Why Is the Federal Tax ID Number Used?

The federal government's need to identify all business entities in the US accounts for why a federal tax number is used. Primarily called an employer identification number (EIN) by the IRS, a federal tax number allows the government and other entities to track income, debts and much more.

Other Types of Federal Identification Numbers

EINs, which identify businesses including corporations and limited liability companies (LLCs), are distinguished from these numbers that the government assigns to eligible individuals:

• Social Security number (SSN)—To obtain an SSN you will have to validate your identity, age and citizenship and fill out form SS-5 ("Application for a Social Security Card").
• Individual taxpayer identification number (ITIN)—This identifies a non-resident or resident alien, along with his/her spouse and dependents, who cannot attain a Social Security number. Unlike with an SSN, you cannot claim an earned income with this ID.

EINs, SSNs and Security

In many regards, an EIN is a business's equivalent to an individual’s Social Security number. The main differences are the security measures tied to each number. Social Security numbers are highly private and intended to be concealed information. Employee identification numbers are published on the Internet and readily available through public records.

Government Forms and Tax ID Numbers

If you run a business that needs or has an EIN, you will have to enter this number on all government forms you need or choose to fill out. If you have a sole proprietorship, you will enter your Social Security number. Your ID number identifies your state sales tax rates and helps keeps track of other regulatory reporting, such as yearly reportings for both S and C corporations.

Federal ID numbers are also important in credit reporting. Businesses rely heavily on credit. Through the EIN, a business can be identified and tracked by leading business credit reporters. In many cases, this is why people say that a sole proprietorship is a risky business. If you are running a business under your SSN, you are claiming full responsibility to it on a personal level. With an EIN and a corporation, you are showing that the business stands as a separate entity and therefore has its own liability.

EINs, SSNs and ITINs all help protect against money laundering in the United States. With implementations of the Patriot Act as well as the Know Your Customer compliance rules, these numbers have to be verified in financial transactions such as opening a bank account.