Tax planning requires a different approach for businesses with complex revenue structures or inventory control challenges. The retail and hospitality industries are good examples of this, dealing with cash flow challenges, high employee turnover, and recent tax law changes. This article is written for any business owner who's feeling the squeeze and wants to learn more about either hospitality or retail tax planning.
Here are some key takeaways:
- Improved inventory accounting methods can dramatically reduce tax liability.
- Classification of employees and reporting for tips are compliance risks that many small business owners either ignore or are unaware of.
- Seasonal businesses perform with year-round tax strategies, and proper planning can eliminate many cash flow problems.
First, retail and hospitality businesses must focus on the most pressing challenges.
Seasonal revenue patterns aren’t unique to retail and hospitality businesses, but they are common in both industries. Retail companies have peak and off-peak shopping times. Restaurants experience slow seasons, which typically follow productive months when tax liabilities are high. Making estimated tax payments during the slow season can lead to cash flow issues, and cash flow is a persistent problem for retailers.
Seasonal fluctuations and high employee turnover are common in both industries.
Hospitality employees, particularly those in back-of-house roles such as dishwashers and prep cooks, tend to burn out quickly. Retail shops often hire students or young people, so turnover is high. The costs of advertising, hiring, and training must be factored into every tax plan.
High employee turnover can also cause you to miss important filing deadlines or miscalculate payroll taxes due. The One Big Beautiful Bill Act (OBBBA) made tips tax-free up to $25,000, but they still need to be reported. I expect several of my restaurant and retail clients to struggle with that this year. My firm has already started scheduling meetings to explain how to navigate it.
Inventory and equipment considerations should be top of mind.
Equipment depreciation rules have always been complex, and the rules just changed again. 100% bonus depreciation is back, and the OBBBA makes it permanent. Look for more information on that coming soon, or call my office if you have questions. My team is standing by to assist you.
Inventory accounting methods can either be a powerful tool for tax reduction or a reliable way to see increased tax liability. Choose carefully.
Inventory is a cost when you acquire it. Inventory is an asset when you sell it. The difference between those two numbers is your profit margin, which will be considered taxable income. The way you manage it and which inventory accounting platforms and methods you use will directly affect profit margin.
Let’s review the tax implications of the FIFO (First In, First Out) and LIFO (Last In, First Out) methods.
With FIFO, your oldest inventory is sold first, which means that during inflationary periods, you’re selling lower-cost inventory at an inflationary price point; this results in a higher taxable income and increased tax liability.
The LIFO method has the opposite effect, as it prioritizes the most recent inventory you purchased. Your cost and your selling price are both high in an inflationary market, so your margins will be low.
If prices consistently rise over time, LIFO is your best option. FIFO works best when prices start to fall.
A third option is the weighted average method. It smooths out cost fluctuations by averaging all inventory costs. That’s simpler to calculate, but it may not provide optimal tax benefits. Adjusting your accounting to reflect rising or falling inventory costs provides the best opportunity for saving money. Work with us to model various inventory methods before the end of the year.
Tighten up on internal controls for employee categorization and optimize payroll tax.
When employees and independent contractors are misclassified, it can be an expensive mistake, and it happens more often than you might think in hospitality and retail businesses.
For example, let’s look at delivery drivers. If you were to list out their tasks and consider the fact that their hours are often scheduled, you might mistake them for employees—that’s because they are, at least for small businesses. Large companies may pay them as independent contractors. The same rules do not apply.
The gray zone between employee and contractor is not a place you want to be.
So, we’re a small business that hires delivery drivers and says, “Hey, you’re an independent contractor, but we’re going to need you to wear this uniform, show up at this time, and complete this specific list of tasks.”
There are two possible outcomes, neither of which is favorable. If the Internal Revenue Service (IRS) discovers you’ve miscategorized an employee, you’ll get hit with fines and penalties on back taxes owed. If that “contractor” figures out they should be an employee entitled to benefits, it could get even more expensive. That scenario gets much worse if they get hurt on the job.
On the plus side, proper employee classification can open up tax savings opportunities for the employer and the employee. Reported tips up to $25,000 are now tax-exempt under the provisions of the OBBBA. That creates new reporting requirements, but it also eliminates one of the main reasons why restaurant and retail workers prefer self-employment over W2 work.
Maximize equipment and property deductions.
Equipment purchases in retail and hospitality businesses can generate massive tax savings if you understand the rules. For tax years beginning in 2025, the maximum Section 179 expense deduction is $1,250,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $3,130,000.
