Starting a business: EIN, sole proprietor or LLC, and startup costs

An employer identification number is free from the IRS and takes minutes, but a sole proprietor with no employees often does not need one. Forming an LLC changes your liability first and your federal tax treatment barely at all.

Do you need an EIN

The IRS says you generally need one in order to hire employees, to operate a partnership or a corporation, to pay sales and excise taxes, to change your business structure or ownership, and to administer certain trusts, retirement plans and estates. Read that list as a list of triggers. A sole proprietor with no employees usually meets none of them and can use their own Social Security number on the return.

Plenty of sole proprietors get an EIN anyway, and the reason is practical rather than legal: it becomes the number that goes on a Form W-9 when a client asks, which keeps a Social Security number out of circulation. There is one warning worth repeating because the IRS puts it on its own page. You never have to pay a fee for an EIN, and a site charging for one is not the IRS.

Applying takes a single sitting on irs.gov, because the application cannot be saved part way, and it expires after a stretch of inactivity. Print the confirmation letter when it appears; it is the document a bank asks for. If you are forming a corporation or an LLC, form the entity with the secretary of state before you apply, or the EIN application may be delayed.

Sole proprietor or LLC: what changes on the return

Less than most people expect. For federal income tax, an LLC with one member is treated by default as disregarded, meaning it is not separate from its owner, so the income still lands on Schedule C under the owner's own return. An LLC with at least two members is by default a partnership. An LLC that wants corporate treatment has to elect it on Form 8832, and that election is its own decision with its own consequences.

In short: an LLC is a liability structure created by state law, and forming one does not by itself change the federal income tax result. The IRS sets out the classification rules on its page for limited liability companies. If what you are really after is a change in how the profit is taxed, the next step up is the subject of S corporation or sole proprietor.

Employment tax is the exception

Disregarded is not disregarded everywhere. For employment tax and certain excise taxes, an LLC with only one member is still treated as a separate entity, even though it is invisible for income tax. That is why an LLC that takes on employees needs an EIN of its own rather than using the owner's number.

Startup and organizational costs

Money spent before the business begins operating is generally a capital expense rather than a deduction, which is a surprise to anyone who spent a year getting ready. An election softens it. You can elect to deduct up to $5,000 of business start-up costs in the year the business begins, and up to $5,000 of organizational costs, with each of those deductions reduced by the amount by which that category of costs exceeds $50,000.

Worked through, that means costs a little over the threshold cut the first-year deduction dollar for dollar, and costs far enough over it remove the first-year deduction entirely. Whatever is not deducted currently is amortized ratably over one hundred eighty months, which is fifteen years, beginning with the month you begin business operations. Two things follow. Once the election is made it is irrevocable. And the date the business actually began matters, because it fixes the year the election belongs to.

Start-up costs are the ordinary things you paid for before opening: advertising, travel, market surveys, training. Equipment and other assets are not in that category, because their cost is recovered through depreciation instead.

The first bookkeeping

Open a separate bank account on day one, keep a running record of income and expense rather than a shoebox, file receipts by month, log mileage from the first business trip, and write down every pre-opening cost with the date it was paid. That last one is not fussiness. The start-up election turns on when the business began, so the dates are what let you sort the pre-opening costs from the ordinary ones.

What you will owe, and when

Net earnings from self-employment of $400 or more bring self-employment tax, and nothing is withheld from what a business pays itself, so the tax is paid during the year through estimated payments. Quarterly estimates covers the dates and the arithmetic. In Texas there is one more: an annual franchise tax report is due from most entities even when no tax is owed, which the Texas franchise tax report walks through.