SeparatingPersonalBizFinances_body.jpgby Iris Dorbian.

It can be very tempting for small business owners to borrow from personal savings to keep their start-ups afloat. But to do so repeatedly would be a serious mistake that could ultimately result in an IRS audit. How then can business owners learn to separate business and personal expenses in ways that will lessen financial risk?

Determine your business entity
Before you establish your small business take the time to figure out what type of entity it will be. Is it a sole proprietorship, meaning you own and run your business by yourself? Or do you have partners? In that instance, your business could be designated as a limited liability company (LLC). Consult a business attorney to figure out what entity type best fits your business. It's important to note that each business structure has its own guidelines concerning specific legal requirements. Be aware of them and do your due diligence to make sure that you have selected the right one. Not taking the time to do this could potentially cause you to run afoul of the IRS. Bradford Hall, managing director of Hall & Co., a 25-member accounting firm in Irvine, Calif., knows this predicament all too well.

“I had just started with a new client that has been a C Corporation (a corporation that is taxed separately from its owners) since it was started 14 years earlier,” he explains. “They shouldn’t have been structured that way and wound up paying more taxes than they should have.”

Use different accounts for personal and business finances
This guidance may sound obvious but it bears repeating. Not only will this help you distinguish one account from the other, it might also prevent you from dipping into the personal well to feed the business coffers.

This same strategy also applies to credit and debit cards. Determine which card you will use for business and which will be used for personal expenses. This is also a good way to establish your business credit.

After launching her small business last March, Dana Manciagli, a Bellevue, Washington-based career consultant, admits she had a hard time distinguishing business and personal expenses.

“Once I started my LLC and realized that I needed to fulfill certain tax and legal requirements, I saw that it would be too time-consuming and potentially cause errors if I didn't have my finances separated,” she explains. Since she was writing off certain business expenses and needed to file 1099s for contractors, she needed to be able to summarize where her business expenses were. “Later, once I got an accountant, they confirmed that separate accounts was a smart move,” she says.

And to further facilitate this distinction, Manciagli advises small business owners to establish online access to those accounts.

Hall says that when his firm takes on a new small business client, he always asks whether they have opened a separate bank account.

“If they say no, we're just paying out of our personal account, I will explain to them that it will be difficult to maintain the deductions with the IRS in the case of an audit,” he cautions. “[In this instance], it's very difficult to distinguish what is personal and what is business when everything goes in and out of the personal account.”

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Hire a knowledgeable financial or business expert
To prevent combining personal and business finances, consult an experienced and knowledgeable outsider, such as a CPA or business attorney to review your financial records for discrepancies and other bookkeeping errors. Again, this tip may sound obvious, but Hall says it's something that many small businesses fail to do.

Maintain good records
Hall stresses the importance of keeping clear and organized records. “When you entertain clients or have meals with them, always write down who you met with and what you discussed on the receipts,” he urges. “Keep those receipts. Also, print out your Outlook calendar at the end of the year and keep that for your tax records for your business.”

Hall recalls a client who only kept a year-end credit card summary as documentation for taxes. According to Hall, the client was told by a prior accountant that if they had had this summary, then it was not necessary to keep other supporting documentation. An IRS audit proved otherwise, says Hall, whose firm handled the audit. Although the client did not lose the business, they did have to pay a hefty penalty fee, he says.

“They learned a hard lesson,” recounts Hall.

Still, if you're the kind of business owner who has an aversion to stockpiling receipts, Hall suggests using software programs such as NeatReceipts, which will scan your receipts and keep them in a digital file.

Launching your business from the ground up is a great accomplishment. But it can be undercut if business and personal finances are continually co-mingled. Audits, stiff penalty fees, and even the failure of your business can result if you don't take the proper safeguards to keep these two accounts separate.

Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified professional for advice specific to your business.

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