Take advantage of the OBBBA’s 100% bonus depreciation rules for same-year deductions on equipment purchases.
One of the most significant changes in the OBBBA is the modification of bonus depreciation. As of January 2025, Section 179 allows for the immediate expensing of equipment purchases rather than depreciating them over several years. Depreciable items include kitchen equipment, POS systems, furniture, and vehicles used in your business.
Renovation expenses are now deductible under OBBBA depreciation rules.
If you’re renovating your restaurant, capitalizing the expense makes it subject to a depreciation schedule of fifteen to thirty-nine years, depending on how you categorize it. Writing off the renovation as a repair will allow you to deduct 100% of the renovation expenses in the year the work is completed. I’d be happy to map that out for you.
If transactions and sales exceed a certain threshold, they create tax obligations, even if they occur outside the state.
In 2018, the Wayfair Decision by the Supreme Court eliminated the requirement of physical presence in a state as a basis for paying state taxes there.
The current standard is “economic nexus,” which is based on the number of transactions and total sales made within that jurisdiction. Once your company hits that threshold, you’re liable for sales taxes.
Should your accounting be aligned with your tax planning? Economic nexus thresholds say, “yes.”
- Texas: $500,000
- California: $500,000
- Alabama: $250,000
- Most other states: $100,000
Economic nexus rules are still shifting. For example, Alaska removed its 200 transaction threshold effective January 1, 2025, leaving only the $100,000 sales threshold. Certain food items, catering services, or promotional activities may be exempt from sales tax. It’s important to do your research on that if you’re in the hospitality business.
Beware of hidden nexus triggers. While you're tracking sales numbers, unseen triggers are silently creating tax obligations. Your Amazon inventory, temporary pop-up shops, remote employees, and dropshipping all create nexus regardless of your sales volume.
Seasonal businesses face unique challenges in aligning cash flow with estimated tax payments.
Revenue fluctuations make it difficult to project quarterly taxes accurately, and underpayment penalties can be substantial. This is one of the biggest obstacles we face when we have a client looking for retail tax planning and exit strategies. Sometimes, the money just isn't there to cover the quarterlies.
The IRS has “safe harbor” rules for businesses in this position. Safe harbor rules protect you if you paid 100% of the prior year's tax or 90% of the current year’s taxes. Companies that meet these criteria may be exempt from penalties for underpayment. For seasonal businesses, the following strategies may help keep you away from penalties:
- Retail Tax Planning Strategy: Accelerating expenses into the current year to reduce taxable income
- Hospitality Tax Planning Strategy: Timing equipment purchases for maximum Section 179 benefits
- Hospitality & Retail Tax Planning Strategy: Deferring income to the next year when legally possible
If you’re not eligible for safe harbor protection, another option is to use business credit lines for tax payments instead of paying underpayment penalties. The interest on credit lines is usually deductible and often lower than the IRS penalty rates, making it a sound financial decision. You could also consider taking out a business loan, but it may be significantly more expensive.
What red flags trigger IRS audits in retail and hospitality businesses?
The IRS often targets restaurants and retail businesses due to their historically poor record-keeping and high volume of cash transactions. Understanding what triggers audits can help you avoid them.
Inconsistent tip reporting patterns are a major red flag. If reported tips are significantly below industry averages or show unusual patterns, expect scrutiny.
High cash transactions without proper documentation immediately attract attention. You need solid procedures for handling cash and maintaining audit trails.
Mismatched cost of goods sold ratios that don't align with industry standards will trigger questions. Your gross margin should be reasonable for your type of business.
Employee vs. contractor misclassification is under increased IRS scrutiny. Make sure your worker classifications can withstand audit review.
Personal insight: The IRS targets restaurants and retail because of historically poor record-keeping. Maintaining clean, organized records is your best defense against audits.
Hospitality and retail tax planning requires specialized knowledge. CPA and M&A advisory teams must stay current on issues such as inventory accounting methods, tip reporting requirements, equipment depreciation, and multi-state sales tax compliance. These industries face unique challenges that demand expert guidance, and my firm is well-positioned to provide it.
The tax code changes every year, and the stakes are too high to figure this out alone.
We work with dozens of retail and hospitality businesses, and I've seen firsthand how proper accounting and tax planning for retail and hospitality businesses can save tens of thousands of dollars while avoiding costly compliance mistakes. Schedule a discovery call to get a qualified team to reduce tax liability, build better systems, and position your business so that you can sell or acquire on your terms.
Talk soon,
Jeremy A. Johnson, CPA, CEPA®
Founder & CEO
The Novyx Group
