Even if you don’t have employees, and even if your business is just a side gig, you need to segregate your business’ finances from your personal finances. In addition to record-keeping and tax preparation being easier, if you ever get audited by the IRS, you’ll be able to show what income and expenses are business-related and make sure you can deduct all of your expenses.
The biggest risks of not separating your finances are (1) IRS audits and (2) if you’re set up as an LLC or corporation, you may lose the protection of limited personal liability. If the IRS audits your business and you haven’t kept business and personal money separate, they may reject the deduction of some expenses. They may also view your work as a hobby instead of a business, which limits which expenses you can deduct, and you can’t recognize a loss for a hobby on your tax return.
In the case of LLCs and corporations, a big attraction is limiting your personal liability in the event of a lawsuit or other judgment against your business. If you haven’t separated your business and personal finances, a court could say that you treat the business as an extension of yourself, of your personal activities, and “pierce the corporate veil.” This means you would have full personal liability, as if the LLC or corporation didn’t exist.
The first step for separating your finances is to open a separate bank account for your business. The only money going into this account should be revenue from your customers, and investments you make in the company. The only money coming out of the account should be business expenses and the salary you pay yourself. Don’t deposit any revenue into your personal account, and don’t pay any business expenses out of that account. If you run your business under a name that’s different from your own, open the account under the name of the business.
Follow the same system for credit cards. Have a separate card that you only use for your business, and don’t put business expenses on your personal card. You’ll probably need to rely on your personal credit in order to get the card, but you should be able to open the card in the name of the business.
Keep receipts for all of your business expenses in a file, either in a physical folder in a filing cabinet, or scan or take a picture of them and file them on your computer. You may be able to attach them directly to transactions in your accounting software, such as QuickBooks. You may need to reference receipts when you’re preparing your tax return, and you’ll definitely need them if you get audited by the IRS. Keep in mind that you may be able to deduct part of certain household expenses as a business expense. The most common are:
- The costs of a home office, if there’s a room in your home that you only use for business
- Your phone bill. If you have a phone that you only use for business, you can deduct the entire cost of it. If you split a phone between business and personal use, figure out what percentage of the time you’re using it for business, and you can deduct that percentage of your phone bill.
- If you drive to customers or other places for business trips, track your mileage. You can deduct a per-mile cost, which the IRS updates every year, typically in the neighborhood of $0.55 per mile. There are smartphone apps for tracking mileage, and you can use sites like Google Maps that give directions from Point A to Point B.
When it’s time to pay yourself a salary, you can write yourself a check out of the business’ account or, if you use the same bank for your personal accounts, you can transfer the money to your personal account.
Separating your finances will also make it easier to manage your business on a month-to-month basis, and to prepare your taxes at the end of the year. You’ll keep better tabs on the amount of revenue and expenses you have and be able to see how much profit you’re making. When you’re doing your taxes, you won’t need to go back and figure out what’s business-related and what’s person – everything will be right there in your business account.
Beyond just having a bank account for your business, you’ll also want to maintain accounting records. This will let you run a profit and loss statement for the month, quarter, or year, and make it easier to budget or project for the future. In future posts, I’m going to cover popular accounting systems, as well as whether to handle the accounting yourself or outsource it. Stay tuned.