Introduction

Table 1. What New Business Owners Need To Know About Federal Taxes

(Note: This table is intended to help you, as a new business owner, learn what you need to know about your federal tax responsibilities. To use it, ask yourself each question in the left column, then see the related discussion on the page shown in the right column.)

What Must I Know?	Where To Find the Answer
Which form of business will I use?	See Forms of Business above.
Will I need an employer identification number (EIN)?	See Identification Numbers on page 3.
Do I have to start my tax year in January? Or may I start it in any other month?	See Tax Year on page 4.
What method can I use to account for my income and expenses?	See Accounting Method on page 4.
What kinds of federal taxes will I have to pay? How should I pay my taxes?	See Business Taxes on page 5.
What must I do if I have employees?	See Employment Taxes on page 6.
What forms must I file?	See Table 2 on page 6 and Information Returns on page 8.
Are there penalties if I do not pay my taxes or file my returns?	See Penalties on page 8.
What business expenses can I deduct on my federal income tax return?	See Business Expenses on page 9.
What records must I keep? How long must I keep them?	See Recordkeeping on page 10.

This publication provides basic federal tax information for people who are starting a business. It also provides information on keeping records and illustrates a recordkeeping system.

Throughout this publication we refer to other IRS publications and forms where you will find more information. In addition, you may want to contact other government agencies, such as the Small Business Administration (SBA). See page 17 to find out how to get more information.

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What New Business Owners Need To Know

As a new business owner, you need to know your federal tax responsibilities. Table 1, below, can help you learn what those responsibilities are. Ask yourself each question listed in the table, then see the related discussion to find the answer.

In addition to knowing about federal taxes, you need to make some basic business decisions. Ask yourself:

• What are my financial resources?
• What products and services will I sell?
• How will I market my products and services?
• How will I develop a strategic business plan?
• How will I manage my business on a day-to-day basis?
• How will I recruit employees?

The Small Business Administration (SBA) is a federal agency that can help you answer questions such as those listed above. For information on how to contact the SBA, see page 24.

Forms of Business

The most common forms of business are the sole proprietorship, partnership, and corporation. When beginning a business, you must decide which form of business to use. Legal and tax considerations enter into this decision. Only tax considerations are discussed in this publication.

Your form of business determines which income tax return form you have to file. See Table 2 on page 6 to find out which form you have to file.

Sole proprietorships.   A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities and you undertake the risks of the business for all assets owned, whether or not used in the business. You include the income and expenses of the business on your own tax return.

More information.   For more information on sole proprietorships, see Publication 334, Tax Guide for Small Business. But if you are a farmer, see Publication 225, Farmer's Tax Guide.

Partnerships.   A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor, or skill, and expects to share in the profits and losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it passes through any profits or losses to its partners. Each partner includes his or her share of the partnership's items on his or her tax return.

More information.   For more information on partnerships, see Publication 541, Partnerships.

Corporations.   In forming a corporation, prospective shareholders transfer money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. However, shareholders cannot deduct any loss of the corporation.

More information.   For more information on corporations, see Publication 542, Corporations.

S corporations.   An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation. An S corporation generally is exempt from federal income tax other than tax on certain capital gains and passive income. Its shareholders include on their tax returns their share of the corporation's separately stated items of income, deduction, loss, and credit, and their share of nonseparately stated income or loss.

More information.   For more information on S corporations, see the instructions for Form 2553, Election by a Small Business Corporation, and Form 1120S, U.S. Income Tax Return for an S Corporation.

Limited liability company.   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. None of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in regulations section 301.7701-3. See the instructions for Form 8832, Entity Classification Election, for more details.

Identification Numbers

You must have a taxpayer identification number so the IRS can process your returns. The two most common kinds of taxpayer identification numbers are the social security number (SSN) and the employer identification number (EIN).

• An SSN is issued to individuals by the Social Security Administration (SSA) and is in the following format: 000-00-0000.
• An EIN is issued to individuals (sole proprietors), partnerships, corporations, and other entities by the IRS and is in the following format: 00-0000000.

You must include your taxpayer identification number (SSN or EIN) on all returns and other documents you send to the IRS. You must also furnish your number to other persons who use your identification number on any returns or documents they send to the IRS. This includes returns or documents filed to report the following information.

1. Interest, dividends, royalties, etc., paid to you.
2. Any amount paid to you as a dependent care provider.
3. Certain other amounts paid to you that total $600 or more for the year.

If you do not furnish your identification number as required, you may be subject to penalties. See Penalties, later.

Employer Identification Number (EIN)

EINs are used to identify the tax accounts of employers, certain sole proprietors, corporations, partnerships, estates, trusts, and other entities.

If you don't already have an EIN, you need to get one if you:

1. Have employees,
2. Have a qualified retirement plan,
3. Operate your business as a corporation or partnership, or
4. File returns for:
   1. Employment taxes,
   2. Excise taxes, or
   3. Alcohol, tobacco, or firearms taxes.

