It is essential that you clearly identify your business to the IRS by using the correct identification numbers and industry codes. 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. In most cases, you will also need to supply your employer identification number (EIN).
Certain sole proprietors need not have an EIN on the tax form. If you operate your business as a sole proprietor, you'll need to have an EIN if:
- you have one or more employees,
- you have a Keogh plan, or
- you have to file excise tax forms, such as those for alcohol, tobacco or firearms.
If you do not need to have an EIN, then your "business identification number," is your own "taxpayer identification number." For nearly all individuals, this is your social security number. If you operate more than one business as a sole proprietor, you should use the same EIN for all your businesses.
If is very important that you use the correct identification number for your business. If you purchase a business for which an EIN is needed, you need to use your own EIN or get a new one. Don't make the mistake of using the EIN of the previous owner.
In contrast to sole proprietorships, each partnership, LLC and corporation must always have its own EIN.
How to apply for an EIN
You can apply for an EIN online using the Internet, 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" application 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 or make electronic deposits. During this time, the EIN can be used for other purposes, such as setting up bank accounts. You can also use it to file paper returns.
The online session will time out after 15 minutes of inactivity. So, before you begin you should review, and perhaps even complete, the 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 or corporation.
However, 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 (Social Security Number, Employer Identification Number, or Individual Taxpayer Identification Number.)
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 267-941-1099 between 6:00 a.m. to 11:00 p.m. (Eastern Time) Monday through Friday. Be forewarned: This is not a toll-free number.
FAX. You can FAX your completed Form SS-4 to the FAX number provided on the form. If you provide your fax number is provided, a fax will be sent back with the EIN within 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
Regardless of the form you use for your business (sole proprietorship, partnership, LLC or corporation), you must correctly identify the type of business that you are running. To do this, you enter a six-digit business code at the top of your annual income tax form you file for your business.
You can find the correct business code by consulting the complete list of these codes that are included in the IRS instructions to the tax form you are required to file:
- Sole Proprietor (and LLCs taxed as disregarded entities): Schedule C or Schedule C-EZ
- Partnerships (and LLCs taxed as partnerships): Form 1065
- S Corporations (and LLCs taxed as S corporations): Form 1120S and
- C corporations (and LLCs taxed as C corporations): Form 1120.
It is essential that you use the correct business code. The IRS has been on a crusade to educate its agents about typical operating procedures in different industries and in specific types of businesses, in order to equip the agents to ferret out under-reported income and overstated deductions.
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).
If you are a general contractor for commercial property, the IRS has a general idea of the percentage of your various expenses. However, if you incorrectly report your business code as a general contractor for residential property, your expenses and accounting methods may appear to be way out of line. The unfortunate result is that your tax return may be selected for an audit.
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 operated 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.
Rose operates a beauty salon. Nearly all of the gross receipts come from providing services to her clients. A small percentage comes from the sale of beauty products, such as shampoos and nail polish. 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 we suggest that you use this only as a last resort.
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, 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.
Deb enjoys making jewelry. She begins to sell her creations at various craft shows in the area. Many of the people who purchase her items express a desire to learn to make jewelry themselves. Deb decides to offer a series of classes covering different styles of jewelry. She is engaged in two separate businesses and should file a Schedule C for each business.
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 the activities.
Other factors that should be considered include:
- Which spouse is the primary operator of the business? For instance, does one spouse run one activity while the other runs a second?
- Where is 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, agent or commission drivers and 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 - 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, 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 Schedule C. So, if your "sole proprietorship" involves some rental or leasing activities, you may need to treat the income and expense from these activities as separate passive activities.