CHAPTER
4

Licenses and Legalities

In This Chapter

• How your local liquor laws could affect your business model
• What permits you need and how to make getting them easier
• How to set up your business entity
• Types of insurance you need to protect your assets

Your restaurant needs to be safe. Your customers need to be safe. And you, the restaurant owner, need to be safe. That’s what this chapter is about, really. Yes, you’ll be filling out forms from A (alcohol) to Z (zoning). But don’t worry, the restaurant industry is easily ushered through the process of procuring the permits and licenses to run a safe and legal establishment.

Most of the laws governing restaurants are local. They vary from state to state, county to county, town to town, and even specific parts of town. If you’re an independent sort, you might wonder why there are so many rules. The answer is that municipalities (and businesses) need safely constructed buildings that aren’t fire traps. Towns and cities want restaurants where the food won’t make people sick.

Your local government website is the go-to site for the details of what’s required for restaurants at your specific location. Along with ways to make the permit process easier, we’ll show you how to structure and set up your business, prepare to pay employee withholding taxes, and take care of the IRS’s tip allocation form. And we’ll tell you what kind of insurance you need to protect yourself, as well as your personal and business assets.

But first, let’s get down to drinking. Laws, that is.

Know Your Local Liquor License Laws

There’s an old restaurant adage: “You make your money on the booze.” In a full-service restaurant with sit-down dining and a bar, alcohol makes up 35 percent of your total sales. Alcoholic beverages are high-profit items. The profit margin is about 75 percent.

Liquor licensing laws have a dynamic effect on your budget. They vary from place to place. Some states have a fee-based system; others have an ownership model. Depending on where you live, you could pay a yearly license fee in the hundreds of dollars or buy a license for hundreds of thousands of dollars.

Some towns or counties, such as parts of Martha’s Vineyard in Cape Cod, are “dry.” They don’t allow alcohol to be sold in stores or restaurants. Most dry towns allow customers to “bring your own booze” (BYOB or BYO). No-alcohol policies and BYOB scenarios cut the high profit alcohol brings to a restaurant’s bottom line.

DEFINITION

BYOB or BYO are acronyms for “bring your own booze” and “bring your own.” Some restaurants that don’t have a liquor license allow guests to bring their own wine. The restaurant charges a corkage fee to cover the cost of the goods and services to serve the wine.

But some restaurateurs choose to open a BYOB anyway. In Philadelphia, the high cost of purchasing a liquor license has spawned a hip BYOB restaurant scene. Young chef-owners opening a BYOB can enter the market without the financial burden of buying a license. Even in cities with reasonable annual licensing fees, some restaurateurs open BYOBs. Customers love them because it lowers tabs. That can keep a restaurant’s seats filled. But be warned: customers wince when corkage fees are more than a token amount.

Fee-Based and Commodity Licensing Model

In places like Boston and Florida, a liquor license is a tangible asset. Most states issue affordable new licenses by lottery, and they are limited by quota. Calculate the odds: a dozen new licenses a year and a lottery. No one in their right mind bases a business on that.

The alternative is to buy a liquor license on the open market. Scarcity determines the price. A distorted inflated market grows for this asset-based commodity. The cost of buying a liquor license could range up to $500,000, depending on the state and county. Often, an old tavern can have value beyond its business enterprise because it owns a license.

There are professional brokers who handle the purchase of a liquor license, and some financing companies will hold the license title in escrow as collateral. Buying a license should be handled through a broker—it’s an expensive purchase and laymen are at a disadvantage. Typically, brokers are attorneys who specialize in obtaining liquor licenses. The attorney-broker runs a title check, and makes sure there are no liens or encumbrances on the license. You don’t want surprises—like finding out the last owner still owes $30,000 to a liquor vendor. Make sure the license applies to your geographic location. Often, licenses are not transferable to a new site.

A fee-based liquor license is an easier proposition. In places like New York and Connecticut, a fee is charged every one or two years. The range can be relatively nominal, $1,200 to $2,500 a year. It’s a lot less expensive than buying a liquor license.

