Basic Tax Information The following discussion gives basic tax information that may helpif you have never been in business for yourself. For more informationabout starting a business, see Publication 583. Employer IdentificationNumber (EIN) EINs are used to identify the tax accounts of employers, certainsole proprietors, corporations, partnerships, estates, trusts, andother entities. If you do not already have an EIN, you need to get one if any oneof the following applies to your business. You have employees. You have a Keogh plan. You operate your business as a corporation orpartnership. You file returns for: Employment taxes, Excise taxes, or Taxes on alcohol, tobacco, or firearms. Use Form SS-4 to apply for an EIN. Business Taxes Four kinds of federal business taxes may apply to direct sellers. Income tax Self-employment tax Employment taxes Excise taxes Your state, county, or city may impose other kinds of tax andlicensing obligations. Income tax.All businesses except partnerships must file an annual income taxreturn. (Partnerships file an information return.) For example, if youoperate your direct-selling business as a sole proprietor, you mustfile Schedule C or Schedule C-EZ as part of your individualincome tax return (Form 1040). You are a sole proprietor if you areself-employed (work for yourself) and are the only owner of yourunincorporated business. Self-employment tax.Self-employment tax is the social security and Medicare tax forthose who work for themselves. It is like the social security andMedicare taxes withheld from the pay of wage earners. If you are adirect seller, you generally must pay this tax on your income fromdirect selling. You must pay it whether you are the sole proprietor ofyour business or a partner in a partnership. Use Schedule SE (Form1040) to figure your self-employment tax. For more information aboutself-employment tax, see Publication 533. Social Security Administration (SSA) time limit for postingself-employment income.Generally, the SSA will give you credit only for self-employmentincome reported on a tax return filed within 3 years, 3 months, and 15days after the tax year you earned the income. If you file your taxreturn or report a change in your self-employment income after thistime limit, SSA may change its records, but only to remove or reducethe amount. SSA will not change its records to not increase the amountof your self-employment income. Employment taxes.If you have employees in your business, you generally withhold andpay the following kinds of employment taxes. The federal income tax you withhold from employees'wages. Social security and Medicare taxes--both the amount youwithhold from employees' wages and the amount you pay asemployer. Federal unemployment (FUTA) tax (none of which is withheldfrom the employees' wages). For more information, see Publication 15. Other taxes.For information about deducting personal property and other taxes,see Taxes under Business Expenses, later. Estimated Tax The federal income tax is a pay-as-you-go tax. You must pay it asyou earn or receive income during the year. There are two ways to payas you go. Withholding. If you are an employee, youremployer probably withholds income tax from your pay. By revising yourW-4, you can increase the amount withheld to cover the incomeboth from your job and from direct selling. Estimated tax. If you do not pay tax throughwithholding, or do not pay enough tax that way, you may have to payestimated tax. Estimated tax is used to pay both income and self-employmenttaxes (and certain other taxes and amounts reported on Form 1040).Estimated tax is discussed in Publication 505. Exceptions.You do not have to pay estimated tax if you meet either of thesetwo exceptions. You had zero tax liability last year, you were a U.S.citizen or resident for the whole year, and your tax year covered all12 months. Your total expected taxes for 2000, minus any expected taxcredits and withholding, will be less than $1,000. Form 1040-ES.Use Form 1040-ES to figure your estimated tax and makequarterly estimated tax payments. Form 2210.If you did not pay enough estimated tax or have enough income taxwithheld, you may be subject to a penalty. You can use Form 2210 tofigure the penalty. Or, in most cases, you can have the InternalRevenue Service figure the penalty for you. See the Form 2210instructions to determine if you must complete the form. Information Returns If you have other direct sellers working under you and you sell$5,000 or more in goods during the year to any one of those sellers,you must report the sales on an information return. The informationreturn, Form 1099-MISC, must show the name, address, andidentification number of the seller placing the orders. Check box 9 ofForm 1099-MISC to show these sales. Do not enter a dollaramount. You must give Copy B or a qualified statement (such as aletter showing this information along with commissions, prizes,awards, etc.) to the seller by January 31, 2000. You must file Copy A of Form 1099-MISC with the InternalRevenue Service by February 28, 2000. If you file electronically, youhave until March 31, 2000. Use Form 1096 to summarize and transmitForm 1099-MISC. See the instructions to Form 1096 for theaddress where you must file Form 1096 and the accompanying Forms1099-MISC. Penalties The law imposes penalties to ensure that all taxpayers pay theirtaxes. Some of these penalties are discussed next. If you underpayyour tax due to fraud, you may be subject to a civil fraud penalty. Incertain cases, you may be subject to criminal prosecution. Failure-to-file penalty.If you do not file your return by the due date (includingextensions), you may have to pay a failure-to-file penalty. Thepenalty is 5% of the tax not paid by the due date for each month orpart of a month that the return is late. This penalty cannot be morethan 25% of your tax, but it is reduced by the failure-to-pay penalty(discussed next) for any month both penalties apply. However, if yourreturn is more than 60 days late, the penalty will not be less than$100 or 100% of the tax balance, whichever is less. You will not haveto pay the penalty if you can