With another new year fast approaching, one of your small business goals may be to catch up on your bookkeeping. Indeed, one of the most common mistakes that small business owners make in this regard is mixing personal and business expenses also known as piercing the corporate veil.
Even if you’ve been comingling your transactions since the inception of your business, it isn’t too late to get a handle on this key aspect of small business bookkeeping.
Why Should You Keep Personal and Business Expenses Separate?
Reduces Legal Liability
The legal protections that come with establishing your business as a separate legal entity (more on the types of a business structure below) mean very little if your business and personal finances are muddled. If, for example, your corporation is on the line for $10,000 and a judge cannot find sufficient separation between your personal and business finances, they may find you personally liable and seize assets to pay off your creditors.
For example, when dealing with a vendor or customer, a check drawn on a business checking account looks much more professional and makes a statement that your company should be taken seriously.
Gives You Peace of Mind
In the event of an IRS audit, the burden of proof rests with you as the small business owner. Said another way, you must be able to “prove (substantiate) certain elements of expenses [in order] to deduct them” according to the IRS. Keeping organized, separate records saves you from having to dig through an old shoebox of receipts to determine which purchases went toward legitimate business expenses and which funded personal needs.
Overall, at the end of the year, all your income and expenses will be in one place, making your accounting and bookkeeping more straightforward and, in some cases, less expensive.
5 Tips to Keep Personal and Business Expenses Separate
Create a separate entity for your business
The entity, or structure, you choose for your business makes a significant impact on your accounting needs and the type of income tax return for you’ll have to file. According to the IRS, “The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute.”’
Open a business bank account
Once you establish your business as a separate legal entity, you will then need to open a business bank account. If there is ever any doubt as to whether you are operating a business or a hobby, one of the first things the IRS checks is whether you have a business bank account or not.
Aside from being able to more accurately keep track of transactions with your business bank account statements, you’ll have fewer headaches come tax time or in the event of an IRS audit. The Small Business Administration offers some additional tips for finding a small business bank account that will meet your needs on this page.
Use a business credit card for business expenses
If you are a small business owner, then it is highly recommended to use a business credit card for business transactions. This is yet another milestone in creating a financial identity for your business because a business credit card is an excellent tool to build healthy credit and increase your company’s purchasing power.
If you are not keeping your receipts safe and organized for the business or worse, if you typically misplace them or lump them in with your personal receipts, then you will have a difficult time in the event of an audit.
The good news is that you can take advantage of technology solutions to make this process easier than ever. Many accounting software platforms such as QuickBooks allow you to upload scanned copies of your receipts so that you can get rid of physical paper altogether.
RQB Tip: QuickBooks’ mobile app makes it easy for users to attach photos of receipts and even has the functionality to “sync PayPal transactions, link business cards with American Express, import sales data from Square and more.” This is a perfect feature if you are often on-the-go while running your small business.
Pay yourself a salary
If you are an employee of your corporation, then it’s time to determine “reasonable compensation” for yourself based on your responsibilities. A good starting point will be to research comparable salary ranges for similar roles within your industry. On the other hand, if you are a sole proprietor or a partner, you can take an owner’s draw by writing a check to yourself from the business bank account.
RQB Tip: You should only pay yourself out of business profits and not revenue, i.e. the amounts left over after you have accounted for expenses such as payroll, overheads, taxes, etc.
Bonus: Leave it to the Professionals
Keeping your business and personal transactions separate can be challenging, especially considering all the other tasks you likely have to juggle as a small business owner. If you would like to focus more on strategic, revenue-generating activities in the new year, then it’s time to consider transferring these critical tasks to a team of experts, thus freeing up your time to focus on value-added activities such as building better client relationships, exploring new partnerships, and expanding your business.
The best part? It doesn’t have to cost an arm and a leg. In fact, RQB will help customize the scope of work you require and tailor solutions that make sense for your budget. Leveraging our scalability means you get to save the time – as well as the cost and hassle of bringing on an in-house bookkeeper. In turn, you can use the additional time and money to gain a competitive edge and scale your own business with ease.
The RQB team wishes you a happy and prosperous 2023!
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