LFTL: Separating Church and State
In this issue of Lessons from the Line, we explore why maintaining distinct financial lines for your business and yourself is absolutely crucial, outlining the legal and financial benefits of “separating church and state” if you will. It's not just good practice—it's essential. This understanding about interrelated personal expenses is part of our ongoing initiative to focus on you, the operator, and make sure that your business is creating wealth for you and your family.
Let’s break down key areas where separation is vital and how it affects your bottom line.
1. Vehicle Deductions: Maximizing Your Tax Savings
If you use a vehicle for both business and personal purposes, properly tracking usage is critical to maximizing tax deductions. The IRS allows deductions for business-related vehicle expenses, but only if properly documented. Here’s how to stay compliant:
Business-Only Vehicles: If your vehicle is used solely for restaurant operations—such as catering deliveries or supply runs—you can deduct the full cost of ownership, including lease payments, insurance, maintenance, and depreciation. It’s important to note that “commuting” or using the vehicle to go to various properties is not a valid business use.
Mixed-Use Vehicles: If your vehicle is used for both business and personal purposes, you must maintain a mileage log. The business-use percentage determines the deductible portion of expenses.
Standard vs. Actual Expense Method: Choose between deducting a set mileage rate (65.5 cents per mile in 2023) or actual expenses (fuel, repairs, depreciation). We work with you at Harmony to determine the most beneficial method.
Of course, you can also maximize your tax savings by working with Harmony's tax team if you don't already.
2. W-2 vs. 1065: How You Pay Yourself Matters
Restaurant owners must carefully structure how they pay themselves, as it directly impacts tax liability and compliance.
Sole Proprietors & Partnerships (1065 Filers): If you own a restaurant as a partnership (Form 1065), you cannot pay yourself a W-2 salary. Instead, you receive distributions and guaranteed payments, which are subject to self-employment taxes. This means that you will be responsible for both the employer and employee portion of the FICA taxes.
S-Corp & C-Corp Owners (W-2 Filers): If your restaurant operates as an S-Corp or C-Corp, you must pay yourself a “reasonable salary” through payroll (W-2), subject to employment taxes. Additional profits can be distributed as dividends, which may have tax advantages.
3. Credit Card Refunds & Cash Back: Tax-Free Money
Restaurants deal with frequent customer refunds, chargebacks, and supplier returns. But how do credit card refunds and cash-back rewards impact your taxes?
Personal Credit Card Use: If you charge a business expense on a personal credit card, getting reimbursed does not create taxable income. Some owners find this a valuable perk to accumulate credit card points and/or cash back.
Business Credit Card Refunds: If a supplier refund or chargeback is processed on a business credit card, it reduces taxable expenses rather than creating taxable income. Ensure that all refunds are tracked accurately to avoid overstating expenses.
Cash-Back Rewards: Many business credit cards offer cash-back rewards on purchases. The IRS treats these as a reduction in expenses rather than taxable income which can flow through to the owner, meaning operators can receive tax-free cash back on purchases they were already making for their restaurant. So essentially, tax-free money.
4. Personal Guarantees on Loans & Leases: What You Need to Know
It’s often necessary for owners to personally guarantee loans and leases, especially when starting out. But do you understand the risks involved?
What is a Personal Guarantee? It’s a legal agreement making you personally liable for business debts if your restaurant cannot pay. Especially in leases, it’s important to note that you don’t necessarily have to pay the guarantee amount – it’s a cap on your personal liability.
Minimizing Risk:
Negotiate limited guarantees (e.g., capping your liability at a fixed amount).
Explore Letters of Credit for Leases.
Explore SBA-backed loans that limit personal exposure.
5. Recourse vs. Non-Recourse Loans: Understanding the Difference
Restaurant financing often involves loans, but not all loans carry the same level of personal risk. Understanding recourse vs. non-recourse loans is crucial:
Recourse Loans: If your restaurant defaults, the lender can seize business assets and pursue your personal assets to satisfy the debt.
Non-Recourse Loans: The lender can only collect from business assets, limiting your personal liability.
Key Considerations:
Most traditional business loans are recourse loans.
Some equipment and real estate financing options offer non-recourse terms.
Strong financials and collateral can help negotiate better loan terms.
Final Thoughts: Protect Your Restaurant, Protect Yourself
Maintaining a clear financial boundary between personal and business funds is not just a best practice—it’s a necessity. Proper financial separation ensures tax compliance, legal protection, and financial clarity, all of which are critical for long-term success.
At Harmony, we’re here to help you navigate these complexities. If you have questions about tax deductions, entity structuring, or financial risk management, don’t hesitate to reach out. Keeping "church and state" separate in your financial life is the smartest business move you can make.