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Taxmap/pubs/p911-001.htm#TXMP391a73af Basic Tax Information

The following discussion gives basic tax information that may help if you have never been in business for yourself. For more information about starting a business, see Publication 583.

Taxmap/pubs/p911-001.htm#TXMP2f7babfb Employer Identification   Number (EIN)

EIN

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

If you do not already have an EIN, you need to get one if any of the following apply to your business.

1. You have employees.
2. You have a qualified retirement plan.
3. You operate your business as a corporation or partnership.
4. You file returns for:
   1. Employment taxes,
   2. Excise taxes, or
   3. Taxes on alcohol, tobacco, or firearms.

You can apply for an EIN in the following ways:

• By going online—Click on the EIN link at www.irs.gov/businesses/small. The EIN is issued immediately once the application information is validated.
• By telephone at 1–800–829–4933 from 7:30 a.m. to 5:30 p.m. in the applicant's local time zone.
• By mailing or faxing Form SS–4, Application for Employer Identification Number.

Taxmap/pubs/p911-001.htm#TXMP4335e232 Business Taxes

Business Taxes

The following kinds of federal business taxes may apply to direct sellers.

• Income tax
• Self-employment tax
• Employment taxes

Your state, county, or city may impose other kinds of tax and licensing obligations.

Taxmap/pubs/p911-001.htm#TXMP67fc2086 Income tax.

All businesses except partnerships must file an annual income tax return. (Partnerships file an information return.) For example, if you operate your direct-selling business as a sole proprietor, you must file Schedule C or Schedule C–EZ as part of your individual income tax return (Form 1040). You are a sole proprietor if you are self-employed (work for yourself) and are the only owner of your unincorporated business.

Taxmap/pubs/p911-001.htm#TXMP6503a69f Self-employment tax.

Self-employment tax is a social security and Medicare tax primarily for those who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners. If you are a direct seller, you generally must pay this tax on your income from direct selling. You must pay it whether you are a sole proprietor or a partner in a partnership. Use Schedule SE (Form 1040) to figure your self-employment tax. For more information about self-employment tax, see Publication 533.

Taxmap/pubs/p911-001.htm#TXMP3f84290a The Social Security Administration (SSA) time limit for posting self-employment income.

Generally, the SSA will give you credit for self-employment income reported on a tax return filed within 3 years, 3 months, and 15 days after the tax year you earned the income. If you file your tax return or report a change in your self-employment income after this time limit, the SSA may change its records, but only to remove or reduce the amount. The SSA will not change its records to increase the amount of your self-employment income.

Taxmap/pubs/p911-001.htm#TXMP0ca090c7 Employment taxes.

If you have employees in your business, you generally withhold and pay the following kinds of employment taxes.

• The federal income tax you withhold from employees' wages.
• Social security and Medicare taxes—both the amount you withhold from employees' wages and the amount you pay as the employer.
• Federal unemployment (FUTA) tax (none of which is withheld from the employees' wages).

For more information, see Publication 15.

Taxmap/pubs/p911-001.htm#TXMP3584eee4 Other taxes.

You can deduct personal property and other taxes as a business expense if you incur them in the ordinary course of your business. For information about deducting these taxes, see Taxes under Business Expenses, later.

Taxmap/pubs/p911-001.htm#TXMP26e6d410 Estimated Tax

Estimated Tax

The federal income tax is a pay-as-you-go tax. You must pay it as you earn or receive income during the year. There are two ways to pay as you go.

• Withholding. If you are an employee, your employer likely withholds income tax from your pay. By revising your W–4, you can increase your withholding to cover the tax you owe on income from your job and from direct selling.
• Estimated tax. If you do not pay tax through withholding, or do not have enough withheld, you may have to pay estimated tax.

Estimated tax is used to pay both income and self-employment taxes.

Taxmap/pubs/p911-001.htm#TXMP60471dfd General rule for making estimated tax payments.

You must make estimated tax payments for 2004 if you expect to owe at least $1,000 in tax, after subtracting your withholding and credits, and you expect your withholding and credits to be less than the smaller of the following.

• 90% of the tax to be shown on your 2004 tax return.
• 100% of the tax shown on your 2003 tax return. Your 2003 tax return must cover all 12 months for this rule to apply.

Taxmap/pubs/p911-001.htm#TXMP2d63a582 Paying estimated tax.

You can use Form 1040–ES to figure your estimated tax and make quarterly estimated tax payments. Or, you can make estimated tax payments by electronic funds withdrawal or by credit card. See the Form 1040–ES instructions or How To Pay Estimated Tax in Publication 505.

