The Business Code for Income Tax Guide
If you’re self-employed and ever tried to prepare your tax returns yourself, you must have been required to select a Business Code for your business in your returns. You may have then wondered, what is an IRS principal business code? What are its purposes? How can I find and know my business code?
What is a principal business code?
An IRS principal business code is a designated six-digit number that classifies the main type of products or related services the business sells.
This code categorizes sole proprietorships or independent contractor jobs by an activity they are heavily involved in to facilitate the administration of the IRS. In other words, it is determined by the business activity that generates the most revenue for it.
The business code that the IRS uses to classify your business is based on the North American Industry Classification System (NAICS) which is updated every five years and was last updated in 2017. The name for business codes is alternatively called “Professional Activity Code” or “Primary Business Code”.
How is the NAICS structured?
NAICS is a two- to six-digit hierarchical classification system, offering five levels of detail. Each digit in the code is part of a series of progressively narrower categories, and the more digits in the code signify greater classification detail.
The first two digits designate the economic sector, the third digit designates the subsector, the fourth digit designates the industry group, the fifth digit designates the NAICS industry, and the sixth digit designates the national industry.
The five-digit NAICS code is the level at which there is comparability in code and definitions for most of the NAICS sectors across the three countries participating in NAICS (the United States, Canada, and Mexico). The 6-digit level allows for the United States, Canada, and Mexico each to have country-specific detail. A complete and valid NAICS code contains six digits.
What is the purpose of a principal business code?
In most cases, the IRS and the U.S. Census Bureau use your principal business code for statistical purposes. They collect, evaluate, and publish statistics by comparing year to year revenue and other useful numbers people report.
Additionally, the Small Business Administration uses the principal business code of your business’s industry to the size of your business to distinguish the small businesses from medium and large corporations. If you would like to know more about the U.S. Census Bureau and other federal statistical agencies and their data analysis for the economy of the United States, please visit the IRS.gov website.
When are these codes required?
You may be aware that you will need to enter the code for principal business activity when you prepare your income tax return for any type of business (e.g. corporation, partnership, or sole proprietors). Basically, you’re required to enter this code on all business tax returns.
As mentioned above, if you have a couple of income sources within your business, you will need to enter the one that brings the most income. According to the IRS, the “principal business activity” is defined as the activity that provides you the largest percentage of “total receipts”.
There are some other U.S. government forms that you may see a requirement for a principal business code. One is the Small Business Administration. This agency also requires NAICS codes for businesses that would like to join an SBA loan guarantee program. The other case is if you want to become a federal government contractor, you will need to enter a code in your application.
How to identify your principal business code
The North America Industry Classification System uses the first two-digit code to represent broad categories such as Agriculture, Forestry, Fishing, and Hunting (11) or Accommodation, Food Services, & Drinking Places (72). On the NAICS website, these categories are listed in numerical order.
Within a category, you must find the description that best represents your business. For example, if you own a sandwich shop, the first category that you would choose is the Accommodation, Food Services, & Drinking Places category. Then, you would go to “Sandwich shops, limited-service” which has the code 722513.
Types of business tax returns and a primary business code
For most types of business tax returns, both a principal business description and the principal business code must be provided.
Schedule C for sole proprietorships and single-member LLCs
You should enter the principal business description on Line A and enter the principal business code on Line B.
U.S. Return of Partnership Income (Form 1065) for partnerships and multi-member LLCs
You should enter the principal business description on Line A and enter a brief description of the principal product or service on Line B. Then, enter the principal business code on Line C.
U.S. Corporation Income Tax Return (Form 1120) for C Corporations
You should enter the principal business code on Schedule K, Line 2a and the principal business description on Schedule K, Line 2b. Then, enter the product or service description on Schedule K, Line 2c.
U.S. Income Tax Return for an S corporation (Form 1120-S)
You should enter the principal business code on Line B and no principal business description is needed.
Do principal business codes change over time?
NAICS is scheduled to be reviewed every five years for potential revisions so that the classification system can keep pace with the changing economy. See the NAICS Update Process Fact Sheet for more information.
Can I have my business’s principal business code changed?
There is no "official" way to have a company's NAICS code changed and there is no central register that represents the "official" NAICS classification for businesses.
Various Federal government agencies maintain their own directories of businesses and assign classification codes based on their own needs. Generally, the classification codes are derived from information that the business has provided on surveys, tax forms, or administrative records.
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At Keeper Tax, we’re on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please email firstname.lastname@example.org if you have questions.