Business vs Personal Expenses
As you operate your business, you will incur costs. Retailers need to buy products. Most businesses need computing technology. You may purchase services, such as internet hosting for your web site. Your business might require professional services, such as lawyers and accountants from time to time, or at tax time. You may travel for business and take a holiday while you are there. You might wish to take your significant other on that holiday. Should your business pay when mixing business and personal expenses?
Employee personal benefits
Businesses providing private benefits to owners, who are employees, are providing compensation or remuneration. In the United States, unless specifically excluded, non cash benefits provided to employees or even contractors are captured by fringe benefit laws. These laws are wide ranging. Examples include limits on car parking value provided and moving allowances. Anything in excess of these is taxable income of the employee. In Australia, the Fringe Benefits Tax applies which may require a tax to be paid by your organization on many benefits provided.
Dealing with fringe benefits is complex. You may choose to avoid the compliance issues with it by choosing not to provide any non-exempt benefits to staff. If you are mixing business and personal expenses and are paid staff, there might be a world of pain for you.
If you work in your business as an owner, but are not an employee or a contractor, fringe benefit tax provisions might not apply. You need to be careful making this presumption. If you based in the United States, the IRS considers people who are company officers doing non trivial work as employees.
Most tax authorities do not permit private expenses to be deducted. If you are mixing business and personal expenses, then you will need to apportion between the deductible business expense and the non-deductible private expense. This apportioning process takes time and is complex. You should question whether you want to take time doing this. It may be better spending that time working on your business. Alternatively you may be paying an accountant a lot of money to sort it out. It is simpler to keep private stuff out of your business. It might also be much cheaper for your business in not paying lots of professional fees than simply paying yourself a higher rate of pay with some extra tax.
If fringe benefit taxes apply, then generally the costs are deductible to the business. On the flip side, either your business has to pay the fringe benefits tax, or you as an employee will pay tax.
Lets say your business is not incorporated. Lets then presume that you are the sole owner. This situation is where it can seem convenient for you to be mixing business and personal expenses. Even though you have the freedom to do this, the complexity described above might make you change your mind.
If you still wish to proceed with mixing business and personal expenses, then in order to try to avoid denied tax deductions and large accountant fees, clearly identify what is private. In accounting speak, expenses are normally debited to expense accounts. Don’t debit private expenses to your expense accounts. Instead, you can debit them to an owner’s drawing account. Think of owner’s drawings is like a loan from the business. As a sole-trader, it is not a real loan as you can’t legally loan money to yourself. It might be helpful to think of it this way, however (on an informal basis).
If you are in business with other people and you are not incorporated, you will generally be a partnership.This applies even if you don’t have a written agreement. Your partners may take some offense if you have the business pay for your private expenses. Alternatively, they might do the same thing! If everyone does it, that might seem ok. It might be very difficult at tax time, however.
Partnerships use owner’s drawing accounts for the private expenses for each partner. Your accountant will want to record these expenses this way. If you mix private expenses into business expense accounts, then it will get very messy. It will then be hard to work out what is deductible. Working out how business profits are being distributed to each of the partners will also be more difficult.
Many tax authorities treat private expenses in companies either as a loan or a dividend. Dividends are generally subject to tax. You may be able to classify the benefit as a return of capital, however there are strict rules that apply to doing this than treating it as a dividend.
If you treat the benefit as a shareholder loan, you then need to investigate loan terms. Tax authorities may enforce rules regarding the terms and conditions of the loan and the interest rate that applies to the loan. The loan may be deemed a dividend where the terms or rate of the loan are not commercial, or in some cases do not meet statutory requirements. In Australia, the consequences of this (Div 7A) treatment really need to be avoided.
Small business owners can easily end up mixing business and personal expenses. What is easy to do now will not be so easy later. You may experience disallowed deductions, greater administration costs and being distracted from your business. Think carefully before having any private expenses in your business. If you do it anyway, make private expenses clear so they can be recorded in owner’s drawing accounts. If you are using a company structure, you will need to ensure what will effectively be loans don’t end up being treated as dividends by tax authorities.