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Separating Personal and Business Expenses - A Must
The commingling of personal and business expenses is an all-too-common mistake many new businesses make. But this can create big headaches at tax time and may lead to a host of other problems ranging from tax audits, to disallowance of valid corporate expenses, to legal judgments.
To maintain the viability of your business, even if you're just starting out, differentiating your personal and business expenses is a must. Here are five tips to help you get started.
Create a budget for the business. Don't be tempted to give the business money even if it is experiencing temporary cash flow problems. How to avoid this? Make sure that all sources of cash are kept separate, including petty cash, loan proceeds and ATM disbursements. If the company needs funds and you have some to spare, have a legal agreement drafted and invest in the company with a capital contribution, or make a loan, but be sure you have proper documentation and understand the differing legal ramifications of debt and equity. If you personally are cash short, request a payroll advance or a loan from your retirement account, all legal methods to help your personal cash flow. Remember to keep all transactions at "arm's length," where both parties are acting independently, legally and professionally.
Keep all of your expenses and corresponding receipts separate. It may be tempting to commingle everything and worry about it later, but you will have more than a headache at tax time -- you may lose your deductions or even your business. Why? The IRS requires substantiation for all business expense deductions -- they must be "ordinary and necessary" -- and the burden is on the taxpayer, whether you are a corporation or a sole proprietor. If you have a new business, or one that is not yet profitable, the IRS may consider it a mere hobby and disallow your business deductions. Many deductions are only available to businesses, such as those for business bad debts, so it is imperative to make sure they are not disallowed or re-characterized.
Maintain separate record-keeping systems. Use a personal financial management program to keep track of your personal expenditures, and a separate system for your business record keeping. Not only will you reduce your accounting expense by being organized once tax time arrives, but you will also be able to sustain the burden of proof in an audit.
Establish separate checking accounts. The best way to keep expenses separate is to open a business checking account. Utilize this account to pay for all of your company's expenses, including paying yourself a salary or draw, and use a personal account for anything else. Make sure you have sufficient funds in both accounts at all times so that you can begin to establish a good credit history. A business checking account will assist you in establishing a relationship with your small business banker, the first step in obtaining business financing later on.
Apply for a business credit card. Not only will this help in establishing a good credit history, another step in obtaining business financing, but you can also give your employees cards with credit limits so you can keep an eye on company spending. If your company's cash flow is problematic, employ temporary financing with your business credit card. Any interest paid is a deductible business expense, helping your company's bottom line at tax time.
It is imperative to keep expenses separate to protect you from potential legal judgments against your business. If your business has insufficient assets and is sued, a court may "pierce the corporate veil", ignoring the protection of the corporate entity that you so carefully set up, and allow creditors to go after your personal assets.
Keep your personal and business expenses separate and you will safeguard your company's finances, your personal assets and your invaluable business reputation.
It's never too late to start. Contact a Cadence Small Business Banker today to discuss the best checking account and credit card options for your business.