Taxmap/pubs/p911-001.htm#TXMP76b36a79 Underpayment penalty.

If you did not pay enough estimated tax or have enough income tax withheld, you may be subject to a penalty for underpayment of tax. You can use Form 2210 to figure the penalty. In most cases, you can have the Internal Revenue Service figure the penalty for you. See Form 2210 to determine if you must complete the form.

Taxmap/pubs/p911-001.htm#TXMP5d57a620 Exceptions.

Generally, you do not have to pay an underpayment penalty if you meet either of the following exceptions.

• Your total tax is less than $1,000.
• You had no tax liability last year.

For more information on estimated tax, see Publication 505.

Taxmap/pubs/p911-001.htm#TXMP544f6966 Information Returns

Information Returns

You must file an information return to report that you made direct sales of at least $5,000 of consumer products to a buyer for resale anywhere other than a permanent retail establishment. The information return, Form 1099–MISC, must show the name, address, and identification number of the buyer (recipient). Check box 9 of Form 1099–MISC to show these sales. Do not enter a dollar amount.

You must also provide a statement to the buyer by January 31 of the year following the calendar year for which the information return is filed, showing your name, address, phone number for contacting you, and identifying number. The statement you give to the buyer for these direct sales may be in the form of a letter showing this information along with commissions, prizes, awards, etc. See the instructions for Form 1099–MISC for more information.

Taxmap/pubs/p911-001.htm#TXMP2d78ea22 Penalties

Penalty

The law imposes penalties for noncompliance with tax laws. Some of these penalties are discussed next. If you underpay your tax due to fraud, you could be subject to a civil fraud penalty. In certain cases, you could be subject to criminal prosecution.

Taxmap/pubs/p911-001.htm#TXMP15087750 Failure-to-file penalty.

If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually 5% of the tax not paid by the due date for each month or part of a month that the return is late. This penalty cannot exceed 25% of your tax, and it is reduced by the failure-to-pay penalty (discussed next) for any month both penalties apply. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the lesser of $100 or 100% of the unpaid tax. You will not have to pay the penalty if you show that you failed to file on time because of reasonable cause and not because of willful neglect.

Taxmap/pubs/p911-001.htm#TXMP0968eb83 Failure-to-pay penalty.

You may have to pay a penalty of 1/2 of 1% of your unpaid taxes for each month or part of a month after the due date that the tax is not paid. This penalty cannot be more than 25% of your unpaid tax. You will not have to pay the penalty if you can show good reason for not paying the tax on time. This penalty does not apply during the automatic 4-month extension of time to file if you paid at least 90% of your actual tax liability on or before the due date of your return and you pay the balance when you file the return.

The monthly rate of the failure-to-pay penalty is half the usual rate (.25% instead of .50%) if an installment agreement is in effect for that month. You must have filed your return by the due date (including extensions) to qualify for this reduced penalty.

Taxmap/pubs/p911-001.htm#TXMP44f81520 Penalty for frivolous return.

You may have to pay a penalty of $500 if you file a return that does not include enough information to figure the correct tax or that contains information clearly showing the tax you reported is substantially incorrect.

You will have to pay the penalty if you filed this kind of return for either of the following reasons.

• A frivolous position on your part.
• A desire to delay or interfere with the administration of federal income tax laws.

This penalty is in addition to any other penalty provided for by law.

Taxmap/pubs/p911-001.htm#TXMP12229cdb Accuracy-related penalty.

An accuracy-related penalty of 20% applies to any underpayment due to the following reasons.

• Negligence or disregard of rules or regulations.
• Substantial understatement of income tax.

This penalty also applies to conditions not discussed here.

Even though an underpayment was due to both negligence and substantial underpayment, the total accuracy-related penalty cannot exceed 20% of the underpayment. The penalty is not imposed if you can show reasonable cause and that you acted in good faith.

Taxmap/pubs/p911-001.htm#TXMP70633a49 Negligence.

Negligence includes a failure to make a reasonable attempt to comply with provisions of the Internal Revenue Code.

Taxmap/pubs/p911-001.htm#TXMP7b710e75 Disregard.

Disregard means the careless, reckless, or intentional disregard of rules or regulations.

Taxmap/pubs/p911-001.htm#TXMP359898cb Substantial understatement of income tax.

For an individual, income tax is substantially understated if the understatement exceeds the greater of the following amounts.

• 10% of the correct tax.
• $5,000.

