How to Separate Business and Personal Taxes - Your Guide to Organizing Your Business

7

Min Read

Tom Smery

As a business owner, learning how to separate business and personal taxes is very important. Getting lost in your tax deductions is highly plausible when you can't differentiate between purchases, which is why you may want to separate personal and business expenses.

But can you do that - and if you can, what are the best ways to do so? Is it necessary for you to do that? Continue reading our article and find out how to handle your personal and business finances.

Note: A really effective way to separate your personal and business finances is with a business bank account like Bonsai Cash. Our business account has no hidden fees, no minimums and has an 'envelope' feature that allows you to instantly create sub-accounts. Our account is easy to set up. See for yourself and open an account today.

Differences Between Personal and Business Taxes

As a person, you owe taxes for any income that you may make. That being said, if you are the owner of other business structures, your business will also have to pay taxes. How you pay those personal and business taxes will depend on what kind of structure you have.

For the most part, owners of pass-through entities (i.e., sole proprietorships, partnerships, or some LLCs) will file their personal taxes together with their business taxes.

However, corporations or LLCs that choose to be taxed as a corporation can keep their business finances separate in the eyes of the IRS, enjoying limited liability.

Personal taxes and business taxes have different deadlines, making it easier for you to keep track of your expenses. Moreover, if you are the owner of a corporation paying business taxes, you may be able to write off more taxes than you would as a pass-through entity.

That being said, depending on how you want your small business to be taxed, you also need to pay different taxes. For example, if you file your business revenue through your personal taxes, as pass-through entities, then you need to pay personal income tax and property tax.

However, if your small business is taxed as a corporation, then you have to pay income tax, and self-employment tax. This is usually the case for S-corporations, C-corporations, and LLCs.

Why Should I Separate My Business and Personal Expenses?

If you co-mingle your personal assets with your business assets, you risk going through a variety of legal issues, along with tax complications.

For example, if someone files a lawsuit against you, then your personal assets (i.e., your car and your home) could be at risk. This is the main problem that sole proprietors go through, as there isn't always a clear line between the two.

Plus, if you don't use a separate business account, all the business transactions will be mixed with your personal transactions. It may be difficult to keep track of what payment was business-related and what payment wasn't.

Many business owners go through audits with the IRS every year, simply because they accidentally mistook several personal expenses for business expenses. On the opposite end, many people saw more losses in their tax returns, because they mistook a business expense for a personal expense.

To prevent these kinds of situations, most legal services recommend that you keep two separate accounts, even if you are a sole proprietor. This way, you can efficiently record your transactions, so that you do not lose time over filing taxes.

Connecting tax software to a second account can also keep track of the nature of the expenses. Bonsai Tax has various accounting and tax features that can help you go through tax season with more ease. In fact, our expense tracker saves freelancers an average of $5,600 every year.

Can I File My Business and Personal Taxes Separately?

You may file your business taxes separately, as long as you own the appropriate business structure for it. The IRS has different requirements, depending on what kind of small business owner you are.

Sole Proprietorship

As a sole proprietor, you are the single owner of your business. All your business income and losses will be reported on your personal tax return, which is filed using Schedule C, Form 1040. Since they go on your personal taxes, you cannot file them as business taxes separately.

Partnership

Partnerships are like sole proprietorships, but instead of being owned by one person, they are owned by two people. All of the partners will report their business losses and profits separately on their personal income tax returns. Since the business itself does not actually pay taxes, you cannot file them separately from your own tax return.

Corporation

C-corporation or S-corporation owners can file their personal and business taxes separately, as the IRS sees corporations as separate entities from the owner. As a result, business expenses are reported separately using Form 1120.

LLC (Limited Liability Company)

The laws of LLCs are different in every state, but for the most part, they are subjected to pass-through taxation. This means that all business gains and losses will pass through the personal tax return of the members.

That being said, if the LLC has multiple members, it may also choose to be taxed as a corporation. This way, it can keep its personal taxes separate from its business ones, using Form 1120.

How to Separate Your Personal and Business Expenses

Separating your personal and business expenses for tax purposes is fairly easy to do if you follow the right steps. Here is what you'll have to do.

Register the Business

In order to treat your business as a separate entity, you will have to register it. In this situation, you may want to choose between the LLC or corporation business structure.

By going for a sole proprietorship, your taxes will go through your personal income tax return, so there will be no viable way to separate everything.

Get an EIN

After choosing between business structures, you will need an Employer Identification Number (EIN). This is like a social security number but aimed at businesses. It will allow you to run tax-related businesses and separate your assets, along with opening separate accounts. You'll need an EIN when you open a business bank account (although you cannot open a bank account with just an EIN).

Open a Business Bank Account

A good way to separate your business income from your personal income is to open a business bank account. Many banking options such as Bonsai Cash allow you to open a bank account with just your EIN and some other standard paperwork. The app also allows you to separate your personal and business finances within the business bank account.

As every business expense will appear separately from the personal type, it will be much easier for you to handle when you are calculating business taxes.

While you are at it, you might want to consider opening a business savings account as well. The interest you earn in your savings account is taxed for your business - but since your business also earns its own interest, the payments are balanced.

Obtain a Business Credit Card

Aside from the account, you may also want to get a separate credit card for business. This way, you will be able to maintain clear records and not mix them up with your personal credit card.

Depending on the credit card that you get, you should also be able to obtain business loans using that credit card. This can help you grow your business. Business credit can also help improve your reputation, allowing you to get loans from multiple banks in the event that you ever need them.

Integrate Some Accounting Software

Once you obtain separate accounts for your business structure, you may want to integrate some accounting software as well. This way, you will be able to classify your business expenses separately, giving you a better idea of your profits and your due payments. Bonsai has a feature called Bonsai Accounting, for instance, which can help you in this process.

Final Thoughts

Separating your business taxes from your personal taxes is likely the first thing that you should do when you start out as the owner of a business. Indeed, some business structures may not allow you to open a business account without an EIN, but there are still banks around that can help you organize your finances.

By separating your business and personal finances, you make sure that you do not accidentally try to claim taxes that should not be claimed. It also ensures you don't accidentally omit taxes that you could have claimed. By staying organized, you'll be able to get the most out of your business.

Tom Smery
Tom Smery is a certified CPA for over a decade. In his free time, he writes articles to pass on his expert knowledge on taxes and accounting. Thomas has a wide range of deep knowledge on 1099 taxes, and finance topics. You can find him fishing when he is not preparing taxes for his clients or writing about accounting.

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