One of the most common crises small business owners face is the separation of personal vs business expenses. Especially when you’re starting out as a sole proprietor, you may not immediately create a separate bank account or even apply for a business credit card. However, that’s usually where the problems arise. Keep your business and your personal expenses separate.
Mixing Business and Personal Expenses
It’s tempting to blur the lines between personal and business spending, especially in the early stages. But using business funds for personal purchases like meals or entertainment can trigger IRS scrutiny and potential penalties. Keeping meticulous records and separate accounts for business and personal finances is crucial.
Confusion around Deductible Expenses
Knowing what you can and can’t deduct from your business taxes can be complex, particularly for new entrepreneurs. Common issues include over-claiming personal expenses as business costs, misunderstanding home office deductions, or neglecting legitimate deductions like business travel or software subscriptions. Investing in proper bookkeeping or consulting with a tax professional can help ensure you’re maximizing your deductions accurately.
Obviously, as a small business owner, you know, the old “9 to 5” becomes a thing of the past. You’re always working. As a result, the separation can become more challenging due to the following:
Overlap in Activities & Shared Resources
Often, small business owners wear multiple hats and work on their business ventures during personal time, making it hard to distinguish between business-related tasks and personal activities. For example, checking emails or making business calls during evenings or weekends might involve personal devices and resources, blurring the lines as to what is deductible and what percentage that is.
Using personal phones, laptops, or even home office space for business purposes can easily lead to intermingling of expenses. It’s tempting to charge a business call made on your personal phone or claim a portion of your home internet bill as a business expense.
Where this gets even more complicated is the emotional attachment.
Productivity over Emotional Drive
As a business owner, maybe you don’t consider yourself overly emotional, but it’s a bit of the caregiver’s dilemma. The “caregiver’s dilemma” being when people sacrifice and spend more on who they care for and neglect their own needs.
For example, maybe you’ve had a crummy TV with faulty cable connections — you know, when discolored vertical lines run down your screen. Maybe you want to a new TV, but haven’t been able to justify the purchase for yourself. Now, however, you’re thinking, well wait-a-minute, I could use a better TV for Zoom meetings. So now, instead of a personal expense, you justify it as contributing to your business growth, blurring the line between professional and personal spending.
Lack of Systems and Processes
Without proper bookkeeping practices, small business owners might rely on receipts or personal memory to track expenses, which can be prone to errors and inconsistencies. This makes it difficult to accurately categorize expenses and identify the true nature of each spending.
When you add to this, not having dedicated business checking and credit card accounts, then it’s doubly easy to mix personal and business transactions. Regardless of if you file quarterly or annually, this can lead to confusion and difficulty in tracing back expenses.
Putting off bookkeeping tasks or struggling with organization can contribute to neglecting expense separation. This can lead to a buildup of mixed expenses and make it even harder to sort them out later.
Finally, some entrepreneurs, especially those starting out, might lack the financial knowledge or awareness of tax regulations related to expense categorization and deductions. This can lead to unintentional mixing of personal and professional expenses due to misunderstanding of what’s deductible.
This is what can also lead many small business owners to make errors in filing their taxes. Because entrepreneurs are responsible for making regular estimated tax payments to the IRS based on their projected income, miscalculating these payments or failing to make them can lead to penalties and interest charges. Understanding estimated tax requirements and staying on top of them is essential.
Understanding your Tax Obligations
Overall, understanding your fiscal responsibilities, keeping organized records, and seeking professional guidance when needed can help you navigate the world of taxes and income reporting.
Remember, tax laws are complex and can vary depending on your specific business location and structure. Always consult with a qualified accountant or tax advisor for personalized guidance and to ensure you’re compliant with all regulations.