What is an EIN and does your business need one?

An Employer Identification Number (EIN) is mandatory for some businesses and optional for others. But in general, an EIN is necessary for independent contractors and small business owners. Understanding who needs to apply and the benefits that come with having an EIN can give your business a real advantage.

What is an EIN?

An EIN is an exclusive nine-digit number assigned to your business by the Internal Revenue Service and identifies your business for tax purposes. It's like your Social Security Number, except it's designed for businesses only. It's necessary for paying employees and managing your business taxes. EINs are issued by the state and used on state tax forms.

Related: How to Close an LLC

Who is required to have an EIN?

The following business structures are required to have EINs:

• Corporations
• Partnerships
• Limited liability companies

Sole proprietorships, in general, are not required to have an EIN. However, an EIN is required if:

• You have employees or plan to hire them.
• You want to offer a Keogh or solo 401(K) retirement plan
• You're inheriting or thinking of buying a sole proprietorship
• You need to file for bankruptcy

The IRS also requires EINs for trusts created by estate funds and representatives who oversee an estate that operates a business after the owner's death.

Independent contractors, freelancers, people running small businesses out of their homes, and people with side jobs who capitalize on the gig economy are generally not required to get an EIN. Still, there are plenty of reasons why they should.

Why can't I just use my Social Security number?

When the IRS mandates an EIN, you don't have a choice. But here's a key reason why it's a good idea to use an EIN for business even when it's not required: avoiding identity theft.

• An EIN helps keep your personal and business finances separate. It reserves your Social Security Number for personal needs and keeps identity thieves from ripping off your personal assets. The IRS recommends using your Social Security Number only if you have a very simple business structure and no employees.

What other advantages come with having an EIN?

In some ways, an EIN is one of the best-kept secrets in the business world. Surprisingly, applying for one isn't on every entrepreneur's to-do list. An EIN makes it easier to:

• Apply for a business license. This varies by state, but many states require an EIN before you can be licensed to conduct business.
• Get a business bank account. More banks require an EIN to open a business bank account, along with the appropriate business license to show that you're permitted to operate in your area. Depending on your business structure, you may have to show articles of incorporation or a “doing business as" (DBA) certificate.
• Take out a bank loan. Most banks require you to have a business account before you apply for a loan.
• Hire employees. Having employees means an EIN is absolutely required, and you can't set up your payroll system without one.
• File your taxes. If you are required to have an EIN and don't have it before you file your taxes, you open yourself up to all kinds of tax penalties.
• Boost credibility. An EIN establishes you as a serious, responsible person who's committed to your business.

What's the difference between an EIN and a FEIN?

A FEIN is a Federal Employee Identification Number. It serves the same purpose as an EIN, except the federal government issues it instead of the state. A FEIN also allows you to enroll in the electronic federal tax payment system, where you can easily make tax payments over the phone or online.

How do I apply for an EIN?

Here's the good news. Applying for an EIN is easy and free. Establish your business type prior to requesting an EIN. For example, if you plan to operate your new business as an LLC, create the LLC prior to applying for an EIN. You can apply online on the IRS's website, or you can use an independent service to complete the process for you. You can apply online, by fax, or by mail with the IRS. If you apply by fax or mail, you will need to complete the Form SS-4, Application for Employer Identification Number. When you apply online, you will be able to view and print your assigned EIN at the end of the online session. Via fax, the process is generally complete within four business days. Via mail, you can expect a wait time of approximately four weeks.

 Note that:

• Your principal business must be located in the U.S. or a U.S. territory
• You must have a Social Security Number, Individual Taxpayer Identification Number (given to those who aren't eligible to obtain a Social Security Number), or preexisting EIN.
• You must be considered a “responsible party," which means you're the person who ultimately owns or controls the entity applying or exercises ultimate effective control over the entity.

Now that you can see the advantages and ease of obtaining an EIN, acquiring an EIN should be one of the first steps you take when creating a new business.