“Aw, dang, which card do I use again?”
“So which account should I use to pay for this?”
“Do I really have to keep all my receipts?”
If you’ve ever asked yourself these questions, now is the perfect time to put together a system for keeping your business and personal expenses separate.
Whether you’re a sole proprietor, partnership, or have a corporation or LLC, running a small business means you’re bound to run into the trouble of keeping your business and personal expenses separate. You accidentally swipe a business expense on your personal card, or forget to ask for a receipt, and it feels like you just made a huge mistake.
It happens even to the best of us.
Part of this comes from the fact that when you start working for yourself, many lines get blurred, from things like work hours vs. personal hours, home office vs. home, and traveling for work vs. vacation time.
As freelancers and entrepreneurs who are mostly bootstrapping our way through, especially in the first few years, here are some systems you can put in place so you’re as clear as possible on when you’re spending for your business or spending for yourself, as well as what to do if you slip up.
Have a separate account for your business expenses
I’m sure this is the first piece of advice someone gives you when you tell them you’re becoming a freelancer (besides save all your receipts, but that’s a whole other can of worms, see below!). It’s the first piece of advice I give my freelance clients.
So why did it take me 4 months into my business to actually do it?
There’s a lot of things I know I rationalized about waiting to separate my accounts early on. I didn’t think I was making enough money, I didn’t have a business entity set up, I have very few expenses or transactions.
And then suddenly, that wasn’t true anymore and I was scrambling to separate the two, both in my head and on paper.
What do I wish I did? Whether Brunch & Budget stayed a side hustle or not, as soon as I started making money from it, I should have opened a separate checking account.
Here’s the big secret though – a separate account doesn’t mean it has to be a business account! If you feel like you’re far from creating a business entity or even trying to register a tax ID number with the IRS, simply open another personal checking account with a separate debit card.
Until you’re a partnership LLC, s-corp, or c-corp, separating the business expenses from personal expenses will give you a hard line in the sand when you go to your accountant come tax time, or, (I’m afraid to even say it out loud), in case you happen to get audited.
You can show your accountant (or an auditor, gulp) very clear records for what you are deducting each year because it will all be coming in and going out of one account.
When you open a separate bank account, make it a practice to spend all business expenses out of that account and deposit all business income into that account, even if you plan to take out the money immediately to do things like pay rent. Have it all flow through the “business” bank account first.
What happens if you, gasp! accidentally charge a personal expense to your business account, or vice versa?
Have a separate savings account for taxes you will owe
Make it a mandatory rule for yourself to set aside 30% of every dollar you make, before deductions. Back when you were a W2 employee, you never saw this money, so it’s definitely going to be a little strange to see thousands of dollars just sitting in a savings account.
But setting up a tax savings account will keep you out of all kinds of trouble and save a lot of heartache come tax time.
Here’s why I recommend putting away 30% of every dollar before factoring in deductions:
- You will be paying self employment tax as a freelancer. This means you cover 100% of your medicare and social security contributions. Back in W2 land, your employer was pay for half of this. This percentage factors in any state and local taxes you may owe too. In NYC, for example, we pay state tax and local city tax, which can mean a pretty hefty tax bill in April.
- You might end up giving yourself a refund! That annual refund you counted on from the IRS was really just you overpaying what you owed in taxes. You may thought of the refund as a forced savings. Now that you’re in control of what you pay and how much you pay, you’ll be able to hold on to the money all year round and might have a nice chunk left over once you’ve filed your taxes.
Whether you get paid in big chunks or small increments, you will need to put aside this money because you will owe it to the IRS. There is no best way to do this, just the best way that works for your business.
For instance, I have some clients who do big projects and get paid in chunks. They take 30% off the top of each payment and put it into savings.
I have other clients who get paid throughout the week (sometimes even daily!) and they add up what they’ve earned and transfer 30% of their income on a weekly basis.
It’s really up to you how often you set aside money for taxes. Just think about how often you get paid and how often you’d need to do it so you remember to do it!
Track and categorize your business expenses through an online budgeting tool like Mint.com
Now that you have your separate account for business expenses and you’re putting away money for taxes, we can do some really fun stuff (right? fun!).
It will probably be a few years before you get to the point where you will need a bookkeeper, but that doesn’t mean you can use some free personal budgeting tools to track what’s going in and what’s coming out of your business.
First, why go through all the trouble anyway?
Often, we just look at the bank account balances to see if there’s money in there or not as a way to gauge if our business is doing okay.
By tracking how much you’re taking in vs. how much is coming out, you’ll be able to tell at a glance not only if your business is doing okay, but whether or not it’s growing.
If you’re in the early stages or don’t have many business transactions, you can create an account on Mint.com (separate from your personal Mint account if you happen to already use it) and only link your business account.
Once you link your business account, all your transactions will pull through Mint. From here, take the time to categorize what’s coming through now, setting rules, and creating custom categories.
You should be able to pull through at least 3 months’ worth of data. Take some time to play around with the Trends tab once you’ve categorized everything and see if you can get a 3 month report of your income and expenses.
If you keep up with this every month, you’ll have a pulse on whether or not your business is growing and be able to make educated decisions on taking whether to take on new clients, hire people, cut expenses, or add or retire streams of income.
BONUS: If you create a separate category for personal expenses for all those times you accidentally slip, you can tag those in Mint and know to keep them out of your deductions come tax time.
EVEN MORE BONUS: You can export all your data to excel and just send the file to your accountant when it’s time to file!
Choose a system to keep proof of every dollar you deduct (yes, this means receipts)
Ah yes, the other piece of advice you probably got when you decided to go freelance was probably, “Hey, make sure to keep all your receipts!”
Then you forget to keep the receipt when you take a out colleague to pick their brain on their business model.
And you lose the receipt for the supplies you just bought for your home office.
And what do you do about that piece of equipment you bought off Craigslist and paid all cash for?
WAY easier said than done, right?
Here’s the deal with receipts. You need to keep receipts because, if you are audited by the IRS, you will need to prove every dollar you deduct from your income was in fact for business expenses and receipts are the easiest way to do it.
You can prove what you write off in other ways. For instance, you may be able to prove your lunch meeting with a colleague was a business expense by marking the date in the calendar and including what you discussed in the calendar description.
You can save the Craigslist ad of the equipment you purchased and file that away, or ask the seller for a handwritten receipt.
You can also choose to err on the side of caution and not write off the purchases where you don’t have proof.
Now, how to keep track of all of this?
If you are tracking your business expenses (nudge nudge above), then you don’t even need to keep your receipts organized to be able to file your tax returns. This means you can literally throw all your receipts in a shoebox at the end of every day, week, or month.
For those of us who are trying to go paperless ::raises hand:: you can use an app like Expensify to take pictures of receipts and toss them as soon as you have an electronic record.
Luckily, you don’t need to keep all your receipts forever. The IRS will only look back as far as three years if they do decide to audit you, so keep your receipts separated by year so you know what you can toss each year.
Remember that it’s not going to be perfect and it’s not the end of the world.
No system will be 100% airtight. When it comes to managing the financial side of your business, there are so many gray areas and it’s easy to slip, even when you have a well oiled machine in place.
The most important step to take is to set up a system that will give you peace of mind most of the time. This way, if something does come up that’s completely out of left field, you’ll have some context for how to deal with it instead of just adding it to the headache pile.
The best part? With a system in place to handle your business finances, you can focus on what really matters to you – running your business and spending more time on the things you really value.