Our quick-hitting FAQs cover some of your most pressing tax-related questions.
How do I get a tax ID number?
Every new business needs its own tax ID number. To get a federal tax ID number, you must fill out IRS Form SS-4 (available from the IRS Web site at www.irs.gov --click on "Forms and Publications"), and either mail or fax it to the IRS office indicated in the Instructions to Form SS-4. There is no fee.
Once the IRS issues you a number, you will have to get a tax ID number from each state in which you have a business address. This will involve filling out a state form (which will look suspiciously like the SS-4) and paying a small filing fee. A complete list of state tax authorities and their websites, from which you can obtain the appropriate form, can be found at www.taxsites.com (click on "State and Local Tax"). You can ask your lawyer, bookkeeper or accountant to do this for you, but they may charge you for their time.
How long does the tax ID process take, and is there a quicker way to get one? I'm anxious to open a checking account right away, and my bank won't let me open one without an ID number.
Most IRS offices will issue the number by mail within two to three weeks after they receive your Form SS-4. If you can't wait that long, you can call the IRS and get a tax ID number assigned to you over the telephone. The toll-free number is (866) 816-2065; the average wait to reach a human being is one to two minutes. It helps to have a completed Form SS-4 in front of you, because the agent will ask you many of the same questions.
What do I do if the IRS issues more than one ID number for my business?
Let's say you file Form SS-4 with the IRS, and then get impatient and call the IRS' toll-free phone number. Because you're dealing with two different IRS offices, there's a good chance the IRS will issue two different ID numbers for your business. If this happens, you must get the IRS to expunge the duplicate number from its records; otherwise they'll think you're operating two different businesses with the same name and will be looking for two different tax returns each year
To correct this problem, first call the IRS' toll-free number (866-816-2065). Explain the problem to the agent, and ask for the "entity fax number" for your regional IRS office. The agent will give you this number over the phone. You must then fax to this "entity fax number" a brief note explaining the discrepancy and telling the IRS which of the two numbers you plan to use for your business. The fax should be addressed to "BMF: Business Master File." Make sure the number you want the IRS to keep on file is the number you have used to open your checking account.
You should also mail "hard copies" of the fax to 1) the IRS office designated to issue your tax ID number and 2) the IRS office to which you're required to file your tax returns. Be sure to send these by certified or registered mail (so you get return receipts) to the attention of "BMF: Business Master File." It's not a perfect solution (the faxes may still get lost), but it's the best you can do.
My partner and I started a business three years ago, but I ended up buying him out earlier this year. Now that I run the business by myself, the IRS says I have to apply for a new tax ID, but all my records are under my current tax ID. What should I do?
Under IRS rules, buying out your partner constitutes a "change of status" that requires you to get a new federal tax ID number. But because you bought him out earlier this year, there's still time to consider making your spouse or significant other a partner with a 1 percent partnership interest. That way, you'll preserve your status as a partnership and can keep your current tax ID number. Just don't "backdate" any documents, as that will get you in serious legal trouble if you're found out.
Last year, I was thinking about starting a business with two friends (an LLC) and got a federal tax ID number. But our circumstances changed, and we've decided not to start the business. Do we have to file a tax return for a business that never existed?
The simple answer is yes. If you have a federal tax ID number and fail to file a tax return with that number on it, the IRS will charge you a nonfiling penalty--in your case, that would be $600 per partner, or $1,800 total. What you should do is download Form 1065 (a partnership tax return) from the IRS website , and fill in all the blanks with zeroes. On the line reading "date business commenced", write in "N/A - never commenced business," and be sure to check the "Final Return" box on page one of the form. That should be enough to put the IRS on notice that you're not planning to use your tax ID number in the future and that "There's nothing to see here."
Do I issue 1099s or W-2s to employees who are family members?
If your family members are truly employees, meaning you direct and control their activities during working hours and they don't work for anyone else, you need to send them W-2s by January 31 for the preceding year. (If you send them out late, you'll incur a $50 penalty for each W-2.) If your accountant thinks you have a shot at treating them as "independent contractors," you should send a Form 1099 to any individual you paid more than $600 total to in the previous year. Again, you'll incur a $50 penalty for each 1099 if you send it after January 31. If you do treat them as "independent contractors," make sure the tax savings are greater than the deductions you're passing up by hiring them as employees. Your accountant can help you with these calculations. One other thing to note: There are some deductions business owners who hire family members, especially minor children, are eligible for. See IRS Publication 15, "Employer's Tax Guide," for more details.
I mailed a W-2 form to a former employee whom we terminated last July. Apparently the employee moved shortly after being terminated, because the envelope came back to us marked "no forwarding address." What do we do now?
According to Linda Hunt, founder of the financial management firm SumSolutions LLC , if a W-2 is returned to you as undeliverable, you should not open it but rather retain it in your files in the original envelope. "When and if the former employee inquires as to the whereabouts of their W-2, you should make a copy of the returned envelope and re-mail it in a larger envelope," says Hunt. "Do not open it and place the W-2 in another envelope."
Why? By re-mailing the original envelope, you create an audit trail of compliance with IRS regulations requiring that W-2s be postmarked by January 31. If you throw away the original envelope, you will have no proof that you actually mailed the W-2 by that date. The same holds true for 1099 forms.
