The Internal Revenue Service requires that businesses report their Principal Business Activity Code on their federal tax return. There are over 400 business activity codes from which a business owner or accountant can select as the appropriate one for their principal activity from a table in the tax return instructions. However, for many small- and medium-sized businesses, even this level of detail does not provide enough specificity to determine which is the right business activity code for the business.
Since the IRS business activity codes are based on the North American Industry Classification System (NAICS pronounced Nakes), NAICSCode.com has constructed a more detailed searchable index of NAICS codes, their descriptive titles, and over 18,000 additional terms that provide alternative descriptions of these industries. With this level of detail, you should be able to find the right business activity code for almost any type of business.
According to the IRS, classifying a business “facilitates the administration of the Internal Revenue Code.” Practically speaking, the business activity code helps the IRS to determine for auditing purposes what is the right comparison group for a business. The IRS uses computer programs to compare financial ratios of a business with the same ratios for a comparable grouping of businesses in the same industry and within the general size range. Companies that show substantially different ratios from the average for their industry group are more likely to be flagged for further scrutiny.
For the IRS, the more accurate the activity code designations are, the better this screening process will work. The IRS does not rely solely upon the business activity codes for categorization. They also request a brief description of the company’s principal business activity and of the company’s principal product or service.
For owners or accountants preparing tax returns for a business, the business activity code is the most important indicator used to determine the peer group for comparison in the IRS audit screening programs. The IRS uses computer programs to compare financial ratios of a business with the same ratios for a comparable grouping of businesses in the same industry and within the general size range. Companies that show substantially different ratios from the average for their industry group are more likely to be flagged for further scrutiny.
The Standard Industrial Classification (SIC) has been replaced by the North American Industry Classification System (NAICS pronounced Nakes). The SIC system was established in the 1930s to promote uniformity and comparability of data collected and published by agencies within the U.S. government, state agencies, trade associations, and research organizations. It was developed as an establishment based industry classification system that classified each establishment (defined as a single physical location at which economic activity occurs) according to its primary activity. The SIC covered the entire field of economic activities by defining industries in accordance with the composition and structure of the economy.
Since the 1930s, the SIC has been revised periodically to reflect changes in the economic structure of the United States. New industries were added and small, declining industries deleted or combined with other activities. However, the overall structure of the SIC remained essentially unchanged since the 1930s. The SIC was last revised in 1987, when approximately 20 new service industries were added to the SIC and a few new industries were added to manufacturing to reflect technological changes occurring in that sector.
By the early 1990s, many data users and analysts were criticizing the SIC as outmoded and not reflective of the economy of the United States. The adoption of the North American Free Trade Agreement underscored the need not only to develop a new system, but also to develop that system in cooperation with Canada and Mexico.
NAICS is based on a consistent, economic concept. Establishments that use the same or similar processes to produce goods or services are grouped together. The SIC, developed in the 1930s and revised periodically over the past 50 years, was not based on a consistent economic concept. Some industries are demand based while others are production based.