«Bars and Restaurants Audit Technique Guide (ATG) NOTE: This guide is current through the publication date. Since changes may have occurred after the ...»
Internal Revenue Service
Market Segment Specialization Program
Bars and Restaurants
Audit Technique Guide (ATG)
NOTE: This guide is current through the publication date. Since changes
may have occurred after the publication date that would affect the accuracy
of this document, no guarantees are made concerning the technical
accuracy after the publication date.
This material was designed
specifically for training
purposes only. Under no
circumstances should the
contents be used or cited as sustaining a technical position.
The taxpayer names and addresses shown in this publication are hypothetical. They were chosen at random from a list of names of American colleges and universities as shown in Webster’s Dictionary or from a list of names of counties in the United States as listed in the U.S. Government Printing Office Style Manual.
www.irs.gov Training 3149-118 (11-2002) Catalog Number 83849L The IRS Mission ____ Provide America ’s taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.
BARS AND RESTAURANTSTable of Contents Page
CHAPTER 1, INTRODUCTIONHistory of the Bars and Restaurants ES&TG
Overview of the Industry
Method of Accounting
Using the Bars and Restaurants Guide
CHAPTER 2, GENERAL INFORMATIONBooks and Records
Point of Sales Systems (POS)
CHAPTER 3, INITIATING THE AUDITPre-Audit Planning ─ IRM 126.96.36.199.1
Setting the Scope
Ratio and Statistical Analysis
Coordination with Employment Tax Group
Using the Intranet/Internet to Research
Non-third Party Public Records Research
Pre-audit Cash T
Initial Taxpayer Contact and Information Document Request (IDR)...........3-5 Initial Interview ─ IRM 188.8.131.52
Tour of the Business Premises ─ IRM 184.108.40.206
CHAPTER 4, PROFIT AND LOSS STATEMENTExamination of the Profit and Loss Statement
Minimum Income Probes
Additional Income Probes and Indirect Methods ─ IRM 220.127.116.11................4-3 Specific Items methods of Determining Income ─ IRM 18.104.22.168.2..4-3 Bank Deposits Method
Net Worth Method
Percentage Markup Method of Determining Income ─ IRM22.214.171.124
Employee Tip Income ─ Reconstruction Using Indirect Methods....4-11 Other Income
Income from Coin-Operated Activities
Other Sources of Income Activities
Rebates from Suppliers
CHAPTER 5, AUDIT ISSUES AND TECHNIQUES ─ EXPENSESCost of Goods Sold
Other Issues Affecting Cost of Goods Sold
Other Expense Issues
Package Design Costs
Charitable Contributions of Food Inventory
Depreciable Life of Restaurant Smallwares Asset Account..............5-3 Amortization Goodwill and Covenants-Not-To-Compete.................5-3 Treatment of Liquor License Costs
Treatment of Franchise Costs
Depreciation of Restaurant Buildings
Sale of a Restaurant ─ Income Issues
Losses Incurred When a Restaurant Closes
Capital Gains on Sale of Business
Ordinary Income Loss on Sale of Business
Income from the Discharge of Indebtedness or IRC section 108 Reductions for Tax Attributes
Taxable Liquidating Distributions to Shareholders
Unused Carryovers, Credits, Recapture Issues
Credits for Taxes Paid on Certain Employee Tips
Work Opportunity Credit (WOTC)
Welfare to Work Credit
Disabled Access Credit
Empowerment Zone Credit
Enterprise Zone Credit
CHAPTER 6, AUDIT ISSUES AND TECHNIQUES ─ BALANCE SHEETExamining Balance Sheet Accounts
Cash Account ─ IRM 126.96.36.199.4.1
Credit Card Sales versus Cash Sales
Inventory ─ IRM 188.8.131.52.4.3
Loans to Shareholders ─ IRM 184.108.40.206.6
Fixed Assets ─ IRM 220.127.116.11.7
Intangible Assets. ─ IRM 18.104.22.168.8
APPENDICESAppendix 1 Glossary of Terms and Measurements
Appendix 2 Audit Checksheet ─ RRA '98
Appendix 3 Common Methods and Indications of Under Reporting Income
Appendix 4 101 Ways to Steal from a Restaurant
Appendix 5 Operating Ratios
Appendix 6 Point of Sales System ─ Employee Tip Reports
Appendix 7 Citations and Resources
Appendix 8 Restaurant Brochures, Posters, Publications, and Forms
Appendix 9 Intranet and Internet Resources
Appendix 10 Bibliography
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HISTORY OF THE BARS AND RESTAURANTS ES&TGThe Examination Specialization & Technical Guidance (ES&TG) initiated studies of specific industries in certain districts. As a result of these studies, Audit Technique Guides were written to assist revenue agent examiners with the examination of specific industries that have unique accounting systems, terminology, and operations unlike other industries.
The 2002 ES&TG Audit Technique Guide for Bars and Restaurants (the ATG) replaces the prior guide for Bars and Restaurants that was last revised in 1995.
Changes to the ATG were necessitated by the passage of the IRS Restructuring and Reform act of 1998 (RRA98), as well as advances in accounting technologies used by restaurants. This Guide also considers relatively new examination research techniques available to revenue agents, including the Intranet and Internet. In the areas of employment taxes and tip reporting, this Guide takes into account significant changes recently made to Tip Rate Determination Agreement (TRDA) and Tip Reporting Alternative Commitment (TRAC) agreement.
Employers can now sign up for these agreements using the Internet. This Guide considers these changes in statutes, technology and practice as they affect the revenue agent and the bar and restaurant industry.
