I recently met with a long-time client regarding his starting a new business. I reminded him that they must consider keeping business and personal expenses separate. In the eyes of the IRS when you co-mingle personal and business and are ever audited all your legitimate expenses can be denied. Even with receipts and logs and ledgers.
Because it’s easy for a business owner if you don’t have a (good) system in place, to blur the lines here. Believe me, I’ve seen plenty of people come to me whose books are a mess, which complicates operations unnecessarily. That’s why I’m bringing it up.
But let’s start here with a little about WHY it’s so important for you.
Keeping Expenses Separate in Your Business
When you started your business, I’m sure you felt that sugar high that comes with it. You have this idea that’s been percolating in your mind for months, maybe even years… and now you finally get to open the doors, make the announcement, close your first sale…
It’s such an exciting (and hectic) time that many small-business owners (especially new ones) easily forget one basic fact about having your own company: Keep the money separate.
If we’re honest, treating your business’s money as your personal account (or vice-versa) is so easy to do depositing a client’s fee paid to your business into your personal bank account, dipping into your business account to pay a personal expense, and not keeping the records because you know where the money went, and everything is doing fine.
The harm comes in the recordkeeping, though… because you might depend on it later to keep your company’s doors open. Here’s how.
If you’re properly in business, having two pots of money confuses your accounting. And accounting is what you’re going to need first and most obviously to determine your company’s strengths and weaknesses, aka profits and losses down the road.
Separating expenses can also be for your own good if you’ve incorporated them. If — heaven forbid — your company goes bankrupt someday, one avenue that creditors will have to your personal money will be if your business and personal finances were intertwined (piercing what’s called your “corporate veil”).
You’ll also need a proper audit trail to prove the deductions and losses you take (and believe me, you’ll need those in the first few years) on your business tax return.
While we’re on taxes, if you’ve got even a small online business, this could be the first year you get an IRS Form 1099. For tax year 2023, if you use a third-party payment platform like Venmo or PayPal or sell on sites like Etsy or eBay and make just $600 for professional services, you and the IRS will get a Form 1099-K in January 2024, and you must report the income.
If you use a payment platform for personal payments, you won’t get a 1099-K – but there’s no guarantee that mistakes won’t be made in this initial year of the 1099 blizzards.
You’re probably beginning to see how keeping good records and separating funds will be especially helpful.
Bank accounts: From the minute you turn on the lights, get a proper business account that’s completely distinct from your personal accounts. To open a business account, you’ll need to get a federal tax ID number (EIN) and a state tax ID number, as well as any documents you filed for when you formed your company such as articles of incorporation or a certificate of formation (LLC, Corporation) from your Secretary of State. If you are a sole proprietor, you do not have these, nor are you required to.
A business account in the same bank where you keep personal money may get you a break on some fees, but it depends on the bank. It’s the same for introductory offers and sign-up bonuses (which are taxable). Shop around and study the fine print — and don’t forget non-bank sources, like American Express.
Credit cards: Getting a business credit card separate from your personal plastic is just as important as having a distinct bank account. It’ll be instrumental in creating the paper trail needed to justify deductible expenses that you take on your business tax return. You will still be personally liable for any debt, but you can know that all charges on a specific card are legitimately for business.
New businesses have a hard time getting a credit card in their name, so do what I did until I could be credit worthy after a couple years. I had a new credit card from my bank with a set limit and only used it for business.
So you co-mingled and now you think all is lost. It’s never too late to begin untangling business and personal finances. Go back through your records (with luck, your company is still young enough, so you won’t have to look at too many years). Pick out the transactions you know are business or personal. Pay special attention to meals and travel, vehicle expenses, and home-office costs — the IRS likes to attack these ones.
We’d also be happy to chat about possibly filing amended returns, and about how we can help keep your biz and personal money separate (and safe).