Classifications

There can be different classifications of liquor licenses, such as live entertainment or cabaret, which permit dancing.

DEFINITION

Municipalities issue liquor licenses according to classifications or classes, which are categories of establishments where liquor is sold and carried away or sold for consumption onsite. A classification such as tavern might indicate an establishment in which alcohol but no food is served.

These classifications affect fees. Some states have restrictions that are enforced through zoning. For instance, you might encounter rules that an establishment selling liquor can’t be within 1,500 feet of a school or church or an existing establishment with a liquor license.

Often, municipalities have exceptions for enterprise zones. Enterprise zones are areas targeted for economic growth. Tax breaks are offered to local businesses. Keep in mind most municipalities are intent on keeping their commercial districts from turning into Vegas overnight.

The classification of restaurant or café can impose restrictions, too. Some states require a separately allocated bar area with the view and access restricted. For instance, the opening cannot be more than six feet and the barrier wall must be at least six feet high with four feet being solid and the remaining two feet being diaphanous (covered with plants, sheer curtains, etched glass, etc.). Minors must be able to enter the restaurant, eat in the dining room, and use the restroom without having to come into direct contact or open view of the bar.

A café license doesn’t require a separation between bar and eating area, but no one under drinking age may enter the premises without a guardian. This is something to consider if you have a family-style dining concept.

Knowing your local liquor code is vital. Do an internet search to find your state alcohol control board. Their websites define state liquor codes and provide links to local county and town codes. You need information to answer the following questions.

Local Liquor Law Checklist:

• ❏ Is alcohol allowed to be sold in your town and location?
• ❏ Are there any specific zoning laws that restrict liquor licenses, such as proximity to a church, school, or other businesses?
• ❏ Are liquor licenses issued by yearly fee or must you buy one in your location?
• ❏ What are the classifications of liquor licenses and how do they affect building regulations?
• ❏ What are the costs of liquor licenses in your location?
• ❏ Could your restaurant thrive if it were BYOB?

There’s a ton of rules, regulations, requirements, and restrictions associated with liquor laws. On your state’s website, you should be able to find the associated fees and downloadable application forms.

Streamlining the Permit Process

“Code” is the word used at the zoning, building, fire, and health departments. Your restaurant must be “code compliant” before they’ll let you open your doors to the public. Zoning is the local government body that determines the intended use of the location. The building department must approve the specifications of materials and methods, such as details like the thickness of insulation and the number of electrical outlets. The fire inspector makes sure your space follows fire prevention codes. Fire departments also inspect commercial buildings several times a year.

Health Codes

Town and city governments regulate food service establishments to ensure they’re safe places to eat and drink. Health codes vary, but all require safe handling, proper storing and preparation of food, and employees practicing good hygiene. Restaurants are required to have a food service establishment permit that states they’ve met all the federal, state, and local health requirements.

Some states require that two people from your restaurant staff take a state food handling course to be certified. It’s recommended that the restaurant owner take the class for his or her own edification and to make sure this knowledge stays when staff changes. If the owner can’t take the course, the manager and chef should.

A yearly food establishment service license is also required. Each new owner must apply for a permit. They aren’t transferrable with the premises.

The building and fire departments will determine that all the components of your plan meet safe building and fire-prevention codes. Inspectors from building, fire, and health will review your progress and sign off when it’s complete.

Contacting your local town hall departments in the planning stage is essential to avoid surprise complications further down the road. They’ll give you parameters to follow.

It’s always best to go along with their requirements rather than try to convince them that you’re “special.” People love to find places with grandfathered conditions—those that existed before local zoning codes were established. Local zoning boards make some exceptions for certain “pre-existing” conditions.

Let us say this loud and clear: safety violations are never grandfathered.

DEFINITION

Grandfathered is used to describe conditions that existed before zoning laws were implemented, and so are allowed to continue despite not conforming to current laws. For instance, a restaurant that has been running since 1920 in a neighborhood now zoned for one-family residential has been grandfathered.

