As a first-time business owner, you might be unfamiliar with the concept of separating personal and business expenses. Mixing the two not only makes it hard to determine your business’ financial health but also causes tax complications. Other than cost savings, separating your expenses shields you from personal liability in case of a lawsuit against your business.
Differentiating Personal and Business Expenses
The IRS defines business expenses as ordinary and necessary costs. They’re charges that are commonplace in your industry, trade, or profession. Other than supporting your business, these types of expenditures are also tax-deductible. Acceptable business expenses include travel, union dues, workwear, tools and supplies, work-related education, home office costs, and work-related mileage.
Some personal costs might be confusing to classify, such as commuting expenses, accreditation fees, and travel for your spouse and children. The IRS publishes a list of acceptable business expenses, known as Publication 535, to help business owners properly track their spending and file taxes. However, if you’re still unsure about whether a purchase is considered a business or personal experience, it’s best to confirm with an experienced tax professional to avoid future problems with the IRS.
How to Separate Business and Personal Expenses
The following tips will help you differentiate between personal and business expenses:
1. Apply for an Employer Identification Number (EIN)
An EIN works like a social security number for your business. It’s a top priority if you want to separate your business and personal assets and expenses. This nine-digit number from the IRS enables your business to perform various tasks, including filing income and payroll tax returns, establishing a business entity, and opening a business account.
2. Register your business entity
Your business structure determines your tax obligations and ability to raise capital. LLCs, C corporations, and S corporations are legally and distinctly separate from their shareholders. Apart from enhancing credibility, incorporation enables access to funding while protecting you from personal liability.
3. Open an account for your business
Having designated bank accounts for your personal and business dealings is one of the most efficient ways to separate expenses. Once you have your EIN, the next step should be to open an account in the entity’s name. A business checking account enhances transparency and efficiency in business expenditures, financial records, and tax preparation.
4. Get a business credit card
A business credit card helps you make clear distinctions between business and personal costs. It’s risky to handle significant business expenses through individual credit cards because they typically have lower credit limits. Business problems could also affect your credit score. A business credit card provides additional benefits, including merchandise discounts and establishing business credit.
5. Use reliable accounting software
Accounting software automates several financial tasks. Examples are tracking business income and generating accurate financial statements. In addition to separating business and personal expenses, accounting software is convenient for classifying payments under the appropriate accounts. This efficiency eliminates many problems you might experience during tax season.
Final Thoughts
Separating business and personal expenses is crucial to improving your financial health and tax standing. The above tips will help you make informed business decisions to pursue growth and fulfill your long-term objectives. If you’re not sure how to perform the above tasks or struggle to find the time, it’s a good idea to seek support from a CPA or financial advisor.