Expensing Restaurant Smallwares

Editor: Albert B. Ellentuck, Esq.

Restaurants and taverns can deduct the cost of smallwares in the year in which the smallwares are received and used, instead of having to capitalize those expenditures; see Rev. Proc. 2002-12. The smallwares method applies to businesses engaged in the trade or business of preparing food and beverages to customer order for immediate on-premises or off-premises consumption. In addition to normal restaurants and cafeterias, it applies to caterers, mobile food servers, bars and taverns, and food or beverage services located in grocery stores, hotels and motels, amusement parks, theaters, casinos, country clubs, and similar social or recreational facilities.

However, the method does not apply to the costs of smallwares that are considered start-up expenses under Sec. 195. A business not already engaged in the trade or business of operating a restaurant may not use the smallwares method as justification for expensing the cost of smallwares purchased before opening. These start-up costs must be capitalized under Sec. 195. Assuming the appropriate election is made, up to $5,000 of the start-up costs can be deducted, with the remainder amortized over a period of 180 months, starting with the month in which the active trade or business begins.

Smallwares consist of the following ten categories of items: (1) glassware, (2) flatware, (3) dinnerware, (4) pots and pans, (5) table-top items, (6) bar supplies, (7) food preparation utensils and tools, (8) storage supplies, (9) service supplies, and (10) small appliances that cost $500 or less individually. Smallwares do not include collectibles or other items of significant artistic or intrinsic value, such as flatware or dinnerware made of precious metals and antique vases or fine art for decoration purposes.

Businesses that qualify for the method are allowed to account for smallwares in the same manner as materials and supplies that are not incidental under Regs. Sec. 1.162-3. This means that the costs are deductible in the year in which they are actually consumed and used in the business. Smallwares are deemed consumed and used when they are received and are available for use. Large purchases of smallwares near year end that are stored at a warehouse or other facility are not treated as received and available for use. Under Rev. Proc. 2002-12, such smallwares’ costs are included as inventory and expensed in the following year when used.

Example: Sammy’s Steakhouses, Inc., incorporates on March 1, 2007. It is an accrual-basis, calendar-year corporation that will open three restaurants in Texas on August 1, 2007. Prior to opening, the corporation purchased table-top items, bar supplies, food preparation utensils, and other items considered smallwares in the food service industry. Sammy’s paid $60,000 for these items prior to opening. It estimates that it will need to purchase an additional $20,000 of replacement smallwares during 2007 and at least $30,000 per year thereafter.

The $60,000 of smallwares purchased before opening are start-up costs under Sec. 195. Sammy’s can expense the $20,000 of smallwares costs incurred after business began when they are received and available for use. If a significant amount of smallwares are purchased at the end of 2007 and stored for use in the following year, such costs are inventoried and expensed in the following year when used. The same rules apply to smallwares purchased in 2008 and later years.

Since Sammy’s is a new corporation in its first year of operations, it simply begins using the smallwares method on its 2007 return (no election is required).

This case study has been adapted from PPC’s Tax Planning Guide— Closely Held Corporations, 20th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard L. Burris, James A. Keller, Mary C. Danylak, and Kellie J. Bushwar, published by Thomson Tax & Accounting, Ft. Worth, TX, 2007 ((800) 323-8724; ppc.thomson.com).