Ohio Department of Taxation Sales Tax Audits: Preemptive Steps a Bar or Restaurant Can Take to Counter Inflated Liability Resulting from the Markup Analysis
There is good chance that if you operate a bar or restaurant in the state of Ohio you will, at some point, be subjected to a sales tax audit by the Ohio Department of Taxation. Given the potential sales tax revenue at stake in the liquor industry, and the fact that most establishments have a high percentage of cash transactions, it is not surprising that the Department has targeted bars and restaurants to ensure compliance with sales tax obligations. Operating a bar or restaurant can be challenging enough without the added stress of a state sales tax audit. The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise bars and restaurants on steps they can take to minimize the sales tax liability that could result from an audit.
In our previous article entitled Ohio Department of Taxation Sales Tax Audits: Contesting the Use of Purchase Markup Analysis When Primary Sales Records Maintained by Vendor, we discussed the Department’s ability to use an alternative method to calculate sales tax liability if the taxpayer’s primary sales records are inadequate. In particular, the Department will use the “mark-up” method or the “purchase analysis,” whereby the Department will typically obtain the taxpayer’s purchase invoices from third party distributors, and then apply a mark-up percentage to the different categories of purchased inventory to arrive at a taxable sales figure. With regard to wine and mixed drinks, this analysis will involve the Department making assumptions regarding the drink size and the number of drinks that can be poured from a bottle. The mark-up method assumes that all inventory that was purchased by the taxpayer was sold by the taxpayer. Anyone who has operated a bar or restaurant knows that this is a misguided assumption given things like theft, breakage, spillage and over-pours by bartenders. Thus, the mark-up analysis almost always results in an inflated taxable sales figure. The taxpayer is left trying to explain the discrepancy with their reported sales. Below is a non-exhaustive list of preemptive actions a bar or restaurant can take to counter the potential negative consequences of this method of estimating taxable sales.
Preemptive Actions to Counter the Potentially
Negative Results of the Markup Analysis
1. Maintaining records of loss due to theft, breakage, etc. It is essential that a bar or restaurant maintain detailed records of losses of inventory from theft, breakage, spoilage, short deliveries, and spillage. Although the Department may provide an allowance for such loss in computing taxable sales, the allowance does not usually reflect reality. Maintaining a daily log of losses, filing a monthly police report of all suspected thefts, and installing security cameras in strategic locations are just a few steps a bar or restaurant can take to properly document loss of inventory. Installing cameras will provide the dual benefit of not only documenting theft and breakage, but also deterring employee theft.
2. Maintaining detailed inventory records. Detailed inventory records can help explain a discrepancy between the total purchases reflected on the purchase invoices and the taxpayer’s actual sales. For instance, if the taxpayer’s year-end inventory is substantially higher than the beginning inventory, this would help rebut the Department’s presumption that everything purchased during the audit period was sold. In order for the Department to accept inventory records as evidence to rebut this presumption, it will want to see more detail than just a bottom-line dollar amount of total inventory. Rather, the taxpayer should track taxable inventory versus non-taxable inventory by each product category. Additionally, bars and restaurants should consider investing in sophisticated inventory management and point-of-sale (POS) software to properly track inventory and sales.
3. Internal controls and training of employees. Bars and restaurants should maintain internal controls to reduce loss of inventory. The proper training of bartenders can prevent over-pouring, which will not only lead to sales records that are more reflective of the purchase records, but will also lead to higher profit margins for the bar or restaurant. Hiring a third-party bartending consultant to train and monitor employees for a period of time will likely pay for itself in the long run. Along that same line, in conducting the mark-up analysis the sales tax auditor will make assumptions with regard to drink size and the number of drinks that can be poured from a bottle. The taxpayer should maintain detailed drink size information so that it can provide credible evidence to the auditor. As an example, if a signature mixed drink served by the taxpayer contains more liquor that the auditor assumes the drink contains, there should be records supporting that.
If you are the owner of a bar or restaurant and you are facing a sales tax audit by the Ohio Department of Taxation, or if you would just like further advice on preemptive steps you can take to minimize potential liability from an audit, you should contact one of the experienced tax lawyers at Nardone Law Group. We have vast experience representing bars and restaurants in sales tax audits, examinations, and litigation with the Ohio Department of Taxation. Contact us today for a consultation.