We recommend that beginners start restaurants in spaces that have been operating as restaurants and are up to code, or will require few alterations to meet code. Remember, every time ownership of a restaurant changes hands, local officials review the plan and can require you to upgrade to current building, fire, and health code and Americans with Disabilities Act (ADA) requirements.

You can greatly simplify the process of opening your restaurant if you’re careful not to modify an existing restaurant space beyond decorating and signage.

Signage, by the way, can be one of the most time-consuming parts of the process. Often, architectural review boards and zoning must approve your plan for a sign. Signage is a strictly enforced code item. The linear street frontage of your building is part of a formula used to calculate how many square inches the sign can be. There are rules governing how tall each letter can be, based on the size of the total sign.

Colors are monitored. Some municipalities have “light blight” restrictions in downtown areas.

Sometimes, even if your sign meets all the measurements and regulations, you may still have to defend it before a city board. A space that never was a restaurant requires some exploration. Can you get a liquor license there? Will your zoning board approve it as a place of public assembly? This process could drag on for months. And that’s before you start your expensive and time-consuming build-out, which town officials will want constructed to current code.

Historic Properties

Historic designation is a potential hornets’ nest. Many older buildings like banks and firehouses make cool venues, but if they’re registered as historic, the modifications you’re allowed to make could be limited. Landlords think historic designation adds value but actually it diminishes it, and in some parts of town it can be very restrictive.

In older construction, external access by ramps possibly might be given a pass as a “pre-existing condition” under a grandfather clause. But in a new development, installing external ramps for access by the disabled is non-negotiable.

Prevent headaches and budget blowouts by finding a property that has been operating as a restaurant and is up to zoning, fire, and health codes, or will need few upgrades to be compliant with building, fire, and health codes.

POTENTIAL PITFALL

Avoid real estate or sites that will require getting variances, official exemptions, and permission to vary from zoning regulations. Variances are available in some cases, but the approval process can be long, expensive, and painful.

If you choose a space with lots of code violations or one where you’re starting from scratch and doing a complete build-out, you’re starting with some big question marks. What you discover behind the walls can blow your budget, your schedule, and your mind.

On a more minor scale, it’s bad publicity to get a bad health inspection report. These days, a customer can easily find out if the staff at their favorite restaurant is washing their hands. Many town websites post restaurant health department ratings.

It can be frustrating. Just remember, behind each form and each official, behind each violation (punishable by fines and court action if not remedied), is the intent of creating a safe environment and a safe community. Sure, it can seem that they go overboard sometimes. But it’s never a good idea to argue or get in a fight with your zoning, fire, or health inspector. We all walk the line sometimes, especially when we’re new to the process.

SMART MOVE

Use your professional team, your lawyer, builder, architect, or designer, to take the emotion out of dealing with town officials. Hire professionals who work in the town frequently. They’re familiar with the process and the people at town hall. That makes the process a lot smoother.

There’s often a mutual respect between the town hall team and the area’s professionals. The combination of an architect and designer presenting a well-thought-out plan to a government panel such as the zoning board of appeals can lessen scrutiny. Colors and interior sketches can help to bring officials to an emotional place. They want their town to thrive. However, the floor plan schematic will ultimately demonstrate the code compliance they’re looking for.

External patio permits are often issued seasonally and they require displacing interior seats so as to not increase overall capacity. This happens when parking spaces determine seating rather than it being determined solely by square footage. Capacity formulas are set according to interior space and available parking.

The dynamic of getting the fire department to allow more seats per square foot and a lower number of allowable seats per parking spaces means you must build in a fixed-capacity design based on displacement. You don’t want to leave broad open areas that you could be inclined instantly to fill in with seats after you’ve been granted a certificate of occupancy (CO).

DEFINITION

A certificate of occupancy (CO) is the official document a municipality will issue to your restaurant once you’ve passed final inspections from the building, health, and fire departments. Once you get that CO, you can open for business.

There’s one old trick that almost every busy restaurant has used. That’s having a seating plan to pass requirements and slowly adding seats to fill in as needed. Local fire inspectors know this, and usually they’ll give you a little slack—as long as you leave clear space at exits and don’t create an obvious hazard by overcrowding.

