Use Tax, Myths & Legal Landmines for Restaurants
If Sales Tax is the one you see coming, Use Tax is the one that hits you from behind. It doesn’t show up on receipts, your POS isn’t tracking it, and most restaurant owners don’t even know they owe it until an auditor does. But if you’re buying equipment, supplies, or even wine shipments without being charged Sales Tax, the state expects you to do the math and pay Use Tax yourself.
This blog breaks down how Use Tax works, where restaurants get it wrong, and why guessing can land you in just as much trouble as missing it completely. With insights from CPA Raffi Yousefian and sales tax expert Mark Stone, we’ll cover audit red flags, common myths, and practical steps to keep your restaurant compliant and your cash where it belongs.
CPA Raffi Yousefian and Sales Tax expert and CPA Mark Stone are back to unpack the tax traps that don’t always show up in your POS report, but can cause massive issues if left unchecked.
What Use Tax Actually Is
Most restaurant owners don’t think about Use Tax until it appears in an audit. It’s not part of your sales, it doesn’t appear on your receipts, and your POS doesn’t track it. But if you buy something for your business and weren’t charged Sales Tax at the time, the state expects you to calculate and pay that tax yourself.
This typically happens with online orders, out-of-state suppliers, or wholesale vendors who don’t apply sales tax. If you use that item, whether it’s a fryer or office chairs, you owe Use Tax, even if the invoice looks clean.
It’s a self-reported tax on business purchases, and because it’s easy to overlook, auditors look for it first.
Raffi: So, how likely is it that New York state will give a restaurant or bar trouble over Use Tax?
Mark: Use Tax… just in case somebody doesn’t know the term… everybody thinks of sales tax. You go into a store, you buy something, and they charge you 8 or 9% extra. If, for some reason, you don’t get charged that, you as the purchaser still have an obligation to pay it to the state. That’s Use Tax.
Mark: Where it shows up in restaurants is two main places. First, when you buy fixed assets. On every audit, the state goes straight to your federal tax return. They look at your balance sheet and zero in on your depreciation schedule, that’s the list of capital assets you’ve bought in the past few years. They pull every invoice related to those purchases to see if sales tax was paid. If it wasn’t, you owe Use Tax.
Mark: So generally, most hospitality businesses should be paying Use Tax on their equipment and assets, ovens, kitchen tools, even chairs, unless they were charged sales tax at the time of purchase. The state assumes that if you didn’t pay it then, you owe it now. And in food service, many items you’d think are exempt, like pizza ovens, actually aren’t, because you’re not manufacturing goods, you’re providing a taxable service. That’s where restaurants in New York get tripped up.
Mark: Second, it comes up with comped items. But here’s what most people get wrong… You don’t owe Use Tax on the retail value of the comped item. You owe it on your cost, and only for taxable goods, like soda or beer (at least in NY). Not the bread, not the chicken, not the flour. That stuff is considered nontaxable grocery items.
Raffi: What’s the most realistic way to figure out that number though? Most people aren’t tracing each comped drink back to an invoice.
Mark: Honestly, you don’t need to go crazy with it. Just be reasonable. Let’s say you track your comps monthly, great. Then, apply your average cost of goods sold, which may be 25%. That gives you your cost. Then break that down. Maybe a third of that cost is drinks, beer, soda, whatever. That’s the part you owe Use Tax on. So if you paid $1,000 for meals, your cost might be $250, and $80 is taxable drinks. You’re talking like $6 in Use Tax. That’s it.
Key takeaway: Use Tax applies when Sales Tax wasn’t charged but should have been.
Top tip: Review your vendor list. Out-of-state or online purchases are common triggers.
Why Some Restaurants Overpay Use Tax
Overpaying on tax might sound like the safer bet, but it’s not. In fact, it’s one of the fastest ways to lose money and raise suspicion in an audit. Use Tax is confusing, and when restaurant owners don’t fully understand what qualifies, they often go too far the other way, taxing everything, just in case.
Raffi: We have seen some sales tax specialists at big firms take the position that everything, comps, discounts combined, was subject to use tax. And so what they did was they got the total comps and discounts and multiplied it by whatever the copy percentage was that they came up with, 25%, 30%. And they applied sales tax to that number across the board. What’s up with that?
Mark: It’s just blatantly wrong.
Raffi: I think they were just trying to be extra, extra, extra conservative just because the audit was a nightmare and they didn’t have the right records like you brought up. So that makes sense of what you’re saying.
