If you operate your small business as a sole proprietorship, you report all income and expense from the business on your personal federal tax return because the business is not a separate legal entity. In many cases, a sole proprietorship does not need a tax identification number, but a couple of exceptions exist.
Excise Tax Considerations
Excise tax is a specialty tax associated with specific items such as fuel, oil, tanning beds, air transportation, tractors, fishing equipment, outboard motors and arrow shafts. Excise tax is collected at the point of service or sale, in addition to any local sales tax collected. Excise tax must be paid to the Internal Revenue Service using Form 720 (Quarterly Federal Excise Tax Return). You must obtain a tax identification number to do this.
Business With Employees
If your business employs others, you must obtain a tax identification number for payroll tax deductions. General contractors who work for your business periodically are not considered employees, but be careful with classifying people who perform the same work on a regular basis as independent contractors. If the IRS determines a person is your employee, you will be responsible for both the employer and employee share of payroll tax due on all past payments to the person.
Filing a Federal Tax Return Without a Tax ID Number
Most sole proprietorships use Schedule C to report business income and expenses. You include Schedule C along with your other personal federal tax forms and use your Social Security number to identify the business. Net income and net loss from Schedule C are transferred to your Form 1040 to increase or offset other earnings.
Benefit to Acquiring a Tax ID Number
A tax identification number allows you to separate your personal credit from your business credit. Using a tax ID number, you can apply for credit for your business, and those loans or lines of credit will not appear on your personal credit report.
Applying for a Tax ID Number
If you decide you need a tax ID number for your sole proprietorship, the IRS provides many methods for application. The simplest and most efficient method is to apply online (see Resource). The IRS will issue you a tax ID number as soon as you complete the application.