If you’re starting a side business, you may have already encountered the term Employer Identification Number (EIN). It’s a common topic of confusion for new business owners, particularly those who are running smaller, more casual operations. This article will help clarify when you need an EIN for your side business, how to apply for one, and the benefits of having one. Let’s break down the essential information so that you can make the best decision for your business.
What is an EIN?
An Employer Identification Number (EIN), sometimes referred to as a Federal Tax Identification Number (FEIN), is a unique nine-digit number issued by the IRS to identify a business entity for tax purposes. It’s essentially a Social Security Number (SSN) for your business. While individuals use their SSN to file taxes, businesses use an EIN to report business income, withhold taxes, and pay employees, among other tasks.
An EIN is required for many businesses. For example, if you plan to hire employees or operate as a corporation or partnership, you need an EIN. However, some side business owners may not need an EIN, depending on their structure and operations.
When Do You Need an EIN for Your Side Business?
There are several situations where obtaining an EIN is not just helpful, but necessary. Below are the key instances when an EIN is required.
You Have Employees
One of the most common scenarios where you need an EIN is if your side business hires employees. According to the IRS, any business that employs one or more individuals must have an EIN to report employment taxes. This applies even if you only plan to hire temporary, part-time, or freelance workers.
For example, imagine you start a small catering business on the side and hire an assistant to help with events. In this case, you would need an EIN to report payroll taxes to the IRS. You would need to provide the required documentation, such as W-2 forms, at the end of the year.
Without an EIN, you would not be able to legally report wages or pay employee-related taxes. This could lead to penalties, interest, or even legal trouble. If you intend to pay yourself or others as employees, securing an EIN should be one of your first steps.
Your Business Structure Requires It
The type of business entity you form also determines whether you need an EIN. If you are operating as a sole proprietor, you may not need an EIN. However, if you form a more formal business structure, an EIN will likely be necessary. For instance, if you form an LLC (Limited Liability Company) or a corporation, you must apply for an EIN.
These types of business structures are separate from you personally. In other words, they require their own identification number for tax reporting purposes. An example of this would be if you set up an LLC for your freelance graphic design business. Even if you do not have any employees, the IRS considers an LLC a separate entity from yourself. That said, you must apply for an EIN to file taxes under that business.
For partnerships, an EIN is also necessary. Let’s say you and a partner decide to open a small coffee shop as a partnership. The IRS would require you to obtain an EIN, even if there are no employees. Partnerships are considered distinct tax entities. The EIN helps track income and expenses, as well as the allocation of profits to each partner.
You Have a Kept or Shared Bank Account for Business Purposes
If you are setting up a separate business bank account for your side business, you will need an EIN. Most banks will ask for an EIN if you are opening an account under a business name, even if you are a sole proprietor. This helps separate your personal and business finances, which is important for accurate bookkeeping and tax filing.
Suppose you start a side business offering handmade jewelry on Etsy. You’ll want to open a separate business account to keep your business finances distinct from your personal finances. The bank will likely require an EIN before allowing you to open an account under the business name. This ensures that the bank has the correct information for tax reporting.
If your business continues to grow, having a dedicated EIN for your business account can also make it easier to apply for business loans or lines of credit. Lenders typically require an EIN to verify the legitimacy of your business.
When Can You Skip the EIN?
While many business owners need an EIN, there are situations where you can legally operate your side business without one. The IRS has specific guidelines for when an EIN is not required. These guidelines are based primarily on your business structure and operations.
Sole Proprietorship with No Employees
If you’re operating as a sole proprietor and have no employees, you can use your Social Security Number instead of an EIN. A sole proprietorship is the simplest form of business ownership. In this structure, you are the sole owner and are personally responsible for all business debts and obligations. For example, if you offer consulting services or freelance writing as a sole proprietor, you may be able to use your SSN for tax purposes. If you do not hire employees and report all business income on your personal tax return, you may not need an EIN.
However, if you prefer to keep your personal and business finances separate or if you want to maintain a level of professionalism, you can still choose to obtain an EIN. While it is not a requirement in this case, an EIN could help you avoid sharing your SSN when working with clients, vendors, or financial institutions.
Reporting Business Income on Personal Taxes
Sole proprietors who don’t have employees typically report their business income on their personal tax return using Schedule C (Profit or Loss from Business). In this case, the IRS allows you to use your SSN for reporting purposes. This is because your business is not considered a separate entity from you personally.
For example, let’s say you run a small online store and you’re the sole owner and operator. You can simply use your SSN when filing your taxes. However, you should still maintain accurate records of your income and expenses for business purposes. This is even if you’re not required to apply for an EIN.
How to Apply for an EIN
If you find that you need an EIN for your side business, the application process is relatively simple. The IRS allows you to apply for an EIN online, which is the fastest method. You can complete the online application on the IRS website, and once submitted, you will receive your EIN immediately.
To apply online, you will need to provide information about your business, such as its legal name, structure, and purpose. That said, your business should already be registered with your state before obtaining an EIN. If your business has employees, you will also need to include information about your payroll. You will be asked to identify the responsible party for the business (usually the owner). Once the application is complete, you will receive your EIN.
If you cannot apply online, you can also request an EIN by mail or fax. This process may take several weeks to complete, so it is not ideal if you need the EIN quickly. The IRS also offers a phone application service for international applicants.
Benefits of Having an EIN for Your Side Business
While an EIN may not always be required for a side business, there are several benefits to obtaining one, even if you’re not legally obligated.
Increased Professionalism and Credibility
Having an EIN makes your business appear more legitimate to clients, customers, and financial institutions. For example, assume you’re running a web development business and you provide clients with invoices that list an EIN. It shows that you are serious about your business and separate your personal finances from your professional ones. This can help you establish trust with your clients and potential partners.
Easier Tax Filing
Separating your personal and business finances makes tax filing easier. When you use an EIN for your side business, you can keep track of business income and expenses separately from your personal finances. This reduces the chance of mistakes when preparing your taxes. The IRS allows you to file taxes for your business under your EIN, even if you’re a sole proprietor. This can simplify tax preparation and help ensure you are reporting your income accurately.
Potential for Business Credit
Having an EIN can also help you build credit in your business’s name. Many lenders and credit card companies require an EIN for business loans, lines of credit, and business credit cards. By applying for credit under your EIN, you can establish a credit history for your business. This can be useful if you plan to expand your business in the future.
Consequences of Not Having an EIN When You Need One
If you are legally required to obtain an EIN and fail to do so, there can be serious consequences. These include delays in hiring employees, difficulty filing taxes, and potential fines from the IRS. Additionally, if your business ever undergoes an audit, not having the correct tax identification number could complicate the process.
Furthermore, failing to obtain an EIN when required may limit your ability to apply for business loans or credit. Financial institutions generally require an EIN to process business loans. Not having one may hinder your ability to access capital for your business.
Tax Help for Businesses
Determining whether you need an EIN for your side business depends on various factors, including your business structure and whether you have employees. Obtaining an EIN is a straightforward process that can help set your side business up for success. By considering your business’s needs and consulting with a tax professional when necessary, you can ensure that you are complying with IRS requirements and positioning your business for growth. If you’re unsure whether you need an EIN or how it fits into your overall tax and business strategy, it’s a good idea to consult a tax professional. Optima Tax Relief is the nation’s leading tax resolution firm with over $3 billion in resolved tax liabilities.
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