Tax identification numbers (IDs) are a common source of confusion and frustration for new business owners.
While it might just seem like one more bureaucratic piece of red tape keeping you from starting a business, tax IDs are indispensable for daily functioning.
The difference between federal and state tax systems aren’t always clear. To complicate matters, regulations can vary by state.
However, understanding both state and federal tax law is essential for keeping your business on a solid legal footing. Furthermore, you will need a tax ID to carry out a variety of standard business operations.
To help clear up confusion, we’ve put together this guide to explain the key differences between federal and state tax IDs.
Here’s what you’ll learn:
- The purpose of tax IDs
- The difference between federal and state tax IDs
- How to register a tax ID
What’s the Purpose of Tax IDs?
Essentially, tax IDs are social security numbers (SSNs) for businesses. They serve the same function SSNs do for individuals.
Each business receives a unique number from both federal and state governments, which act as their tax IDs. Primarily, you need a tax ID to file your business’s taxes, including income and payroll taxes.
However, other essential business operations require a tax ID, as well. Therefore, once you’ve determined your business’s legal structure, it’s a good idea to obtain relevant tax IDs as soon as possible.
Start with making sure you understand the difference between federal and state tax systems.
What’s the Difference Between Federal and State Tax IDs?
Federal and state governments have separate tax systems and varying laws that determine income tax amounts. For this reason, you will need to obtain a different tax ID from each.
Federal income tax applies to every registered business. Some states have more advantageous tax laws for businesses than others, but nearly every company will have to pay state taxes.
Currently, there are seven states that don’t levy any personal income tax:
- Alaska
- Florida
- Nevada
- South Dakota
- Texas
- Washington
- Wyoming
However, depending on your business’s structure, you might have to pay corporate income tax instead. The only states that don’t charge corporate or personal income tax are Wyoming and South Dakota.
The main difference between federal and state tax systems comes down to who you are paying.
Keep this in mind:
Your state has a tax system that is separate from the federal government’s. So, you will need to go through the process of registering your business twice — once for the state and once for the federal government.
After you’ve done that, you’ll receive a separate tax ID from each. Let’s take a look at these in greater detail.
Federal Tax ID vs EIN
Your federal tax ID is officially known as your employer identification number (EIN), also referred to as a federal employer identification number (FEIN).
There’s no distinction between a federal tax ID and EIN. They’re completely interchangeable names referring to the same unique number that classifies your business as a tax entity in the eyes of the federal government.
While paying taxes directly to the federal government is the primary function of an EIN, you’ll also need this ID to apply for business permits and licenses, set up a bank account in your business’s name, and hire employees.
Keep in mind that federal taxes apply to all businesses. Even if your business is exempt from taxes in your state, you’re still liable for taxes at the federal level.
Unless you are a sole proprietor or single-member LLC (limited liability corporation), securing an EIN is a must, no matter where you do business in the U.S.
What Is a State Tax ID Number?
A state tax ID number is also called a state employer ID or state EIN. It is your state’s version of the federal EIN, and serves the same purpose — a unique number associated with your business for state tax purposes.
There is no difference between federal and state tax IDs besides which is used to pay your federal or state taxes. However, the rules surrounding how you obtain a state tax ID and precisely what you need it for may vary based on your state’s unique tax laws.
At the very least, you’ll need a state tax ID number to qualify for business licenses and permits, hire and pay employees, and file state and municipal taxes.
Do You Have to File Both Federal and State Taxes?
Every business and individual is legally required to file both federal and state taxes.
So, in a word: Yes.
Each level of government operates on its own budget. Therefore, you must pay taxes into each system. There is no difference between federal and state taxes when it comes down to whether or not you have to pay them — you do.
The only exceptions are businesses in locations without a state income tax. However, you can be exempt from a personal income tax and still owe corporate tax. If you want to stay on the right side of the law, you need to have a clear understanding of precisely what kind of taxes your business owes to both the state and federal governments.
What Kinds of Businesses Need Tax IDs?
The only types of business structures that don’t need to apply for an official tax ID are sole proprietorships and single-member LLCs.
As the simplest form of legal business entity, sole proprietors don’t have any employees and don’t file pension or excise tax returns. This qualifies sole proprietors to file and pay taxes on their business through their personal income.
An individual operating as an LLC also fits this description. Instead of a federal or state tax ID, these basic business structures simply use their SSNs to pay taxes. However, any LLC that hires employees is automatically required to obtain official tax IDs.
While there is a slight difference between federal and state tax requirements, you should consider getting a tax ID if your business is doing any of the following:
- Hiring employees
- Structured as a partnership or corporation
- Using a pension plan that’s tax-deferred
- Filing returns for employment
- Involved in the selling of firearms, tobacco, or alcohol
How to Register For a Federal Tax ID
Another significant difference between federal and state tax IDs is how you register for them.
Since there’s only one set of federal tax laws, all businesses apply for a federal EIN in the same place. This simplicity makes the process of getting your federal tax ID easy.
In order to apply for a federal tax ID, you need to fill out a Form SS-4 through the Internal Revenue Service (IRS). The fastest way to do this is by filling out an EIN application online. You’ll be guided through a series of questions about your name, address, social security number, and Doing Business As (DBA) name.
If you’re not comfortable putting this information online, you can download the Form SS-4 as a PDF and follow the submission instructions.
Either way, it doesn’t take long to fill out the application and verification usually comes in a few days. The process of applying for a federal tax ID is entirely free.
How to Register For a State Tax ID
Since tax requirements vary between states and localities, it’s not possible to give a generic set of instructions that all businesses can follow.
Instead, you should visit your state’s government websites to find the correct information. Googling “how to register for a state tax ID in [your state]” should also provide you with helpful results.
Alternatively, you can consult the IRS’s official list of state revenue websites for relevant tax information by state.
Typically, employment and income taxes are the most common types of state taxes small businesses are required to pay.
Make sure you’re extremely clear on your state’s specific requirements.
Despite the varying systems, there shouldn’t be any major differences between the federal and state tax registration processes. You’ll need to provide some basic information about your company, fill out an application, and wait.
Even if you think your business structure is exempt from state taxes, you should still look into state tax IDs since these numbers can offer you some advantages. For example, sole proprietors can use a state EIN as an extra layer of protection from identity theft.
Due to the difference between federal and state tax systems, businesses are required to apply for these IDs separately. After structuring your company as a legal entity, start applying for a federal and state EIN.
While the federal tax law impacts all businesses the same, you’ll need to do some targeted research to understand what kind of taxes your state uses.
In addition to filing and paying taxes, having a state and federal tax ID will qualify you for a variety of important business functions such as hiring employees and applying for permits and licenses.
Once your business is registered, the next step in building your company should be to create a killer website.
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