The Importance of Tax IDs for Your Business
Understanding the significance of tax identification numbers (Tax IDs) is crucial when running a business. Mistakes in handling Tax IDs can lead to severe consequences, including personal liability, tax penalties, and operational disruptions. This article will explore the different types of Tax IDs, common mistakes business owners make, and how to avoid them.
The Role of Tax IDs in Business Operations
The primary goal of properly managing Tax IDs is to maintain a clear separation between your personal finances and your business operations. This helps avoid personal liability for business obligations and ensures compliance with tax laws, thereby preventing penalties and fines.
Common Tax ID Types
Social Security Number (SSN)
An SSN is issued to U.S. citizens and eligible residents by the federal government. It serves as a personal tax ID and is used to track individual earnings and tax responsibilities.
Individual Taxpayer Identification Number (ITIN)
For those who do not qualify for an SSN, such as non-citizens, the federal government issues an ITIN. This number allows individuals to comply with U.S. tax laws.
Employer Identification Number (EIN)
An EIN is a federal tax ID number for businesses, including corporations, partnerships, and LLCs. It is used for reporting employment taxes, income taxes, and other business-related taxes. Even non-business entities, like trusts, may require an EIN.
Real-Life Example of Mismanagement
Consider the case of a business owner who set up a PayPal account to receive customer payments. Due to confusion during the setup process, the owner provided both his personal and the corporation’s information. Over the years, substantial sums flowed into the account. However, during a subsequent lawsuit, it was unclear whether the account belonged to the individual owner or the corporation. This ambiguity led to severe complications, illustrating the critical importance of correctly associating Tax IDs with the appropriate entity.
Common Mistakes and How to Avoid Them
Incorrect Use of Tax IDs
One of the most common errors is using the wrong Tax ID when setting up accounts or filling out forms. For example, using a personal SSN instead of the business’s EIN can blur the lines between personal and business finances, leading to potential personal liability for business debts.
Multiple EINs for One Business
Each business entity should have only one EIN. Adding a DBA (Doing Business As) does not require a new EIN. The EIN is linked to your business’s relationship with the IRS and should remain consistent, regardless of how many DBAs you operate under.
Not Registering for a Tax ID
Failing to obtain the necessary Tax IDs for your business can result in non-compliance with tax laws, leading to penalties. Ensure that your business is registered with both federal and state authorities to avoid these issues.
Mismanagement of State Tax IDs
In addition to a federal EIN, businesses often need a state tax ID number for state-specific tax filings, including sales tax, use tax, and payroll tax. Neglecting to obtain or correctly use a state tax ID can result in state tax compliance issues.
Ensuring Proper Management of Tax IDs
Clarity in Ownership and Responsibility
When setting up accounts with financial institutions or payment processors like PayPal and Venmo, it is essential to clearly specify whether the account is for the business or the individual. Use the correct Tax ID to reflect this ownership accurately.
Consult with a Legal Professional
Given the complexities involved, consulting with a legal professional when setting up your business’s financial and tax structures can prevent future problems. An attorney can help ensure that all forms are correctly filled out and that the proper Tax IDs are used.
Regular Review and Compliance
Periodically review your business accounts and tax filings to ensure federal and state tax requirements compliance. This practice helps identify and rectify any issues before they escalate into more significant problems.
Conclusion
Understanding and correctly using Tax IDs is vital for maintaining the legal and financial health of your business. Avoiding common mistakes by using the appropriate Tax ID for each situation, ensuring clarity in account ownership, and consulting with legal professionals can safeguard your business from severe financial and legal consequences. By staying informed and vigilant, you can ensure that your business operates smoothly and remains compliant with all tax regulations.
Video Transcript
You would think this is something pretty simple. Do we really need to cover it? But unfortunately, it can be devastating if a few errors are made. And we will talk about how to avoid those errors.
The Goal
Now, the goal is to avoid personal liability for business obligations, avoid tax consequences, penalties, and fines, and keep all of your business operations separate from your own. But let me tell you a real story about what happened and the devastating consequences that resulted.
A Real-Life Example
A business owner set up a PayPal account. And it was a little confusing how to set this up. The business owner’s intent was to set up a business account in order to receive payments from customers for the business. Now, like most banking institutions, PayPal asks for a social security number for the business owner.
Now, PayPal might have also requested a tax ID for the business, but it was a little confusing, and the business owner didn’t quite know which type of account I set up. Do I set it up as a business owner under the name of the business, or do I set it up as a business entity under the name of the owner?
And so, because it was confusing, the business owner ended up providing information for himself and the corporation. And then, in the years that followed, the corporation’s customers paid money to this PayPal account. Hundreds of thousands of dollars went into this account. And then there was a lawsuit.
