The following is a guest post by Tim Chen of NerdWallet.com.
Keeping business and personal finances separate may be the best advice for small business owners. In fact, many businesses are legally obligated to separate their business and personal accounts, but some small business owners find themselves in situations in which they are tempted to blur the line, especially if their businesses are organized as sole proprietorships .
I had no idea what I was doing my first year,” says sole proprietor Liza Murray, owner of a Web design firm in Sonoma County, California. I just put everything on my credit cards. I guess that means my personal credit was my business credit back then. But the next year I set up separate business accounts, including a credit line. Since then, I’ve been strict about the separation and I haven’t run into any problems.”
Make sure you know the difference
Not all business owners are quite so quick to change, however. Freelance copyeditor Roy Phillips credit is entirely personal. “As a sole proprietor, I’m not required to keep separate accounts, so I just never bothered,” Roy admits. “My situation is really simple. I have very few business expenses, so credit isn’t an issue.”
But Roy does rely on his credit cards to cover day-to-day living expenses during cash flow crunches. “I’m not sure how the IRS views that, but I don’t report any credit card interest as a business expense.”
After two recent slow quarters, Roy’s cash reserves were gone. His solution? “I took out a zero-percent credit card through Citibank that I don’t have to pay back for almost two years. I borrowed the maximum, $6,500, and that’s what I’m living on until work picks up.” That’s the most Roy has ever borrowed. “As a rule,” he adds, “I don’t carry debt unless I absolutely have to.”
In Roy’s case, substantially all of his credit needs are personal rather than business-related, so it’s good that he doesn’t mix his credit cards up in his taxes. The IRS would have something to say about his chosen deductions if he did, since the tax code clearly states that interest on personal loans cannot be deducted.
It’s not personal, it’s just business
Carson Ewing owns a high-end dress shop on Manhattan’s Upper West Side. Carson, too, is a sole proprietor, but unlike Roy, he generally separates his business accounts from his personal ones.
I’m meticulous about the accounting part. That being said, there are times when I’ve given myself a ‘small business loan’ by charging something on my card.” Carson is obligated to pay his vendors upon delivery of merchandise, but he doesn’t have much control over when those deliveries occur. “We write the [fashion] lines twice a year at trade shows, and sometimes it’s six months before we actually get the stuff. If we get several major deliveries in a single month, we’re going to be in the red that month. For example, I have a Wells Fargo business line of credit with a limit of $40,000 that’s maxed out at the moment because of the holiday inventory I’ve paid for. But I intend to pay that back by the end of the year. In the mean time, I’m using a few other low-interest credit cards to meet expenses.”
Carson offers this advice to other business owners: “Play by the rules. You don’t want trouble with the IRS. Talk to a tax accountant or attorney, and make sure you’re doing the right thing.”
As a small business owner, especially someone who’s going it alone, you have enough problems. The last thing you need is the IRS banging on your door, so be careful when it comes to your personal and your business credit.
Tim Chen is founder and CEO of NerdWallet.com, a website that helps consumers to compare small business credit cards. Tim also educates consumers about credit cards and debt management at the Forbes Moneybuilder Blog, the Huffington Post, and the Christian Science Monitor.
[Kevin] So, reader, do you also tend to let your personal and business accounts overlap? I find this post very interesting and relevant, especially as a fellow blogger.
In doing supplier audits, I’ve generally found that the more successful small businesses are the ones with solid cash flow and little or no debt. A business (un)plan that relies on credit cards for daily operations is not sustainable.
Comingling person and business funds is a very bad idea and can lead to numerous problems with the IRS.
I am a sole trader in UK standards and have never split my accounts although I have been having palpitations at how messy my accounts are and feel I need to find an accountant who will deal with me online and help me keep things in order so I can start getting this all done correctly and in the right manor.
Thanks for the post getting me thinking about it again!!!!
It is really important to separate the business accounts from personal accounts in order to really organize the expenses. This is also very helpful come tax time. In some cases, it may be harmful for small business owners when they get audited by the IRS.
It’s very important for people to understand, that a majority of people who are looking to start a new business or home business haven’t done so before. There is a lot of uncertainty, especially when they are used to receiving a regular income which is usually non existant when starting up your own business. It always seems that you are throwing money into somthing, when deep down you really dont know if it will be a success. Researching your new business area, and taking everything one step at a time is the place to start. Start small and build your business slowly, giving you time to iron out the kinks.