Application requirements vary, but most include the application form, a nominal fee, scale drawings, the name of your contractor and his license number, and certificates of insurance for workers’ compensation with the property owner listed as the certificate holder.

Ultimately, no matter what the stage of planning and construction, you have to demonstrate the code compliance they’re looking for.

Permit Expeditors

In a metropolitan market, the cost of hiring a permit expeditor is well worth it. Permit-expediting companies take care of all permits needed to get your building and space within all city codes and laws.

An expediter can cost in the range of $2,500 to $7,500 in New York City, but it’s a slam dunk. They take care of it—it’s a game they know how to play. They know Jim at the city’s zoning desk. If you go it on your own, and you’re unfamiliar with the people, culture, and requirements, your application could be denied. A delay caused by a permit denial can push you off course. Permit expeditors will also find and remove any violations and represent you in zoning court. However, it’s better to find a space that doesn’t have violations.

Structuring Your Business Enterprise

You will have to set up your business’s legal and operating structure. For restaurants, a limited liability company (LLC) is the business model of choice. LLCs have many benefits:

• They offer protection from liability.
• They’re taxed at the owner’s individual rate instead of the corporate tax rate.
• Losses offset income from other sources.
• They’re easy to set up.

Most restaurants form an LLC. It protects personal assets from liabilities incurred by your business. LLCs can be made up of one or multiple members. When there’s just one member, it’s taxed as a sole proprietorship. Benefits include being compensated through distributions of the profit, which are taxed at the owner’s individual rate.

Business profits and losses are treated as “pass-through”; members report profits on their own taxes. Losses can be used to offset income an LLC member gets from sources other than the business.

The federal government doesn’t tax LLCs, but some states do. All LLCs must file tax returns. A single owner files a sole proprietor tax return. Multiple members file as an S Corporation. Profits are taxed at a corporate rate of 15 percent. Members are considered self-employed, which means they’re required to pay self-employment tax contributions toward Medicare and Social Security. The LLC’s entire net income is subject to this tax.

Depending on what state you live in, LLCs are issued by the state attorney’s office, department of commerce, or another government entity. You’ll find the forms and instructions on their website. Even if you use a lawyer, which is recommended, familiarize yourself with the components of an LLC:

• Choose a name for your business.
• File an article of organization.
• Draw up an operating agreement (if there are multiple members).
• Get a federal tax number in order to start the LLC.

The Taxman Cometh

Tips your employees get from customers are subject to withholding tax, and employees must claim all tip income, including tips you paid to them for charge customers and any the employee got from the customer directly.

Point of Sale (POS) systems are sophisticated. Your POS system can be your best friend and record tip information if you use it properly.

DEFINITION

Point of Sale (POS) systems are computer programs that act as the central nervous system of a restaurant. The system manages table orders, kitchen order tickets, and guest checks; processes credit and debit cards; keeps track of inventory; and runs detailed financial reports.

Your POS system will calculate and keep a record of tip allocations. Employees are required to report tip income using Form 4070, “Employee’s Report of Tips to Employer,” due on the 10th day of the month after the month the tips are received. This statement must be signed by the employee. If the monthly tips are less than $20, no report is due. We tell our employees that if they report less than 10 percent on tips, they must be doing a really bad job as a server to get tips that low. They should report at least 10 percent.

The IRS has forms employees can use to keep track of tips. For complete information go to the IRS’s Restaurants Tax Center at www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/Restaurants-Tax-Center.

Withholding

As the employer, you’re required to collect income tax, employee Social Security tax, and employee Medicare tax on tips reported by employees. You can collect these taxes from an employee’s wages or from other funds he or she makes available. But the best advice is to hire a payroll service.

A payroll service will make automatic deductions from your employees’ paychecks. That will prevent a danger—a restaurant owner dipping into payroll deductions to cover expenses. Everyone says they’ll never do it, but it happens again and again. It causes a lot of headaches come tax time.

