The number of small businesses in the United States has grown 49% since 1982, reaching 23 million and accounting for 54% of all sales, according to the U.S. Small Business Administration. The entrepreneurs who own and run these businesses work overtime, juggling many tasks and overcoming numerous obstacles, including the perpetual problem of keeping business books separate from personal finances.
It’s easy to mix your sales receipts with your grocery bills, and pay your business debts off with personal credit cards. This can create problems, such as overextended credit, late payments, bookkeeping messes and tax liability. Knowing how to keep your personal and business finances separate can help you avoid these issues.
Setting Up a Separate Home Office
Financial segregation begins with physical separation. Nearly 70% of entrepreneurs start up out of their homes, notes small business trends. If you have a home office, you may be eligible for tax deductions on a percentage of expenses like utilities. Your eligibility depends on how much you use your office space for business, and whether your home is your principal workplace, notes the IRS.
Separating Your Legal and Tax Liability
Tens of thousands of small businesses go bankrupt annually, while even more Americans do not file for bankruptcy because they cannot afford it, notes CNN Money. To keep this from happening to you, keep your company’s legal and tax liability separate from your personal finances.
Your business structure also impacts your personal liability if your company gets in debt or faces a lawsuit. A sole proprietorship or partnership exposes you to more risks than other forms of incorporation, such as LLCs. Another option is having a trust assume liability for your business.
Your business structure also affects your personal taxes. An LLC lets you pass your company taxes on to you for simplified reporting. A C-corporation is taxed separately from its owners. An S-corporation does not pay federal taxes, but passes this responsibility on to its shareholders, affecting your personal tax obligations when you pay yourself.
Keeping Financing Separate
The U.S. Small Business administration lent a record $30 billion to entrepreneurs in 2012. Keeping your business financing separate from personal funds is another important element of financial segregation. When raising startup capital, even if you use your own money, you should make this a separate budget item to ensure you can still cover personal expenses. If your personal budget is tight, consider seeking outside funding.
Use business accounts and credit lines to cover company expenses, instead of paying for them directly out of your personal funds. For instance, if you need to buy a Pitney Bowes postage meter, write a business check for it, or use your company credit line, instead of your personal card.
Likewise, if you need business funds to pay your own bills, write a check to yourself instead of paying directly out of company funds. This avoids auditing complications that can arise if the IRS sees you using company money to cover personal expenses.
Separating Your Business Bookkeeping
If you keep your grocery and utility bills together in a shoebox with business receipts and invoices, you’ll have a mess to clean at tax time. Avoid this by separating business and personal records. This includes physical business records, such as mail and receipts, as well as digital records like email, word processing documents, spreadsheets and even social media accounts.
You should also separate your business bookkeeping system. For simplicity, use an electronic bookkeeping system such as QuickBooks, and hire a specialist to maintain your books. It’s ideal to maintain separate files for business and personal finances, but if this proves difficult, one solution is itemizing your own income and expenses within an “other” category.
Keeping Your Tax Reporting Separate
As an individual, you’re probably used to doing your taxes once a year, but as a business owner, you may have quarterly filing obligations. Automated tax calendar software, such as that provided by the IRS, can help you establish a filing routine.
Finally, to reduce your tax burden, know what items you’re eligible to claim as deductions and keep good records separating these from your personal expenses. For instance, you can’t deduct the cost of commuting to work, because this is considered a personal expense, but you can deduct mileage for specific business purposes, such as visiting clients. Consult a specialist with questions about your eligibility on specific items.