Do You Avoid Separating Business and Personal Expenses?
You’re in good – or should we say, bad – company. Over half of American business owners use either their personal checking account or credit card for business purposes, according to a Forbes Expert Panel.
Why is that such a bad thing? For starters, if the IRS ever audits you, you must prove that every expense you deducted for business purposes was legitimate. Separating business and personal expenses becomes even more critical in the case of a lawsuit (we’ll dive deeper into the #1 “golden rule”).
Here at Robert P Russo CPA, we ensure our clients understand the importance of separating business and personal expenses – and exactly how to do just that.
1) The Golden Rule of Separating Business and Personal Expenses: Create the Right Business Entity!
This may seem obvious, but the sooner you form an official structure for your business, the better. The reasons for officially forming a business entity transcend accounting and taxes and move into life-altering situations.
For example, let’s say you have been operating a side business as a sole proprietor, making porch swings. One swing out of hundreds of breaks injures a person, and you’re being personally sued for $1 million. If you had set up any of these other business entities, such as an LLC, you’d have a better chance of making a case that your personal assets are off limits. After all, LLC stands for “limited liability company.”
However, simply having an LLC isn’t enough…if you’ve never bothered separating business and personal expenses! The judge might allow the injured person to go after your personal assets – from your home to your savings accounts – instead of the $1,500 in your business account.
Now that we have your attention about the importance of selecting the right entity – and separating business and personal expenses – take action. Contact a qualified CPA, like members of our team at Robert P Russo CPA, to analyze which business structure is best for you.
2) Open a Credit Card and Checking Account, Use it ONLY for Business Purposes
Next up on our list of tips for separating business and personal expenses is to immediately set up a business checking account and credit card after creating your entity. Depending on the entity you chose, you may have a separate Tax ID number – known as an EIN. This will be associated with your accounts going forward, and will help you build credit for your business.
You may face temptation when separating business and personal expenses thanks to alluring offers from credit card companies. They may promise $250-$500 cash back if you spend a certain amount on your business credit card within a few months. Don’t fall into the trap of using that business card for personal expenses! Think of that potential audit or lawsuit – it’s just NOT worth it.
3) Track What You’ve Invested Into Your Business
In most cases, business owners start up operations using some of their personal savings. That’s fine from a tax and accounting perspective. But be sure you record this in your business ledger because this amount is typically considered “owner equity” and is not taxable (there are exceptions, talk with a CPA to review your situation).
4) Splitting and Separating Business and Personal Expenses Related to a Single Item
Not everyone likes to have two smartphones: one for business, one for personal. So how can you go about separating business and personal expenses you incur for a single smartphone or laptop? What about Internet fees? You’ve got two options. You can deduct the actual amount used for business purposes from your bill each month. Or, if you have a home office, you can deduct all utilities – such as Internet fees – at a percentage that relates to how much square footage your office takes up compared to your home’s total square footage. A qualified CPA can help you sort out which is more beneficial for you. See, you’ve got options for separating business and personal expenses!
5) If You DO Use a Personal Account for a Business Purchase? Track It!
It happens. You’re purchasing office supplies, and you left your business credit card at home. You have no choice but to whip out your personal card and pay. Good news, you won’t miss out on that deduction, as long as you pay yourself for the supplies via your business account AND you’ve saved your receipt. Proof is essential when separating business and personal expenses.
6) Convenience at a Cost: You Need to Separate Business and Personal Expenses Online
Temptation arises again. You need to buy business equipment online right away and the supplier only accepts PayPal. The only PayPal account you have is tied to your personal social security number, not your EIN. PayPal requires a few documents before they’ll set up your business account, so what do you do if you’re getting serious about separating business and personal expense? If it’s a one-time occurrence, go ahead and use your personal PayPal account and reimburse yourself – just like we mentioned in tip #5. But don’t make this a habit! Set up business accounts for Amazon, PayPal, etc.
7) Get Smart About Separating Business and Personal Expenses While Traveling
Now here’s where things get a little more complicated in regards to separating business and personal expenses. What happens if you live in the Northeast but have business in Florida in the dead of winter? You want to bring your family along, but you’re unsure how to go about separating business and personal expenses. First, you know what to do: talk to a qualified CPA before you start trip planning. And of course, review these general rules about deducting travel expenses. You’ll learn things like the fact that you can deduct lodging for you only, not your family – and only on the days that you spend primarily engaged in business work (not on the days you went to Disney World).
Now that you’re informed about the basics of separating business and personal expenses, the next step is to put what you’ve learned into practice. Save all receipts, track every expenditure in QuickBooks or whichever accounting software you use, and by all means, speak with a CPA so that your business is set up for success!
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