If you own a large food or beverage establishment, meaning you have more than 10 employees working more than 80 hours on an average business day, you’ll use Form 8027, “Employer’s Annual Information Return of Tip Income and Allocated Tips” to report employee tip income. A worksheet for determining whether a business meets the criteria listed above is included in the Instructions for Form 8027.

The best resource on restaurants and taxes is from the horse’s mouth itself, the IRS’s Restaurants Tax Center. Don’t expect your accountant to wave a magic wand. Be prepared to ask useful questions during meetings with your accountant.

Insurance

Restaurants can be dangerous places, with flames, knives, boiling liquids, and alcohol in a high-pressure, fast-paced environment. However, many restaurants actually overinsure. There are four types of insurance a restaurant owner needs:

• Property insurance
• General liability insurance
• Liquor liability insurance
• Worker’s compensation

Most states require liquor liability insurance for any establishment holding a liquor license. Yet many restaurants overinsure for liquor liability. If your insurance broker is offering you extra coverage for liquor liability, evaluate the cost/benefits. The notion you’ll be sued every time a person who drinks in your restaurant does something stupid … well, let’s examine it.

A 200-pound man comes into the restaurant. He’s coherent and articulate, and you serve him one drink. It’s the drink that puts him over the edge. He leaves the restaurant unnoticed, and drives his car into a tree. The point is, there’s no scientific way to measure someone’s sobriety when they come into your restaurant. A restaurateur will be sued only in the event of gross negligence. Instead of buying extra insurance, put time into training your manager, bartender, and waiters to manage noticeably intoxicated guests and facilitate safe transportation home.

Business interruption insurance is another thing for which we don’t recommend increasing your monthly payment. A lot of people are spooked after years of storms, hurricanes, and week-long power outages. After Hurricane Sandy, Jody’s restaurants were out of power for days and lost a lot of food. He put in a claim with his insurance agent and received a check.

SMART MOVE

Instead of increasing your overhead costs by overinsuring, reduce risks by training your staff to promptly address any issue that creates a potential liability, such as mopping up spills.

Instead of business interruption insurance, invest in an alarm system on your walk-through that will tell you when power’s gone off. It should go to you, your manager, and chef’s iPhones. If you get that message, get down to the restaurant and flip the circuit breaker. If it doesn’t go back on, bring in dry ice and protect your food.

The cost of an entire restaurant package, with general liability and workman’s compensation, can average about $25,000 per year. You’ll see state restaurant associations offering links to insurance. Look at those offers carefully, and don’t subscribe to an expense you can’t control. Insurance should be considered one of those constants in your overhead budget, like your rent.

Our theory is you want to first build your business into something worth protecting before you spend a lot of money protecting it.

Be Honest

You’ll be estimating sales and payroll, but don’t lie. The days of cash and scamming are over. Everyone’s wired, all information is available. In the electronic age, it pays to be above board. You don’t want to be audited. You don’t want the audit to come back with a walloping number of outstanding taxes you need to pay, plus penalties. You can’t get away with it.

It’s good to create a “Black Belt Team” of professionals who have higher skills and experience when they’re needed. There’s a host of folks who can help you make your way through the thicket of licenses and legalities, most importantly your lawyer, insurance broker, accountant, and payroll service.

Don’t hire professionals to manage something just because you don’t understand it. Hire them because they can devote more time to doing it correctly with their advanced skills and experience. That’s worth paying for and needs to be part of your operating budget. When you’re working with your team, remember that you’re the leader. You’re paying the salaries of your lawyer, architect, builder, and designer. Never let a consultant intimidate you into doing something that compromises your restaurant concept beyond recognition.

The Least You Need to Know

• The laws governing building and running restaurants are intensely local. You need to research liquor licenses; zoning, building, fire, and health department codes; and ADA regulations on your city or town website.
• If your state uses the ownership model for liquor licenses, work with a license broker or real estate agent who specializes in restaurants.
• Work with, not against, your local zoning, health, and fire officials and members of regulatory boards.
• Rely on your builder, architect, and designer to make presentations and pull permits at town hall.
• Hire professionals such as an accountant and insurance broker who specialize in restaurants and payroll services.