It is essential that you clearly identify your business to the IRS by using the correct identification number and industry code. Trouble finding the correct code to describe your business may mean you are operating more than one trade or business. This article discusses the use of various taxpayer identification numbers by businesses and tips for determining if you have more than one business for tax purposes.
Regardless of how you operate your business, when you file your annual income tax forms, you must provide your business name (if it's different from your own name), your principal business or profession, and your principal business code.
A Business Identification Number, often referred to as an Employer Identification Number (EIN), is a unique nine-digit number issued by the IRS to identify a business entity in the United States. States also issue their own forms of business identification numbers, such as state tax or sales tax ID numbers.
Not all businesses require an EIN
Partnerships, LLCs (other than LLCs that are disregarded as an entity for federal income tax purposes), and corporations must always have an EIN. But this requirement is not necessarily the case with sole proprietorships and single-member LLCs that are disregarded as an entity – meaning that the IRS does not recognize the business as being a separate taxable entity from the owner of the business.
As long as they do not meet certain conditions that require an EIN, sole proprietorships and disregarded single-member LLCs can use a Social Security Number (SSN) for IRS tax filings.
However, you'll need to have an EIN for your sole proprietorship or disregarded single-member LLC if:
- you have one or more employees;
- you have a Keogh plan; or
- you have to file employment, excise, or Alcohol, Tobacco, or Firearms taxes
You must use the correct identification number for your business. If you purchase a business that requires an EIN, you need to use your own EIN or get a new one. Each EIN is tied to a specific legal entity.
Don't make the mistake of using the EIN associated with the previous business owner. This could lead to issues such as having to deal with unpaid taxes or improperly claimed tax credits.
How to apply for an EIN
You can apply for an EIN online, by fax, and through the mail. Regardless of which method you use, the IRS will issue only one EIN per responsible party per day.
Online applications. The online application is the most efficient and quickest way to obtain an EIN. You complete an "interview style" form online. Once the application is submitted, the information is validated during the same online session, and an EIN is issued immediately.
However, even though you receive your number immediately, you must wait for two weeks before you can file an electronic return, make electronic tax deposits, or pass an IRS Taxpayer ID Number matching program. During this time, your new EIN can be used for other purposes, such as setting up a bank account or applying for a business license. You can also use it to file paper tax returns.
It’s not possible to save your progress once you’ve started, so you must complete the application in one session. The session will also time out after 15 minutes of inactivity. So, before you begin you, should review and perhaps even complete a physical or PDF copy of Form SS-4, Application for employer identification number, to make sure you have all the information and answers that you will need.
You can use the online application process regardless of whether you will operate your business as a sole proprietorship, partnership, LLC, or corporation.
To apply for an EIN online, you must meet the following requirements:
- The principal business, office, or agency, or legal residence (in the case of an individual), must be located in the United States or U.S. Territories.
- The principal officer, general partner, grantor, owner, trustor, etc. must have a valid Taxpayer Identification Number. This can be a Social Security Number, Employer Identification Number, or Individual Taxpayer Identification Number. You cannot apply with an EIN (unless you are a government entity).
Telephone. You cannot apply for an EIN using the telephone if you reside in the United States. If you are not in the United States, you can apply by phone by calling the number listed on the IRS’ website.
FAX. You can fax your completed Form SS-4 to the number provided on the form. If you provide your fax number, the IRS will send the EIN via fax in four business days.
Mail. This is definitely the slowest method of application. The processing time for an EIN application received by mail is four weeks, provided that everything on the form is properly completed.
Using the correct business code is essential
When submitting your annual income tax form, you will also need to provide a principal business activity code. Regardless of the business structure you use for your enterprise (sole proprietorship, partnership, LLC, or corporation), you must correctly identify the six-digit code that best describes the business activity producing the income being reported.