One goal of the ES&TG Program is to reduce audit cycle time by helping agents become familiar with specific industries prior to starting an examination. This reduction of audit cycle time is a key goal in establishing customer satisfaction. In a recent national survey report of customer satisfaction, suggestions for improvement included, "when an auditor does not understand the business he or she is auditing, the outcome can be unfair. Appealing the outcome is out of the question, because the loss of income in appealing is greater than the amount owed the IRS." Understanding the industry being audited is essential to determining the correct tax liability, fairly administering the tax laws, reducing audit cycle time, and increasing customer satisfaction.
OVERVIEW OF THE INDUSTRY
Statistics published by the National Restaurant Association (NRA) state that restaurant sales are projected to be $399 billion in the year 2001 and, on a typical day in that year, the restaurant industry will post average sales in excess of $1.1 billion. Over 11 million people work in restaurants in America representing approximately 8 percent of the work force. Approximately 44 percent of
Restaurants can be divided into two types of restaurants: fast food and full service. Fast food restaurants include those that provide only take-out services, as well as franchises offering -in or drive-through services. Generally, customers do not tip employees of fast food restaurants. In contrast, full service restaurants and bars are generally privately owned and few are part of larger chains. A restaurant employee generally seats customers of full service restaurants. The menus and service are more customized than those of fast food restaurants and customers generally tip restaurant employees. The NRA states that average sales for full service restaurants in 1998 were $601,000; average sales for fast food restaurants in 1998 were $555,000. Also according to the NRA, the average per person check in a fast food restaurant in 1999 was $4.72.
In general, full service restaurants are individually owned and fast food restaurants are franchised. Franchisees typically pay a fixed percent of gross receipts to the franchiser for advertising and royalties. Franchisees will also purchase their inventory from franchisers and have their records regularly audited by the franchiser. Some fast food franchisers also lease the restaurant building to the franchisee for an additional monthly fee or percentage of sales. Internal controls of franchised restaurants are generally extensive and designed to detect fraud, waste, and theft. Individually owned restaurants may not have the same third party verification of income and costs.
The NRA maintains statistics regarding restaurant employees. For example: 7 out of 10 restaurants have fewer than 20 employees. The typical employee in a
foodservice occupation is:
The NRA has also determined that more than 60 percent of restaurants maintain an Internet web site. In fact, 13 percent of restaurant customers have used the Internet to find information about a restaurant. Moreover, as many as 10 percent of restaurant customers place orders over the Internet. Other restaurants permit customers to fax food orders to the restaurant before the customers arrive. More than two out of five households with a cell phone (41 percent) have used it to place an order at a restaurant for takeout or delivery. Such advances in technology are changing how restaurants service their customers. It is a challenge for both 3149-118 1-2 the restaurant owner and the IRS examiner to be certain that orders sent to the restaurant over the Internet, by phone, or by fax are properly recorded and that internal controls are maintained Many states impose a sales tax on food. Some city/county governments also impose a sales or excise tax on food in addition to that collected by the state.
Alcohol is also taxed and controlled by many state agencies. The examiner should contact his or her local Fed/State Coordinator to obtain information from state or local agencies that may be helpful in conducting the examination. IRS Strategy, Research, and Performance Management (SRPM, formerly DORA) has conducted studies comparing income reported on state sales tax returns with income reported on Federal income tax returns, and sales of alcohol reported to state liquor control boards with alcohol sales reported on Federal income tax returns. The examiner should contact SRPM for information obtained from these studies.
The bar and restaurant industry is particularly susceptible to theft and embezzlement. Bars and restaurants typically make numerous small dollar sales in a relatively short period of time (for example, lunch or dinner). Many employees receive and manage large amounts of cash. Some restaurants do not properly segregate the duties of their employees to the extent necessary to maintain good internal controls. This is especially true of bars where one bartender takes the order, fills the order, receives the payment, records the payment, and may even balance out the till at the end of the day. Bars and restaurants tend to pay their employees near minimum wage and have a high rate of employee turnover. Additionally, bar and restaurant employees often have access to large inventories of food and alcohol. For these reasons, bars and restaurants may have a high risk of employee theft and embezzlement unless they implement and maintain a set of good internal controls.
Some bar and restaurant owners may underreport income by any of several methods. For example, they may operate open tills, use double sets of books, and fail to report certain sales transactions. Restaurant employees may be aware of the owner's underreporting, and may even have been asked to assist in the underreporting of income. Additionally, a dishonest bar or restaurant owner may encourage dishonest employees. Bar or restaurant employees may underreport income by concealing cash receipts or underreporting tips.
The challenge for the examiner is to separate restaurant owners who are in compliance with the tax laws from restaurant owners who have failed to satisfy their tax obligations. To do this, the examiner should focus on 1) unreported income by the restaurant, 2) cost of sales, and 3) unreported tip income by the employees. While other issues may also be of concern to the examiner, these three issues will generally need to be addressed in the audit of a restaurant.
The NRA publishes considerable information and various statistics regarding the restaurant industry (See www.nra.com ). Additionally, many states have separate restaurant associations with Internet links on the NRA website. These Internet
The IRS is trying to educate taxpayers within the bar and restaurant industry. For example, the IRS often participates in State and National Restaurant and Food Industry tradeshows. Another educational outreach effort is the restaurant cite on the IRS Digital Daily web page at www.irs.gov. This web page contains information available to the pubic regarding restaurants and tip income reporting, and is linked to both the Small Business Administration and the NRA.
Choice of Business Entity: Bars and restaurants can operate as a soleproprietorships, partnerships, subchapter C corporations, subchapter S corporations, or Limited Liability Companies (LLC). For tax years 1998 and after, subchapter S corporations are not part of TEFRA proceedings. Therefore, results of audit examinations must be given to all shareholders and statute extensions must be obtained from all shareholders of a subchapter S corporation.