable” Records

Many restaurants keep sales ledgers showing cash and credit totals of taxable and non-taxable sales (e.g., alcohol) and tips for each day. This may be enough for their accountants to file sales tax returns, but not for state sales tax auditors.

The Department requires businesses to keep guest receipts or daily POS (point of sale) printouts detailing individual sales transactions. Without this information, the Department may deem your records inadequate and estimate your taxable sales using an alternative methodology.

A favorite alternative methodology for auditors these days is to compare the owner’s records against the “industry average” for ratios of credit cards receipts from Forms 1099-K to gross sales, which is based on confidential information compiled by the Department concerning a collection of restaurants. In many instances, the restaurant’s ratio will exceed the “industry average.” This is because restaurants have different business models, serve different cuisines, and cater to different clientele. Nonetheless, to the extent a particular restaurant’s ratio exceeds this average, it can expect to find itself assessed with additional tax and penalties. Moreover, since these assessments will be based, not on the restaurant’s actual records, but on secret data compiled concerning other restaurants, they often outsize the restaurant’s ability to pay. Given these intricacies and ramifications, it is recommended that restaurant owners seek advice from a tax professional as soon as it becomes apparent that the Department is considering using this methodology.

It’s Not Only the Business

If the business has an audited sales tax liability, a “responsible party assessment” against the owners isn’t far behind. Many owners – and some tax representatives – don’t know that when a business collects sales tax but doesn’t send it to the state, the Department will impute the tax liability to the owners personally if they are considered to be “responsible parties.” This is true even if the business didn’t actually collect the tax, but simply has an audited liability from the Department. 

The Department believes that, under Pennsylvania law, most active restaurant owners and officers are responsible parties. But this isn’t necessarily true. A fact-specific analysis by knowledgeable professional might help avoid and/or reverse responsible-party determinations against owners and officers.

It’s Not Only Money

The Department treats sales tax audits seriously because sales taxes are considered “trust taxes.” Because they are collected on behalf of the state, misuse of such funds is treated as theft. Thus, the Department often threatens and sometimes does criminally prosecute owners and officers of restaurants for sales tax matters.

The Upshot

The best defense is often a good offense. By keeping detailed sales tax records and enlisting the assistance of competent tax professionals as early as possible, taxpayers can minimize the potential consequences of the inevitable sales tax audit.

Kevin Sweeney is a shareholder at the Chamberlain Hrdlicka law firm in Philadelphia. He specializes in civil and criminal tax controversy and litigation matters and represents clients in IRS audits, civil tax litigation, white-collar criminal defense matters, and whistleblower matters for business owners, corporate executives, and public and private companies worldwide. Reach him by email at ksweeney@chamberlainlaw.com or call (610) 772-2327.

Adam Koelsch is a co-author of the article.