Taxmap/pubs/p911-001.htm#TXMP38249379 Information reporting penalties.

A penalty applies if you do not file information returns by the due date, do not include all required information, or do not report correct information. The amount of the penalty is based on when you file the correct information return, as follows.

• Correct information returns filed within 30 days after the due date, $15 each.
• Correct information returns filed after the 30-day period but by August 1, $30 each.
• Information returns filed after August 1 or not filed, $50 each.

Maximum limits apply to all these penalties.

Taxmap/pubs/p911-001.htm#TXMP36792f40 Failure to furnish correct payee statements.

If you do not provide a complete, correct, and timely copy of an information return (payee statement), you may be subject to a penalty of $50 for each statement. If the failure is due to intentional disregard of the requirements, the minimum penalty is $100 per statement with no maximum penalty.

Taxmap/pubs/p911-001.htm#TXMP79a15313 Failure to supply identification number.

If you do not include your identification number (SSN or EIN) or the identification number of another person where required on a return, statement, or other document, you may be subject to a penalty of $50 for each failure. You may also be subject to the penalty if you do not give your identification number to another person when it is required on a return, statement, or other document.

You will not have to pay the penalty if you can show the failure was due to reasonable cause and not willful neglect.

Taxmap/pubs/p911-001.htm#TXMP5a352644 Accounting Periods   and Methods

Accounting Periods and Methods

All income tax returns are prepared using an accounting period (tax year) and an accounting method.

Taxmap/pubs/p911-001.htm#TXMP46a48f7d Accounting Periods

Accounting Period

When preparing a statement of income and expenses, you must use books and records for a specific interval of time called an accounting period. The annual accounting period for your tax return is called a tax year. You can generally use one of the following tax years.

• A calendar year, which begins on January 1 and ends on December 31.
• A fiscal year (including a period of 52 or 53 weeks). A regular fiscal year is 12 consecutive months ending on the last day of any month except December.

You generally adopt a tax year by filing your first income tax return using that tax year. If you filed your first return as a wage earner using the calendar year and you later start your own business, you must continue to use the calendar year as your business tax year. You generally cannot change your tax year without IRS approval.

For more information, see Publication 538.

Taxmap/pubs/p911-001.htm#TXMP7751e0b6 Accounting Methods

Accounting Method

An accounting method is a set of rules used to determine when and how income and expenses are reported. You must use the same accounting method from year to year. The two most common accounting methods are the cash method and an accrual method. A third method, called a hybrid method, is generally a combination of cash and accrual.

The text and examples in this publication generally assume you use the calendar year as your tax year and either the cash or hybrid method as your accounting method. Generally, if inventories are needed to account for your income, you must use an accrual method, discussed later, for your sales and purchases. However, if you are a qualifying taxpayer or a qualifying small business taxpayer, you can use the cash method of accounting, even if you purchase or sell merchandise. You also can account for inventoriable items as materials and supplies that are not incidental. For more information, including definitions of a qualifying taxpayer, a qualifying small business taxpayer, and an explanation of materials and supplies that are not incidental, see Publication 538.

Taxmap/pubs/p911-001.htm#TXMP3489d64d Cash method.

Under the cash method, you report income in the year it is received, credited to your account, or made available to you on demand. You need not have physical possession of it. You deduct expenses in the year you pay them, even if they were incurred in an earlier year.

Taxmap/pubs/p911-001.htm#TXMP2f508e90 Check received.

If you receive a check before the end of the tax year, you must include it in income for the year you receive it even though you do not cash or deposit it until the next year.

Taxmap/pubs/p911-001.htm#TXMP022f218f Accrual method.

Under an accrual method, you generally report income for the tax year when all events have occurred that fix your right to receive the income and you can determine the amount with reasonable accuracy. Generally, you deduct or capitalize business expenses when all events have occurred that fix the fact of liability, the liability can be determined with reasonable accuracy, and economic performance has occurred. See Publication 538 for an explanation of economic performance.

Taxmap/pubs/p911-001.htm#TXMP22e480f1 Prepaid expenses.

Expenses paid in advance generally can only be deducted in the year to which they apply under either the cash or an accrual method. (However, see Exception for recurring items under Accrual Method in Publication 538.) For example, suppose you have a subscription to a direct-selling journal that runs out at the end of 2003. It will cost you $30 to renew the subscription for one year or $54 for 2 years. You decide to renew for 2 years and mail your check at the end of November 2003. You cannot deduct the $54 on your 2003 return. However, you can deduct half of the $54 in 2004 and the other half in 2005.

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