Our attorney and our accountant are both professional corporations (PCs). Do we still have to send them 1099 forms?
IRS regulations require that attorneys always receive 1099s, regardless of the manner in which they do business. The law is a little fuzzier when it comes to accountants and other professionals, but Hunt advises that 1099s be sent to all providers of professional services, even if they are LLCs or corporations.
A graphic designer performed more than $600 of services for us last year, but she operates as a single-member limited liability company (LLC). Do we still have to send her a 1099 form?|
The IRS views single-member LLCs as "disregarded entities"--that is, the IRS does not view them as separate from their owner. Hunt believes the safest bet is to send 1099s to any contractor that is an LLC, a limited liability partnership (LLP), a business trust or other unincorporated business entity, especially if they use their personal Social Security number as their business's tax ID.
Last year we hired someone to act as a consultant to our business. We treated her as an independent contractor, but we only recently learned that we were this person's only client last year, and our attorney says there's a possibility this person might be considered an employee of ours. Should we send the consultant a W-2 or a 1099 at this point?
Your attorney is 100-percent correct. Your consultant has failed one of the basic tests of independent contractor status--that the consultant has other clients. Without knowing more about the relationship, though, no one can say for sure if she was or not. For example, if the consultant did all her work at her own location, worked less than 1,000 hours last year, and submitted regular invoices for her hourly fees and reimbursable expenses, she may still be considered an independent contractor even though you were her only client. You won't know for sure unless you go through an audit and the IRS agrees with your position.
If you send her a W-2, you are admitting that she was an employee last year, and you'll be liable for Social Security, Medicare, and federal and state unemployment taxes on the amounts you paid her (along with interest and penalties for paying these taxes late). Talk to your attorney some more about this relationship, and see if you have any good-faith defenses to a claim that the consultant was an employee. If the attorney feels that you do, you can send the consultant a 1099 for last year. Just make sure she pays all federal and state withholding taxes on the amounts you paid her last year (don't be afraid to ask for proof, such as a copy of her tax return for that year). Not a risk-free solution, but the best you can do under these circumstances
Then, keep an eye on the relationship going forward. If you continue to be her only client, and especially if she is working so many hours that realistically she doesn't have time for other clients, you should put her on the payroll and start paying employment taxes to avoid liability this year.
If most of the individual sales I generate for my service business are $600 or less, do I have to pay taxes on them? And send out 1099s on them?
If your question is, "Do I have to pay taxes on what I make?" the short answer is yes. Even if you generate just $1 in sales, you have to report it as income and pay taxes on it. As for your question on 1099s, the short answer is no. But any customer that paid you more than $600 total last year is supposed to send you a 1099, not the other way around.
My husband and I are equal partners in an LLC, but last year, he began taking a salary generated through our payroll service, with all pertinent taxes withheld. But now I understand that my husband can't be paid as an "employee" of the LLC if he owns 50 percent of it. What are the tax consequences of our mistake?
Generally, the members of an LLC don't receive a salary because they're not employees. What they receive instead is a percentage of the LLC's profits and losses each year. In this case, that would be 50 percent each. Any money they take out of the LLC checking account for their own use is considered a "draw" or "advance" against their percentage share of profits. If their percentage share is more than $400 per year, they must pay self-employment taxes (FICA, SDI and Medicare) as well as income taxes. If their percentage share comes to more than $1,000 a year, then they must "estimate" their income and self-employment taxes and pay them in quarterly installments.
We're not aware of any law that says LLC members can't "voluntarily" withhold taxes from their periodic "draws" in order to avoid having to pay quarterly estimated taxes. But you should ask your accountant about this. As for any consequences, you'll have to calculate your husband's 50 percent share of your LLC's profits last year (whether or not they were actually paid to him), determine the total federal and state taxes he should have paid on that income, subtract all amounts withheld by your payroll service, and determine the amount of taxes--including any interest and penalties if he was "underwithheld"--due on the balance. And don't forget you still owe taxes on your 50 percent share of the profits, too.
If I carry inventory in my business, do I need to file as an "accrual" taxpayer or can I do it as a "cash basis" business?
If you take in more than $1 million in sales each year, the IRS requires that you use the "accrual" method of accounting, where you record sales when your customers have a legal obligation to pay (not when you actually receive the cash). The IRS is more flexible when it comes to smaller businesses, but I'd get into the habit of using the accrual method, as it more accurately reflects the operating results of a business that maintains inventory.
Last year, after retiring from my job, I started a business selling toys on the internet. How do I handle inventory for tax purposes for the toys I've been collecting and storing for many years that I'm selling now? Many of the things I bought several years ago for low prices are highly collectible--and more valuable--now.
It sounds as if you're asking how you should report the "cost of good sold" for these items when you don't have accurate records of how much you paid for them. If you can recall how much you paid for the item, use your memory to record the cost, but keep some type of written "memo to the file," such as "purchased at Danbury Antiques Fair 03/96 for $10." You can also look through old auction catalogues and ads in antique toy collector's magazines to see what specific toys were selling for at roughly the time you bought them. The IRS will usually accept that type of information.
Another (less reliable) approach is to show your toys to a local antiques dealer who's been around a while and get a rough written estimate of how much these items were selling for "way back when." Many dealers collect old catalogues and magazines and will do this research for you--for a fee, of course.