You can find your business code by reviewing the complete list of these codes that are included in the IRS instructions to your tax form:
- Sole Proprietor (and LLCs taxed as disregarded entities): Schedule C
- Partnerships (and LLCs taxed as partnerships): Form 1065 (and Schedule K-1 for each partner or member)
- S Corporations (and LLCs taxed as S corporations): Form 1120S and (Schedule K-1 for each shareholder)
- C corporations (and LLCs taxed as C corporations): Form 1120
It is essential that you use the correct business code. The IRS may screen your return to determine whether your income and expenses are unusual for that type of business indicated by your business code. If you use the wrong business code, the IRS may be judging you by the incorrect standard. If so, they may decide to dig further into your return (and ask you to produce a lot more records to prove your figures).
Special considerations for sole proprietorships and disregarded single member LLCs
What if it appears that your business doesn't fit into any one business code? If this is the case, you should first consider whether you are actually operating two (or more) different businesses. If so, you'll want to report the income and expenses from each business separately. However, if you believe that you are operating only one business, then you should use the code that accounts for the highest percentage of the total receipts of your business.
Example. Rose operates a hair salon. Nearly all of the gross receipts come from providing services to her clients. A small percentage comes from the sale of hair products, such as shampoo, conditioner, and hair treatments. Rose would use 812112, Beauty Salon, as her business code since the sale of products represents only a small portion of the total receipts.
The IRS does provide a code 999999 for business owners that are unable to classify their operations, but you should use this only as a last resort. If you are not sure what code to use you might want to consult with a tax adviser because of the serious consequences of using the wrong code.
Each business needs its own business code
It's not uncommon for successful business owners to expand the initial business into additional, related activities. In addition, many business owners may operate completely separate businesses. If you operate more than one distinct business, and you operate the business as a sole proprietorship or disregarded single member LLC, it is essential that you use the proper business code for each business. Also, if you have two or more separate business activities, you usually can't report them both on the same Schedule C.
Example. Deb enjoys making jewelry as a hobby, but wants to turn it into a side hustle. She begins selling her creations at various craft shows in the area. Deb also wants to launch a mobile dog grooming service to supplement her income. Since she is engaged in two distinct business activities (one for retail trade and the other for pet care services), she must file a separate Schedule C for each business with a separate business code.
Unfortunately, there is no hard-and-fast rule that determines when you are operating more than one business because the facts and circumstances can vary so much from case to case.
The questions found in the instructions to Form 5213, “Election to Postpone Determination as to Whether the Presumption Applies that an Activity is Engaged in for Profit” can also help you determine if you are engaged in more than one type of activity. These instructions state that you must consider all of the following in determining whether you are engaged in more than one activity:
- the similarity of the activities;
- the business purpose that is (or might be) served by carrying on the activities separately or together in a trade or business or investment setting; and
- the organizational and economic interrelationship of the activities
In general, if you provide similar products or services to similar clients, you have a single business. If the products or services are different or if the client base is different, you may have more than one business depending on how close the relationship is between activities.
Other factors that should be considered include:
- If you own businesses with a spouse, which spouse is the primary operator of the business? For instance, does one spouse run one activity while the other runs a second?
- Where are the businesses located? If you have two different but related businesses that occupy two separate sites, it's more likely that they should be considered two separate businesses.
In addition, if you receive income as a "statutory employee” (a grouping that includes full-time life insurance agents, drivers delivering certain goods who are your agent or work on commission, traveling salespersons, and certain homeworkers), you must report this income on a Schedule C. If you also receive other income as a self-employed person, don't combine the two types of income. Instead, you must file a separate Schedule C for each type.
One last factor to keep in mind is that the tax law provides for separate treatment of "passive activities". Basically, this is because income or losses from a passive activity can only be offset by income or losses from other passive activities.
Real estate rentals are most often classified as passive activities which must be reported on Schedule E, Supplemental income and loss, not on Schedule C. (In some cases, short-term rental income is also reported on Schedule E, particularly when no substantial services are provided.) So, if your sole proprietorship or disregarded single member LLC involves some rental or leasing activities, you may need to treat the income and expenses from these activities as separate passive activities.
As you can see, determining whether to report the income of businesses separately and whether you need separate business codes for each business can be difficult. If you have any doubts, consult with a tax professional.