How to get an EIN.   You can get an EIN by mail, telephone, or fax. But first you must fill out Form SS-4, Application for Employer Identification Number. You can get Form SS-4 at SSA offices or by calling the IRS at 1-800-829-3676. It is also available from the IRS web site at www.irs.gov.

When to apply.   You should apply for an EIN early enough to receive the number by the time you must file a return or statement or make a tax deposit. If you apply by mail, file Form SS-4 at least 4 to 5 weeks before you need an EIN. If you apply by telephone, you can get an EIN immediately. If you apply by fax, you can get an EIN within 4 business days.

If you do not receive your EIN by the time a return is due, file your return anyway. Write Applied for and the date you applied for the number in the space for the EIN.

More than one EIN.   You should have only one EIN. If you have more than one EIN and are not sure which to use, contact the Internal Revenue Service Center where you file your return. Give the numbers you have, the name and address to which each was assigned, and the address of your main place of business. The IRS will tell you which number to use.

More information.   For more information about EINs, see Publication 1635, Understanding Your EIN.

Payee's Identification Number

In the operation of a business, you will probably make certain payments you must report on information returns (discussed later under Information Returns). The forms used to report these payments must include the payee's identification number.

Employee.   If you have employees, you must get an SSN from each of them. Record the name and SSN of each employee exactly as they are shown on the employee's social security card. If the employee's name is not correct as shown on the card, the employee should request a new card from the SSA. This may occur, for example, if the employee's name has changed due to marriage or divorce.

If your employee does not have an SSN, he or she should file Form SS-5, Application for a Social Security Card, with the SSA. This form is available at SSA offices or by calling 1-800-772-1213. It is also available from the SSA web site at www.ssa.gov.

Other payee.   If you make payments to someone who is not your employee and you must report the payments on an information return, get that person's SSN. If you make reportable payments to an organization, such as a corporation or partnership, you must get its EIN.

To get the payee's SSN or EIN, use Form W-9, Request for Taxpayer Identification Number and Certification. This form is available from IRS offices or by calling 1-800-829-3676. It is also available from the IRS web site at www.irs.gov.

If the payee does not provide you with an identification number, you may have to withhold part of the payments as backup withholding. For information on backup withholding, see the Form W-9 instructions and the General Instructions for Forms 1099, 1098, 5498, and W-2G.

Tax Year

You must figure your taxable income and file an income tax return based on an annual accounting period called a tax year. A tax year is usually 12 consecutive months. There are two kinds of tax years.

1. Calendar tax year. This is a period of 12 consecutive months beginning January 1 and ending December 31.
2. Fiscal tax year. This is a period of 12 consecutive months ending on the last day of any month except December. A 52- or 53-week period is a fiscal year ending on a specific day of the week that occurs in a particular month or occurs nearest to the last day of a specific month.

If you operate a business as a sole proprietor, the tax year for your business must be the same as your individual tax year. Special rules apply to S corporations and partnerships.

For more information, see Publication 538, Accounting Periods and Methods.

First-time filer.   If you have never filed an income tax return, you can choose either a calendar tax year or a fiscal tax year. You must choose a tax year by the due date, not including extensions, for filing your first return.

You must use a calendar tax year if you have inadequate records or you have no annual accounting period, or your annual accounting period does not qualify as a fiscal year.

Changing your tax year.   Once you have chosen your tax year, you may have to get IRS approval to change it. To get approval, you must file Form 1128, Application To Adopt, Change, or Retain a Tax Year. You may have to pay a fee. For more information, see Publication 538.

Accounting Method

An accounting method is a set of rules used to determine when and how income and expenses are reported. You choose an accounting method for your business when you file your first income tax return. There are two basic accounting methods.

1. Cash method. Under the cash method, you report income in the tax year you receive it. You usually deduct or capitalize expenses in the tax year you pay them.
2. Accrual method. Under an accrual method, you generally report income in the tax year you earn it, even though you may receive payment in a later year. You deduct or capitalize expenses in the tax year you incur them, whether or not you pay them that year.

For other methods, see Publication 538.

If you need inventories to show income correctly, you must generally use an accrual method of accounting for purchases and sales. Inventories include goods held for sale in the normal course of business. They also include raw materials and supplies that will physically become a part of merchandise intended for sale. Inventories are explained in Publication 538.

Certain small business taxpayers can adopt or change to the cash method of accounting and can choose to not account for inventories. For more information, see Publication 538.

You must use the same accounting method to figure your taxable income and to keep your books. Also, you must use an accounting method that clearly shows your income. In general, any accounting method that consistently uses accounting principles suitable for your trade or business clearly shows income. An accounting method clearly shows income only if it treats all items of gross income and expense the same from year to year.

More than one business.   When you own more than one business, you can use a different accounting method for each business if the method you use for each clearly shows your income. You must keep a complete and separate set of books and records for each business.

Changing your method of accounting.   Once you have set up your accounting method, you must get IRS approval before you can change to another method. A change in accounting method not only includes a change in your overall system of accounting, but also a change in the treatment of any material item. For examples of changes that require approval and information on how to get approval for the change, see Publication 538.

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