Keeping your business and personal finances separate makes sense for both you and your company
By Reed Richardson
Many small business owners view their business as an extension of themselves, an outlet for their drive or creativity. Other small business owners are so busy building their businesses that they have little personal life outside it. In either case, most small business owners have sunk so much time, work, and investment into their businesses that the business's finances may become inseparable from their own. But letting the boundaries of personal and business finances overlap can lead to problems that are better just avoided altogether.
Since many entrepreneurs start their companies with their own money, it's natural that the line between business entity and owner is blurred, especially in the early days. Corporations, partnerships, LLCs and LLPs are required by law to maintain official business accounts, but sole proprietorships-the most popular form of small business-are not required to do so. Many fledgling business owners haven't set up a business checking account or obtained a business line of credit or credit cards, so they use their own checks or credit cards when purchasing materials their new business needs. "It's very easy to charge that new printer or PC on your own credit card," says management consultant C. Davis Fogg. "After all, it's your business, and you're the one doing the buying." But doing so creates problems when you file your taxes, Fogg warns. "If you want to deduct business expenses from your tax bill, you are going to have to demonstrate to the Internal Revenue Service (IRS), that they are in fact business expenses," Fogg explains. If all the business purchases are mixed together with your personal spending, the IRS may question whether or not the deductions you claim are valid. If you deduct office equipment as a business expense, the IRS wants to make sure it is only used for business. If you've charged it on your personal credit card, the IRS can legitimately ask if the purchase was entirely business related. This can lead to a time consuming and ultimately expensive confrontation with the government. "No one likes an audit," Fogg says.
Segregating business expenses by using a company checking account or credit card keeps a sharp line between you and your business. This makes it much easier to justify deductions at tax time, since purchases like computer equipment or office supplies, which potentially could have personal uses as well, are clearly defined as business expenses. It can also keep the IRS from going on a fishing expedition through your personal finances, which might prove invaluable on its own.
This is particularly true if your business operates from a home office. The IRS has always been particularly picky about allowing home office deductions, Fogg says. Any evidence that you have used office equipment or space for personal purposes could give the IRS an excuse to deny important tax deductions. But aside from tax issues, mixing personal and business finances muddies your business's accounting. If it becomes difficult to parse your personal expenses from your business's, it will be difficult to get a good handle on exactly how well your company is doing. Worse, it could count against you in the event you try to get a business loan to expand your business. "Banks want to see clear, clean business accounts before they lend you any money," says Kay McDermott, a New York City-based CPA. "You need to demonstrate to the bank that not only is your business generating enough revenue to repay the loan, but that you are running the business professionally enough to keep that revenue coming in."
Co-mingled personal and business expenses often result in messy financial statements, Berman warns. Many banks will interpret that as a sign that you don't take your business seriously enough to maintain proper accounting. That alone can sink your chances of getting a loan or line of credit. Failing to separate business and personal finances is much less excusable today than it was in the past. Today many banks cater to small businesses and have established products and services geared to cater to small business needs. Additionally, there are numerous accounting and business management software packages available at very reasonable prices to help small business owners construct and maintain accurate and professional accounting records for their companies.
Reed Richardson is a writer/editor for Business 24/7 magazine.
