Why It’s Important to Keep Personal Expenses Out of Your Business Accounting
You may be thinking it’s no big deal to mingle your business and personal expenses in your business’s accounting system. You’re out shopping and decide to pay for dinner or groceries with your business credit cards or through your business checking account. The business pays you anyway, so why not just charge that personal item to your business accounts, right? Well, think again. There’s a right way to pay yourself from your business and reasons why you shouldn’t run personal expenses through your business accounting system. Here’s what to keep in mind…
You Can’t Deduct Personal, Living or Family Expenses – Personal expenses can’t be deducted as business expenses on your taxes. Some business owners try to deduct personal expenses such as meals, travel, supplies, phone, and car expenses as business expenses in their accounting system to reduce their taxable income. For one thing, the IRS doesn’t allow personal expenses as business deductions. Secondly, taking personal expenses as business expenses in your accounting system obscures the financial picture of your business because your expenses are inflated with expenses that aren’t related to your business. This can effectively eliminate your ability to determine the financial health of your business and make sound business decisions based on accurate financial information.
You Make Your Bookkeeping Harder – When you run personal expenses through your business credit cards or bank accounts, those items must be entered into your business bookkeeping system so the bank and credit card accounts can be reconciled every month. That increases the amount of time it takes to complete your monthly financial reports. You also run the risk of missing business expenses when you don’t reconcile your checking and bank accounts every month.
You Make it Harder on Your Accountant – When you commingle personal and business expenses in your business accounting system, your accountant must review your expenses carefully to ensure they are including only your business expenses as deductions on your tax returns.
You Muddy Your Financial Reports – Your business financial reports tell you about the health of your business and should be used as tools to make sound business decisions. When you commingle personal and business expenses, it skews the information on your financial reports and makes it harder to see the true financial picture of your business. Even if you record the personal expenses as an Owner’s Equity: Draw, your business equity may show more taken out of your business than if you just took a simple draw from your business for your personal income.
What if You’re Audited? If your business is audited by one of the tax agencies and they see personal expenses commingled with business expenses in your business accounting system, they may adjust your tax returns, which may result in you being assessed additional tax due. Do you have receipts proving the expenses you’re claiming are clearly business expenses?
What if You Sell Your Business? When businesses are sold, prospective buyers will want to review your accounting system to see the true income and expenses of the business. By overstating your business expenses with personal expenses to reduce your net income and (you think) your taxable income, what financial picture of your business will that show to a prospective buyer?
Bottom line? Don’t mix your personal and business expenses in your business accounting system. Period. So what should you do? Here’s a few tips.
Pay Yourself a Salary – Add yourself to your payroll and pay yourself a salary. You may also pay yourself a draw in addition to salary. The IRS frowns on you paying yourself a draw without salary as you’re not paying payroll taxes. Check with your tax accountant regarding the correct amount of salary and draw you should be taking.
Pay Yourself a Draw – You may wish to take money out of your business from time to time. When you do, write a check from your business checking account to yourself and record it as Draw. You will be required to pay tax on the draw you take out of your business, so check with your tax accountant regarding the appropriate amount of draw to take in your situation. If you must pay for personal expenses from your business, write yourself a check for Draw and charge it to Owner’s Equity:
Have Personal and Business Credit Card Accounts – Charge your personal expenses to your personal credit cards and business expenses to your business credit cards. If you charge business expenses on your personal credit card, write a check from your business to you to reimburse yourself.
Have Personal and Business Bank Accounts – Again, only pay business expenses from your business bank accounts. Keep your personal expenses in your personal checking account only. If you purchase a business expense from your personal checking account, write a check from your business to pay yourself back for that expense.
Keep All Business Receipts – You should keep all business expense receipts and ensure they are clearly marked for the customer the business expense was intended, such as in the case for meals and entertainment.