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Why You Need to Separate Your Personal and Business Expenses

Why You Need to Separate Your Personal and Business Expenses

One of the biggest mistakes that a business owner can make when starting their business is neglecting to create a clear distinction between their business and personal expenses.

This common mistake occurs because most individuals who start businesses begin by funding their businesses out of their pocket, using personal assets as startup capital, or using their personal credit score to secure a small business loan.

Using your own income and assets may make sense at the outset of a business’s lifetime, but as the business begins to grow and earn revenue, the line between business and personal expenses can start to blur very quickly. This can lead to all sorts of complications with the IRS and expensive, stressful and time-consuming issues.

Why is Separating Your Expenses Important?

The most important reason to separate your expenses is that it makes reporting to the IRS significantly easier. It also decreases the likelihood of an IRS audit.

When you maintain two separate bank accounts, it clearly demonstrates to the IRS that you are running a business. It also makes these tasks a lot easier:

  • Tracking expenses and income
  • Obtaining business loans
  • Claiming deductions
  • Creating profit and loss statements
  • Filing your taxes

Additionally, if you run a limited liability company or a corporation and there is no clear distinction between your personal and business expenses, then you may be held personally liable for any debts owed by your business.

How to Separate Your Business and Personal Expenses

1. Start as Early as Possible

The sooner you can start keeping separate records of your business and personal accounts, the better. If you’ve been mixing your finances up until this point, stop now and begin restructuring how you run your business.

2. Register for a Business Tax ID

Visit the IRS website to get your Employer Identification Number (EIN) which allows you to open a business checking and savings account at your local bank. It also demonstrates to the IRS that your business is a separate financial entity, and can prevent you from being audited.

3. Obtain Business Accounts

Sign up for a business banking account and for a business cell phone plan as soon as possible to keep accurate records. It’s wise to register for a business PayPal account so that you can send and receive money without getting hit with unnecessary banking fees. This is especially important for businesses that work with independent contractors.

4. Be Diligent About Tracking Business Finances

Unless you can afford to hire a full-time accountant, you’ll have to track your business income and expenses. Maintaining a manual ledger in MS Excel, Google Spreadsheets or Open Office is a great first step, but eventually, you’ll want to invest in tools like Quickbooks or Freshbooks, which are easy to use, cost-effective solutions,

There’s never a wrong time to start making the right choices when it comes to your business, so start taking these steps today to set yourself and your business up for personal and professional financial success.

Categories:   Protect Your Assets