The Tax Trap: Mixing Business and Personal Money
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| Photo by Andrea Piacquadio |
What happens when you mix personal and business funds?
It's one of the biggest mistakes that any business can make to mix personal and business funds. Your business books will be in a mess beyond your imagination.
This is very common, regardless of the type of the business, industry, or how long the business has been operating. When you do this as a business owner, it becomes almost impossible for an accountant to determine the difference between business and personal expenses.
It will take longer and cost you more to fix the mess in your books. This is one of the biggest headaches for bookkeepers and accountants and they will charge you more for the additional time and effort required.
Mixing personal and business money also makes it extremely difficult to actually see a true picture of how the business is doing financially.
What is the difference between business and personal expenses?
Business expenses could be salaries and wages; office equipment like computers and printers or manufacturing equipment like machinery; stationery and printing like cartridges, paper, pens and the rental of equipment. It's the money you spend on the business.
Personal expenses are when the owner uses the money for personal needs. For example a business makes R2 million for the year but the owner uses R1.75 million to buy groceries and clothes, go on trips and for entertainment. Nothing was bought for the business; it was all spend on stuff for family and friends.
This is the part many business owners don't understand. They use the business income to finance personal luxuries rather than reinvesting in the business. If you withdraw more from the company than you spend on business expenses, you may owe more in taxes.
Some South African business owners mistakenly think they can claim tax deductions when they've bought their monthly groceries and pay school fees with money from the business. SARS does not take kindly to this. To claim any tax deduction there must be proof that you've spent the money on and in the business.
How do you separate business and personal expenses?
Have two separate bank accounts, one for business and one for personal needs.
Pay yourself a salary, which is much easier said than done. But the sooner you start doing this, the sooner there will be order in your books. This will simplify your books, increase your expenses which in turn will lead to less profit and less taxes. Remember, you pay taxes on your company's profits; the bigger the profits, the higher the taxes. And the smaller the profits, the less are the taxes.
The relief that comes with knowing that you've already paid tax on the money you're using, is priceless.
If it's too difficult or too early for you to take a salary, then take drawings out of the company. Instead of swiping the business card for personal expenses, pay the cash amount into your personal account. This will immediately clean up your business account, reducing clutter and the number of transactions to review. Instead of a bunch of unrecorded card transactions, you'll now have a single, clear cash withdrawal.
There is no rule about how much you can take. Only you can decide if you want to take an amount weekly, monthly, or as money comes in. But whatever you decide, take out the amount and put it into your personal bank account.
The key is to separate your funds the moment you start running a business. Don't wait until the business start making money. Habits take time to form; the sooner you start, the sooner you'll get used to it.
Can I use a business account for personal expenses?
Yes, you can. We are human and we do from time to time use the business account for personal expenses. But you have to be very cautious when you do it, and only use it when it is absolutely necessary. The first priority should always be to only use the business account when you want to buy something for the business.
Even if you're paying yourself a salary, you'll still occasionally use the business income for personal expenses. Again, instead of swiping the business card, take the cash out of the business account and put it into your personal account.
We all know when you run a business, it takes immense discipline to keep your fingers out of the cookie jar. Discipline and control, that most of us lack when the business starts booming, and that's what we need the most to build a profitable business.
Do I have to separate my funds when I have an extra income or a side hustle?
Yes, you do. Even if you're earning a salary and have a side hustle, you must still separate your funds in two different bank accounts. The same applies as to a business owner who has a registered business: open a second bank account the moment you decide to start a side hustle.
To you it might just be a side hustle, but the banks and SARS (South African Revenue Service) treat it as a business, The expectation is that you'll have a bookkeeping system that will record the transactions in your business.
It's a good idea to split your money if you are in any of these groups:
If you don't have a registered business and are self-employed.
If you are employed and have a regular extra income or a side hustle, separate from your salary
If you're running a business and don't yet make enough money to pay yourself a salary
If you're running a business and you are paying yourself a salary.
Doing this takes practice and more practice, planning and discipline. It doesn't happen automatically but it is definitely worth it. The biggest rewards are your well-organised company books, a streamlined tax filing process, and, most importantly, the peace of mind knowing that your tax affairs are a breeze, not a headache.
If you're not separating your business and personal expenses, you're giving more money to the taxman on a silver platter with golden handles.
Keeping your invoices, recording all the transactions, and getting a bookkeeper or an accountant are crucial for your business. In business and taxes, it all comes down to what documents you can produce to support your numbers. It's not about how much money you're making but all about how you spend it.
If you're facing similar challenges in managing your finances, I'd be happy to assist you. As an accountant, I can provide tailored solutions to your specific needs. Please feel free to contact me for a consultation at profitsandbooks@gmail.com or +2764 049 03038
Disclaimer
The information provided in this blog post is for informational and educational purposes only. It is not intended
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