The Sole Proprietor’s Simple Guide to Rocking Business Expenses
Most financial experts would agree that it is a good business practice to keep your records straight. One area that’s important for sole proprietors to keep in mind is that personal and professional records should always be kept separate. New business owners – especially those operating as sole proprietors – may not appreciate the significance of this when developing systems that make transactions easier to track. Yet even the simplest business situations can cause unnecessary headaches and anxiety around tax filing time when personal and professional records are mixed together.
What Can Go Wrong?
For most business owners, the biggest indication that comingling personal and business finances is not a good idea is when it’s time to file taxes. What may have saved you time and effort throughout the year will cost you twice the amount of time to separate and compile your personal and business records in order to accurately compute your taxes. However, that’s not the troublesome part. Should your return trigger a tax audit, the comingling of business and personal records could jeopardize your business deductions if the IRS agent finds that there’s too much entanglement of the two. That could be the most costly reason why you should keep your business and personal lives separate.
The time to put the practice of separating your personal and professional records is early on when your situation is far less complicated. No matter where you are in your business, you should follow these six steps to keeping your records straight:
1. Separate Expenses
One of the big benefits of operating a small business as a sole proprietor is that any business-related expense can be deducted from your business income. Business expenses such as supplies, advertising, training, mailings, fees and licensing reduce your business income dollar for dollar. Where it gets a little more complicated is with the business use of your car, your cell phone and your internet.
All of these are legitimate business expenses except for the portion of their use that is considered personal. You will need to keep accurate records for the amount of use that can be attributed to your business. If you mix business with personal travel, you can deduct a portion of costs based on the amount of time spent on your business activity. Meal and entertainment expenses can be deducted if any portion of the activity is related to your business. Good records make it easier to track this information and provide a stronger paper trail if required.
2. Separate Space
If you work out of the home, it’s important that your workspace be fully dedicated to working if you’re claiming a home office deduction. This is especially important for claiming deductions by the foot or utilities associated with operating your office. Your business work space should be walled off from the rest of the house with dedicated business furniture and equipment, if possible. If personal documents are found within the home office or it’s clear the space is being used for non-work purposes, the IRS may disallow associated business deductions.
3. Separate Record Keeping Software
Record keeping software such as Quicken comes in business and personal versions. When possible, a separate program should be used for business record keeping. At tax time, programs such as Quicken will automatically compile your checking and credit card transactions and organize them in the proper categories when computing deductions. Better yet, get separate computers for business and personal use. If you try to deduct your computer and software programs as a business expense, the IRS may disallow them if the computer is also for personal use. This may sound extreme but the underlying message is the same: separate your business and personal expenses as much as possible by carefully demarcating what’s for personal use and what’s for business use.
4. Separate Bank Accounts
By separating your personal and business checking accounts, you set the foundation for keeping transaction records separate. This is especially important if your business name is different than your own name. Banks may not be willing to cash checks made out to a name that is different than the name on your account. A separate business account gives your business more legitimacy. Opening a business checking account is fairly straightforward. Most banks require a Federal Tax ID number and a DBA to open an account, and they usually charge a service fee.
5. Separate Credit Card
It’s difficult to obtain credit when your business is young. Still, it’s important to maintain separate credit accounts for personal and business use even if you simply earmark one of your personal credit cards for business use. Many suppliers, such as Office Max or Uline will issue a line of credit or credit card to a business with limited credit, as will some gas companies. As soon as your business is able to qualify, you should obtain a VISA or American Express card.
6. Separate Phone
Using a separate phone for business ensures that that your business phone expenses will be 100 percent deductible. It is recommended that a separate phone line or cell phone account be established for the business. Often times, business owners find that they can get away with a cheaper cell phone plan for personal use as it is their business that requires the more extensive plan.
These are not monumental steps; however, they are very effective at laying the foundation for keeping personal and professional records straight. They also serve as a psychological reinforcement of your intent to build and run a successful business.
What strategies do you use for keeping your business and personal expenses separate? Let us know in the comments below or join the conversation on one of Kabbage’s social media accounts.