What Are the Disadvantages of Having an EIN?

An Employer Identification Number, or EIN, is a nine-digit number the Internal Revenue Service assigns to identify a business for tax purposes. It functions much like a Social Security number does for an individual, creating a distinct identity for the business with federal and state tax agencies. While an EIN is a foundational step for many business structures, such as corporations and partnerships, or for any business that hires employees, it also introduces a new layer of administrative and compliance duties.

Increased Filing and Reporting Obligations

Obtaining an EIN changes a business’s relationship with the IRS by introducing more complex tax filing requirements. A sole proprietor who previously reported business income on a Schedule C with their personal Form 1040 may become responsible for entirely new tax returns. For instance, a business structured as a partnership must file Form 1065, an informational return, while a corporation is required to file Form 1120 to report its taxable income.

This transition establishes the business as a distinct entity with its own annual reporting duty. The responsibility extends beyond the primary income tax return, as a business with an EIN must also track and report certain payments made to others.

A primary reporting requirement involves payments to independent contractors. If a business pays a contractor $600 or more for services during a calendar year, it must issue Form 1099-NEC to both the contractor and the IRS. This creates the administrative task of collecting taxpayer identification numbers from vendors, tracking payment totals, and meeting the January 31 filing deadline.

Responsibility for Payroll Compliance

The decision to hire employees triggers the need for an EIN and introduces a set of ongoing responsibilities related to payroll taxes. This process requires calculation, timely deposits, and regular reporting to government agencies. An employer must withhold federal income tax from employee wages based on the information provided on the employee’s Form W-4.

Beyond income tax, the employer is responsible for FICA taxes, which fund Social Security and Medicare. This involves withholding the employee’s share of these taxes from their paycheck and matching that contribution with an equal amount from the business’s own funds. The combined amount must then be deposited with the IRS according to a set schedule, which can be semi-weekly or monthly depending on the size of the payroll.

The obligations extend to unemployment taxes. Employers must pay federal unemployment tax (FUTA) based on employee wages, which is reported annually on Form 940. Most states also have their own unemployment tax systems, adding another layer of payments and reporting. All of these activities are reported to the IRS quarterly using Form 941.

Formal Business Closure Process

An EIN creates a permanent record with the IRS that cannot simply be abandoned if the business ceases to operate. The IRS expects a business that has been assigned an EIN to continue filing tax returns, and if it stops receiving them, it may begin issuing notices for unfiled returns and assessing penalties. This makes a formal closure process necessary.

To properly close the business account, the owner must file a final tax return for the business entity, clearly marked as “final.” This return must account for all remaining income and expenses up to the date of dissolution and ensure all outstanding tax liabilities have been paid in full.

After settling all tax obligations, the business owner must send a letter to the IRS to formally request the closure of the EIN account. This letter should include the complete legal name of the business, the EIN, the business address, and a clear statement explaining the reason for closing the account. Only after the IRS processes this request is the EIN officially deactivated, severing the entity’s filing obligations.

Potential for Penalties and Scrutiny

The administrative responsibilities that accompany an EIN carry the risk of financial penalties if not managed correctly. The most common are the failure-to-file penalty, for not filing a required tax return by its due date, and the failure-to-pay penalty, for not paying the taxes owed on time. These penalties are calculated based on the amount of unpaid tax and the length of the delay and can accumulate quickly.

The consequences are particularly severe in the area of payroll taxes. Because payroll taxes include money withheld from an employee’s wages, the IRS considers these to be held in trust by the employer. If a business fails to remit these withheld taxes to the government, the IRS can impose the Trust Fund Recovery Penalty (TFRP).

This penalty can be assessed against the individuals responsible for collecting and paying the taxes, making them personally liable for the unpaid amount. This means the IRS can seek payment directly from a business owner’s, officer’s, or responsible employee’s personal assets, bypassing any liability protections offered by a corporate structure. The TFRP shows how administrative missteps can lead to serious personal financial consequences.