And long story short, it was not clear under PayPal’s records whether the account was owned by the individual, the owner, or the corporation. And this happens time and time again, where a creditor will go after the assets of a bank account or a PayPal account where there is a tax ID number associated with the account.
It is not clear whether that tax ID number is the owner or just one of the authorized signers or the person who set up the account. So the big takeaway here is understanding that a social security number is a tax ID number for an individual. Corporations, LLCs, and other business types get their tax ID number. That is called an EIN, which stands for Employer Identification Number.
As a business owner, company president, or COO, it is really important whenever you set up an account with PayPal, Venmo, a credit card company, or a financial institution, to make sure you are using the right tax ID so that the right ID is making sure that the owner is clarified. Is it the company, or is it you as an individual?
Credit Card Example
By the way, I have even seen this with credit cards, where the intention was to set up a credit card for a company. The COO set up the credit card account, and the credit card company opened the account under the name of the COO. And allowed the business to use the card. What was the problem? When the business went under and didn’t pay the credit card account, the credit card company came after the COO and said, “This is your account. You are personally liable.”
So tax ID numbers are vital because you want to be clear about who is the owner of the account. And if your tax ID number, personal, your social security is associated with the account, you want to be clear about where your personal liability ends.
Usually you are personally liable for whatever you do, but you don’t want to be liable for whatever happens to the account. Only the owner of the account should be liable for whatever happens to the account. So, what is the takeaway here? Make sure you clearly understand the difference between your social security number and the EIN, which is the tax ID for your company.
Filling Out Forms
And whenever you are filling out forms, be clear about which tax ID owns the account or is responsible for the account, and who the other people who are signers. A lot of times, this gets into a lot of legalese, and it is not clear from the forms that are filled out. So this is a great opportunity to involve an attorney if you are not sure. It is never a problem right in the beginning. What happens is years go by and then, all of a sudden, there is a dispute or the IRS freezes funds in the account.
Imagine running your company and the IRS freezing your company account because your secretary from years earlier set up the account in her name and it wasn’t the company as the owner. So the company has a hundred thousand dollars in its account. And when the secretary doesn’t pay her income taxes, the IRS comes and freezes the money in your company account. Why? Because the account is under her social security number, it is not listed as the company being the owner. I have seen these issues time and again.
Takeaway
And so the takeaway is to make sure you are using the right tax ID number and clarifying who is the owner, who is the signer, and who has access to these accounts. So liability is properly allocated to the individual or entity you want it to go to.
Types of Tax IDs
So let’s quickly talk about the different names and types of tax IDs and how to get them. The government issues tax ID numbers for people. These are called Social Security Numbers if you are a citizen of the United States.
And if you don’t qualify for a social security number, for example, because you are not a citizen of the United States, then you can get an individual tax ID number. Both of those are issued by the federal government through the IRS or a similar government branch.
Businesses also have a tax ID number. Those are called Employer Identification Numbers or EINs. It is called that even if the company is not employing anyone. EINs are used for other entity types, like a trust, even if it is not a business, and so it wouldn’t have employees. So EIN is just a term used for a tax ID number that is created for a non-individual. So, like an LLC, corporation, etc.
The IRS provides EINs. So to get an EIN, is very simple, it is free, and it is immediate. You go on to the IRS website. You can go to the page that allows you to get an EIN. You fill out the information, and it is immediately given to you. Even before anybody reviews your information, the IRS computer issues you an EIN.
Once you get that EIN for your company, you generally also need to get a state tax ID number. Common names include State Tax ID Number, State Taxpayer Number, State Sales Tax Number, and State Corporation Number. Different states have different names, but they all serve the same purpose. It is kind of like a social security number for your company. It is a number that is used to track your company in that state. And you are generally going to use that tax ID number whenever your company does a state tax return. That includes sales tax, use tax, income tax, and any other tax.
One important part of that is often payroll tax because whenever you are withholding money from employees’ wages, you are going to notify the state and use your state tax ID number. So every company has a federal tax ID number and a state tax ID number. Every individual has a federal tax ID number, and for citizens, that is called the social security number.
Common Mistakes
So what are some common mistakes? The big one is using the wrong tax ID number on a form or when setting up an account. The second mistake is not getting a tax ID number. Not getting a business registered with the state.
The other mistake I often see is a company will have more than one EIN. Every company should have one. If you add a DBA, you don’t get a new EIN. The EIN is for your relationship with the IRS and the federal government. So when your company has an EIN with the federal government, it doesn’t matter if you set up multiple DBAs. You still just use one EIN. And if you start another LLC or another corporation, each one has its own EIN.
Key Takeaway
So what is the key takeaway here? Well, now that you understand the different types of tax IDs, just make sure that you use the right tax ID number for each situation.
