Four years ago, as my husband and I were shopping for a mortgage, we found that we needed to have an income audit. We were getting a mortgage based on my self-employed income. We wanted to be able to include my income from the first six months of the year, since my tax returns from the previous two years didn’t reflect a sudden upsurge in work I had received. At the time, with my sole proprietorship, I was preparing my own taxes, and I didn’t have a separate business account. The accountant asked me, as part of the audit, to go through all of the bank statements and highlight my business income and expenses.
Then he told me that, even if I stuck with a sole proprietorship (I didn’t; I decided to form a LLC), I should open a separate account for business expenses.
Keeping Business Expenses Separate
One of the main reasons to keep business expenses separate from personal expenses is due to record keeping — especially for tax purposes. It is much easier to identify business income and expenses if they come out of an account that its different from a personal account. For tax purposes, it helps you with documentation, and sets up a definite line between the two.
The separation between personal expenses and business expenses is also important because the IRS is quite clear about what is deductible against your business income. The IRS says that you can’t use business items for personal purposes if you want to deduct their cost. So, if you have a home office, you can’t be using it for storage if you want the deduction. The same is true for other business items you might purchase. You can bolster your case if you use a designated business account for your business purchases.
Plus, separating them out provides you with a psychological reminder that you should use business items for business, and not for personal purposes. This separation can help you remember the importance of distinguishing between personal and business expenses.
Just Passing Through
When I first set up a business account, I felt kind of silly. I put income from my business into the business account. Then, as soon as it clears, I move most of it to the joint household checking account. (I transfer the money now, but I used to write checks to my husband, who is my LLC partner, or to myself.) At first it seemed like an unnecessary step, but now I understand that it’s more about creating a trail that shows the business income that I have. It makes things easier for me, and my accountant, and it helps make everything with my home business appear more legitimate for the IRS.
Bottom Line
Drawing a line between business expenses and personal expenses is important. You need to be able to document what you are doing with your money, especially if you have a home business. The line can get kind of blurry, and it’s important to try and define it as much as possible.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.