Separating Personal & Business Expenses
Set boundaries between your personal finances and your small business accounts.
In a recent article from Fundera, an online marketplace for small business loans, they offered several tips for small business owners. Below is a recap of some of the advantages of keeping your personal and business expenses separate.
Regardless of the type of business you run, you should separate your personal and business expenses. Not only can this make analyzing your financial situation easier and possibly save you money on taxes, it also ensures you stay on good terms with the IRS (who have specific guidelines to follow).
While some personal and business expenses tend to blend together, setting boundaries that separate your business and personal expenses will help your business and your life run more effectively.
Why You Should Separate Personal & Business Expenses
Simply put, you want your business to avoid financial headaches and tax issues. To do that, you can’t get your business and personal expenses intertwined, even if you used a personal loan to start your business.
According to the National Federation of Independent Business, cash flow and money management are two of the most common reasons small businesses fail. If you’re not tracking and separating your business expenses from your personal ones, you run the risk of mismanaging your funds.
And if you accidentally deduct personal expenses as business expenses on your tax report, you run the risk of alarming the IRS. And you could get audited. You don’t want those things to happen.
Keeping business and personal expenses from getting too friendly with one another is just a matter of being diligent. Here’s what you should do:
1. Choosing the Right Business Structure
Understanding the pros and cons of each type of business structure is important. Choosing the right structure for your business is essential because it affects how you should be legally handling business and personal expenses. Here is a brief summary
- Corporations: As the Small Business Administration (SBA) states, a corporation is “an independent legal entity owned by shareholders,” so you have to keep personal and business expenses separate. But there are still times where the line between a personal and business expense blurs.
- LLCs: A limited liability company is a hybrid structure, with owners referred to as members. An LLC has the limited liability legal features of a corporation, but like an S corporation, profits and losses are “passed through.” With an LLC, they’re passed through to the members; with an S corporation, they’re passed through to the shareholders.
- Sole Proprietorship: If your business is a sole proprietorship, there is no legal distinction between the business and the owner. That being said, you can still report business expenses. If your business is a partnership where two or more people, business expenses are deducted in the same manner as a sole proprietorship. But since more people are involved, it’s essential that all parties carefully separate personal and business expenses.
NOTE: While it might seem easier to operate as a sole proprietorship or partnership, you won’t get the legal protection that you would as a corporation or LLC.
2. Maintain Separate Bank Accounts & Credit Cards
you should have distinct personal and business bank accounts, so that money from a friend for dinner shouldn’t be heading to the same place as an invoice payment from a client.
It’s also a good idea not to use your own credit cards for business expenses. Open a business credit card. This will help you keep track of your business expenses and give you access to money when cash flow is slow.
Another reason for having a business credit card is that you can write off fees that you can’t with a personal card, such as annual fees, late fees, and interest charges.
3. Understanding the Gray Areas
Sometimes, it can be hard to decern whether an expense should be classified as personal or business. For example, many small business owners use their personal vehicles for work or you may even take a vacation with your family that involves some work-related travel. While you certainly want to write off what you can, you have to be careful not to go overboard when deducting business expenses that are linked to personal expenses. If you’re unsure of how to categorize an expense, consult the IRS website.
In general, the IRS lists the following three business expense categories:
- Business costs: These include labor, materials, storage, and other expenses related to the pricing of goods to be sold.
- Capital expenses: These include start-up costs, business assets, and improvements. For practical purposes, just think of these as business costs, too.
- Personal expenses: Sometimes an expense is partly for yourself and partly for your business. For instance, if you use a home office, you can deduct a portion of the rent or mortgage, utilities, repair, depreciation, and more.
4. Keep Track of All Expenses
Always track your expenses. Save receipts, and keep them in organized filing folders. Not only is this a best practice, it’s also a great way for you to take advantage of every deduction you can come tax time.
The good news is that you can automate expense tracking with software, which can save you time and money in the long run.
You may think this should go without saying, but many business owners have forgotten (or simply ignored) this cardinal rule of business ownership and paid the penalty when the IRS came knocking.
5. Be Smart, Minimize Risks
By keeping your business and personal expenses separate, you can:
- avoid tax problems
- protect your personal finances
- maximize savings
- improve money management.
Just make sure you choose the right business structure for your needs, use separate bank accounts, navigate gray areas properly, and take advantage of available software.
Source: Original article