Mark: And if you erroneously file your returns, either way, you know, underpaying, overpaying. If you’ve overpaid, you have the right to go back for the last three years, the last 36 months, and get a refund from the state.
Raffi: As long as you have the right backup. You have to document everything.
Mark: And just with what you said with discounts and stuff like that, you know, you take a $100 meal and you discount it 50%, 90%. You don’t owe any use tax on that whatsoever. You just have to charge sales on the remaining 10%. And if you do things like buy one, get one free, that’s still deemed to be selling two items. So again, you don’t owe use tax on the one item that you gave away for free, because it’s really two sales at 50% rather than one sale at 100%.
The thing that kind of comes to mind with that—a little bit off topic—is if you’re donating something to charity, people get in trouble for this. You donate something to charity, you end up owing use tax on your cost of whatever you paid, assuming it’s taxable, that you gave away to the charity.
So let’s say a bar. A bar is going to give away $500 in beer to a charity for a barbecue. The bar now owes use tax on $500 because they should have paid sales tax when they bought it, but they claimed it was for resale, but they gave it away. So it’s not for resale.
Rather than doing that, the bar should sell the beer to the charity for $1. And the charity is exempt from tax, so they collect $1 with no tax on it. They still sold the beer. They just sold it at a loss. So they didn’t blow their resale exemption. So rather than owing $50 of use tax on a $500 giveaway, they collected a dollar, and they saved, you know, whatever.
Key takeaway: Overpaying doesn’t make you safer; it drains your cash and raises more questions.
Top tip: Don’t guess. If you’re unsure, ask someone who handles restaurant tax specifically.
Capital Improvements and Why Leases Matter
Making improvements to your space is often a smart move; it’s an investment in your business. However, it can also come with sales tax consequences in New York and other applicable states that many restaurant owners overlook. Whether installing a new bar, upgrading your kitchen, or adding outdoor seating, how that work is structured determines whether you’re responsible for the tax.
If you’re a tenant, your lease matters. It can dictate who owns the improvements and who benefits from them long-term which impacts whether you owe use tax on the capital improvement purchases. If those details aren’t clear, the state won’t ask questions, they’ll just assign the bill to whoever they think can pay it.
Raffi: So you owe Use Tax on all fixed asset purchases except for the leasehold improvements, right? The real property.
Mark: New York State has this concept of a capital improvement. When you have a capital improvement done, you don’t have to pay sales tax on a capital improvement. So, a capital improvement has three criteria. It adds value or prolongs useful life. It’s attached in such a way that removal of the item will cause damage to either the item or the property. And number three—this is the big thing—it’s the intent of the property owner or the landlord for it to be a permanent installation.
So most, not all, but most commercial leases say that the property has to be returned in the original condition. So you have a restaurant come into a property, and they sign a 10-year lease with two five-year extensions. That’s a typical thing. And they spent $600,000 building out the restaurant. And they put in beautiful bathrooms, tile walls, hardwood floors, and granite countertops. They make a beautiful restaurant out of it. But their lease says the property has to be returned in the original condition.
So New York State took a place up in Syracuse and the case is called The Matter of Flah’s of Syracuse. And what the courts ruled was that the improvements to Flah’s didn’t qualify as a capital improvement because the lease said the property had to be returned in its original condition. Therefore, no matter what they did to the property, it wasn’t a permanent installation.
So generally, leasehold improvements don’t qualify unless you put the terminology in your commercial lease that all improvements to the property vest to the landlord upon installation. Then your leasehold improvements can qualify as a capital improvement and then they can be non-taxable.
Raffi: So now you’ve got to read the lease agreements to determine the sales tax on the property. Certain services…
Key takeaway: Property improvements can create tax liability depending on how the deal is structured.
Top tip: Before you renovate, show your contractor and lease to your tax advisor.
Final Thought
Most tax trouble in restaurants doesn’t come from negligence; it comes from assumptions. For example, assume your software is set up correctly, your lease covers Use Tax implications, and your purchases don’t require a second look. But as we’ve seen throughout this chapter, small oversights in Use Tax or asset purchases can open the door to major audit exposure.
The businesses that came out ahead weren’t perfect; they were consistent. They asked the right questions, understood how the law applied to their setup, and could back up their decisions with documentation. That’s what separates a grey area from a costly mistake.
In Part Four, we’ll turn our focus to gratuities, service charges, and cover charges, an area where things often fall apart without anyone noticing. We’ll explore what really counts as a tip, how mislabeling happens, and why treating these details casually can lead to serious payroll or Sales Tax issues.
