As a small business owner, it’s a challenge to keep your personal and business finances separate. But the failure to separate the two creates difficulties for your business, and can even get you into legal trouble. Separating personal and business expenses makes your life significantly easier by saving you time and money. Here’s how to do so. 

Defining Personal Vs. Business Expenses

Before we discuss separating personal and business expenses, it’s important to know how these terms are defined. The IRS allows business owners to claim tax deductions on business expenses. They define a business expense as one that is:

“[B]oth ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”

Business expenses are the actual costs for running and maintaining your business. They may include costs related to:

  • Supplies and equipment
  • Employee pay
  • Taxes and insurance
  • Office rent
  • Professional development activities
  • Business gifts
  • Travel
  • As with other accounting terms, there can be gray areas. For example, if you run your business out of your home, a portion of your home expenses (like your mortgage or utilities) could be considered a business expense. Typically, though, there is a clear line between personal vs. business expenses. 

    Why is it important to separate personal vs. business expenses? 

    As noted, commingling your finances could lead to tax and legal issues.

    For example, if your business was subject to a lawsuit, your personal assets could be at stake if there’s not a clear line between the two. More commonly, separating personal and business expenses saves you from the headache of an IRS audit. 

    The IRS allows businesses to deduct business expenses, such as supplies and travel, on their taxes. Yet, all these expenses must be properly recorded for the IRS to verify, which could be difficult without the proper separation of your personal vs. business expenses. 

    Further, falsely claiming personal expenses as business expenses could lead to back taxes, unpaid interest claims, and tax penalties.

    5 Steps For Separating Personal And Business Expenses

    Luckily, small business owners who haven’t separated their expenses can do so by following a few simple steps.

    1. Register Your Business

    The first step to separate yourself from your business is to officially register your business.

    There are multiple business structures to choose from, like Limited Liability Companies and Corporations. Choose carefully when deciding on your business structure, as this affects your ability to raise capital, the amount you pay in taxes, and your amount of personal liability. Turning your business into a C corporation, S corporation, or LLC gives your business a distinct legal identity of its own and separates you from any other shareholders.

    Incorporation offers the strongest protections to its owners from personal liability, enhances a business’ credibility, and gives your business easier access to capital. However, incorporation also comes at a higher cost than other business structures, including potentially higher taxes, additional administrative duties, and more stringent record-keeping.

    Make sure to do your research on business structures before registering. The U.S. Small Business Administration offers a guide on launching your business.

    2. Obtain an Employee ID Number(EIN)

    An EIN is like a social security number but for businesses. Getting an EIN should be a top priority, as it allows you to separate your social security number from your business affairs and documentation. It’s a unique nine-digit number assigned by the IRS that identifies your business as an operating entity.

    This number allows you to conduct tax-related business and open a bank account for your business. Having an EIN is a useful way to separate your business assets from your personal assets, and it also has the added advantage of preventing identity theft.

    Applying for an EIN is both completely free and only takes a matter of minutes. Applications are done on the IRS website.

    3. Open a Business Bank Account

    An efficient way to separate your personal and business expenses is to divide them into separate, designated bank accounts. After you receive an EIN, open a checking and savings account in your business’ name. A number of banks require an EIN to open a business account. Conduct all business transactions through your business accounts.

    Business checking accounts allow for transparency in business activities and expenditures. They accommodate better organization of financial records, easier filing of taxes, and a way to check your business’ profitability.

    4. Get a Business Credit Card

    Similar to a separate checking account for your business, a business credit card helps maintain records by clearly defining what is a business expenditure and what isn’t.

    A business credit card also enables you to stop mixing personal vs. business expenses on a personal credit card. Placing a large amount of business expenses on your personal credit card is risky, since personal credit cards generally have much lower credit limits than business credit cards. Business expenses can easily eat up the majority of, or even max out, your personal credit limit. Maxing out your personal credit cards can cause your credit scores to quickly drop. Also, any problems that occur with your business could end up on your personal credit reports, causing difficulty for you to secure funding for large purchases, such as a home or a car.

    Not only do business credit cards help you separate personal vs. business expenses, but they come with a range of additional advantages. They assist in establishing business credit and provide rewards on any business expenses. They also provide benefits such as merchandise discounts. 

    Just like personal credit cards, business credit cards are serious financial tools. Informed and responsible use are vital to fully benefit from their advantages.

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    5. Integrate Your Payment and Accounting Software

    One of the most efficient ways to separate your personal and business financials is through utilizing a reliable accounting software.

    Accounting software can help track your business income and expenses, monitor your financial transactions, and generate statements. These are all functions your business needs to keep organized and stay up to date.

    As an example, accounting software such as QuickBooks Online allows you to easily classify your incoming expenses as personal or business, without unnecessary headache. With our QuickBooks Online integration, all payments collected through PaySimple are processed directly into accounts you’ve set up within your accounting software. This allows for seamless reporting on your business’s finances which will save you hours down the road.

    For smaller businesses that are not financially ready for robust accounting software, PaySimple makes it easy to classify your business revenue. Within PaySimple, all your transactions are tracked, documented, and ready to view via reports. Every service and payment made to you is recorded and instantly accessible at the click of a button. While it may not function as a complete accounting software, it can still help your business with primary filing duties such as documenting expenses and recording incoming revenue. Overall, having one designated area to review all your transactions is paramount come tax season.

    Start Separating Personal and Business Expenses Now

    Small business owners: it’s not too late to start getting your finances in order. 

    Implementing these steps for separating personal and business expenses will take time initially. However, they will bring numerous advantages that will save both you and your business time and money in the long run.

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