show reasonable cause for not filing ontime. Failure-to-pay penalty.You may have to pay a penalty of 1/2 of 1% of yourunpaid taxes for each month or part of a month after the due date thatthe tax is not paid. This penalty cannot be more than 25% of yourunpaid tax. You will not have to pay the penalty if you can show goodreason for not paying the tax on time. You may still have to pay a failure-to-pay penalty if you receivedan automatic extension of time for filing. You will have to pay thepenalty in either of the following situations. The tax shown on the extended return is more than 10% of thetotal tax. The amount due is not paid by the extended due date. Penalty for frivolous return.You may have to pay a penalty of $500 if you file a return thatdoes not include enough information to figure the correct tax or thatshows an incorrect tax amount due to either of the following reasons. A frivolous position on your part. A desire to delay or interfere with the administration offederal income tax laws. This penalty is in addition to any other penalty provided bylaw. Accuracy-related penalty.An accuracy-related penalty of 20% applies to any underpayment dueto 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 andsubstantial underpayment, the total accuracy-related penalty cannotexceed 20% of the underpayment. The penalty is not imposed if there isreasonable cause accompanied by good faith. Negligence.Negligence includes the lack of any reasonable attempt to complywith provisions of the Internal Revenue Code. Disregard.Disregard includes the careless, reckless, or intentional disregardof rules or regulations. Substantial understatement of income tax.For an individual, income tax is substantially understated if theunderstatement of tax exceeds the greater of the following amounts. 10% of the correct tax. $5,000. Information reporting penalties.A penalty applies if you do not file information returns by the duedate, if you do not include all required information, or if you do notreport correct information. A penalty applies to information returnsas follows. Correct information returns filed within 30 days after thedue date, $15 each. Correct information returns filed after the 30-day periodbut by August 1, $30 each. Information returns not filed by August 1, $50 each. Maximum limits apply to all these penalties. Failure to furnish correct payee statements.Any person who does not provide a taxpayer with a complete andcorrect copy of an information return (payee statement) is subject toa penalty of $50 for each statement. If the failure is due tointentional disregard of the requirement, the minimum penalty is $100per statement with no maximum penalty. Identification numbers and other information.Any person who does not comply with other specified reportingrequirements, including the use of correct identification numbers(employer identification numbers and social security numbers), issubject to a penalty of $50 for each failure. The following areexamples of information you must provide. Correct identification numbers for yourself, your spouse,and your dependents on returns and statements. Correct identification numbers for other taxpayers whererequired. Correct identification numbers when required by anothertaxpayer, such as a bank. Accounting Periodsand Methods All income tax returns are prepared using an accounting period (taxyear) and an accounting method. Accounting Periods You must figure your taxable income and file a federal income taxreturn on the basis of an annual accounting period called a "taxyear." There are two accounting periods you may use. A calendar year, which begins on January 1 andends on December 31. A fiscal year (including a period of 52 or 53weeks). A regular fiscal year is 12 months in a row ending on the lastday of any month except December. You establish a tax year when you file your first income taxreturn. If you filed your first return as a wage earner using thecalendar year, you must use the calendar year as your business taxyear. You generally cannot change your tax year without IRS approval.For more information, see Publication 538. Accounting Methods An accounting method is a set of rules used to report income anddeduct expenses. The two most common accounting methods are the cashmethod and an accrual method. The text and examples in this publication generally assume that youuse the calendar year as your tax year and either the cash method or ahybrid method (a combination of cash and accrual) as your accountingmethod. If inventories are needed to account for your income, you mustuse an accrual method, discussed later, for your sales and purchases.If you use a fiscal year or an accrual method, you must makeadjustments. For more information on accounting methods, seePublication 538. Cash method.Under the cash method, you report income in the year it isreceived, credited to your account, or made available to you ondemand. You need not have physical possession of it. You deductexpenses in the year you pay them, even if you incurred them in anearlier year. Check received.If you receive a check before the end of the tax year, you mustinclude it in your income for the year you receive it even though youdo not cash or deposit it until the next year. Accrual method.Generally, you report an item of income in the tax year when allevents have happened that fix your right to receive the income and youcan determine the amount with reasonable accuracy. Generally, youdeduct or capitalize business expenses when you become liable forthem, whether or not you pay them in the same year. Prepaid expenses.Expenses paid in advance can be deducted only in the year to whichthey apply under either the cash or an accrual method. For example,suppose you have a subscription to a direct-selling journal that runsout at the end of 1999. It will cost you $30 to renew the subscriptionfor one year or $54 for 2 years. You decide to renew for 2 years andmail your check at the end of November 1999. You cannot deduct the $54on your 1999 return, even if you use the cash method of accounting.However, you can deduct half of the $54 in 2000 and the other half in2001.