How to Separate Business and Personal Taxes in 6 Steps

It’s not a secret: as an individual or business owner, you owe taxes on the income you make. But before you can start filing your tax return, you need to get your money in order, since as a business owner every transaction you make impacts you come tax time.

Separating your business from your personal finances is the first thing you need to do to properly separate your business and personal taxes.

Here at Relay, we get the challenges business owners face when it comes to money management. It's why we built a business banking and money management platform that helps business owners get visibility into their finances and stay on the money. Getting a dedicated business banking platform is one way to make sure you're not commingling your finances come tax time — but there are a few other things you need to do as well.

In this article, we’ll look at the steps you need to take to separate your business finances from your personal ones, the differences between business and personal taxes, and how to file your business taxes.

How to separate business and personal expenses in 6 steps

To clearly separate your personal and business expenses, you need to start by setting your business up right from day one. It begins with selecting the best business structure for your needs, then registering it. Once you’re officially set up, you can open up a business bank account, get a corporate expense card, and from then on keep your finances organized. Here are the 6 simple steps to success:

1. Decide on a business structure and register it

First, you need to decide on your business structure. Depending on what you choose, you may also need to register it. In the United States, you have a few different structures to choose from, including sole proprietorships, corporations and LLCs. The type of structure you select depends on three key considerations: liability, taxation and record-keeping. Let’s look at each one.

Sole Proprietorship

Making up 73% of all businesses in the US, sole proprietorships are the easiest way to get started and have the lowest set-up costs, as you don't need to formally form one. These are unincorporated businesses that are owned wholly by you, giving you complete managerial control.

The downside of running as a sole proprietor is that you’re personally liable for any financial commitments — including debt or legal issues.

Partnership

A partnership is similar to a sole proprietorship, except there are two or more individuals who agree to share the profit and losses of the business. In this scenario, each business owner must report their earnings on their individual tax returns.

The biggest drawback of a partnership is that all individuals in the partnership are legally and financially responsible for the entirety of the business, so if one person acts recklessly in the business, the other partners may still be held liable for that individual's actions.

Corporations

A corporation is a separate legal entity. The founders or owners of the company are considered to be employees, and it's the corporation — not the individuals — that is held liable for its actions.

The biggest disadvantages of incorporating are the associated costs and the extensive records you’ll be expected to maintain. You also have two types of corporate structure to choose from: a C corporation or an S corporation. C corp owners are taxed separately from the business, while an S corp functions as a pass-through entity. In other words, an S corp can pass income onto its shareholders, meaning the income made by the corporation may be reflected on the individual's tax return.

Incorporation is typically associated with large enterprise companies, but nothing should stop your small, medium-sized, or even solopreneur business from incorporating if it makes strategic sense. 

Tip: looking for help forming your business? Check out our guide on the best incorporation services for US businesses.

LLCs 

Establishing your business as a Limited Liability Company or LLC means you as an individual are a separate entity from your business and you won’t be held financially liable if any claims are brought against the business. Applying for an LLC is straightforward and the cost is minimal (expect a $50 to $800 filing fee depending on your state, plus any legal fees if you choose to hire a professional to file the paperwork). 

2. Apply for an Employer Identification Number (EIN)

An EIN is like a social security number but for businesses. The unique nine-digit number is issued by the IRS to keep track of a business’s tax reporting. They are sometimes also referred to as "federal tax ID numbers." Just like your social security number, an EIN never expires. An EIN is mandatory for most businesses, except if you’re a sole proprietor.

Tip: If you’re a sole proprietor without an EIN, you can use your Social Security number (SSN) for business purposes.

Even if you are a sole proprietor and aren’t required to have an EIN, getting one anyway may still be a good idea. Not only will it allow you to keep your SSN private, it can also be helpful when applying for a business bank account or credit card and filing your taxes.

You can apply for an EIN for free, either online through the IRS website, by mail or fax. If you apply online, you’ll receive your EIN instantly once your electronic application is submitted.

3. Open a business banking account  

Arguably, this is one of the most important steps in keeping your business finances and your personal finances separate, and you should make it a priority. 

A dedicated business bank account lets you manage everything, from paying bills to buying office supplies, in one place. The alternative is your business transactions getting mixed into your personal account, which is not only frustrating down the road, but in some cases can cause liability issues. 

Consider a digital banking platform, like Relay, for low fees, convenient online banking and the ability to create multiple checking accounts (we’re talking up to 20 individual checking accounts!). You can also create dedicated accounts for single-purpose expenses, like one for operations or rent — or accounts for critical needs like payroll.

With a banking platform like Relay, you'll also be able to speed up your bookkeeping process, and your accountant is bound to love you come tax filing time.

4. Get a dedicated card for business expenses

Just like you need to have a separate banking account, you should also have a dedicated corporate card for your business purchases. Using personal credit cards to make business purchases will cause a lot of bookkeeping headaches. So avoid it!

If you use a banking platform like Relay, you can issue multiple physical and virtual cards (as many as 50!) and use them for specific expense categories. For example, rather than just having one card, you can create dedicated cards for:

• Marketing expenses

• Travel expenses

• Specific employees

• and anything else!

Having specific types of transactions all in one place will make record-keeping cleaner and simplify your life come tax time or if you're ever faced with an audit.

5. Track your expenses and keep receipts

Every single purchase you make for your business needs to be recorded. There are great apps out there like QuickBooks Online and Xero (Relay integrates with both of these platforms), designed to help small businesses manage everything from invoices to payroll. 

While you may not have tons of physical receipts hanging around, you still need to keep them and record what you spent. If you ever get audited, you’ll be asked to show documentation. 

6. Educate your team members

Everyone on your team needs to be on the same page, or else you’re likely to find out that your finances aren't as organized as you'd hoped they'd be once tax time rolls around. For example, if a team member decides to use their personal credit card for business expenses, it will create more work for you or your accountant at the end of the year. One way to avoid this is to issue employees with their own cards.

Tip: if you bank with Relay, you can issue dedicated cards to your employees — as many as 50 — and control spending limits!

Differences between business and personal taxes 

It doesn’t matter if you’re working for yourself or someone else, the IRS wants to know how much you made and then taxes you accordingly. When you own a business, your taxes start to get a bit more complicated. 

The type of taxes you owe, the tax rate and when you pay all depend on a variety of factors, including your business entity and what kind of business you run. For example, if you run a coffee shop and own the building, you’ll need to pay property tax. If you have employees you pay wages to, then you’ll need to pay payroll taxes. Knowing exactly what and how you’re spending your money will speed up your filing. 

Despite the extra legwork, the good news is as a small business owner, you are eligible for far more tax write-offs for your business than those available to individuals. These tax deductions include things like vehicle and home office expenses, to everything else you need to run your business.

How to file your business taxes

You’re probably aware your personal income tax return is due on April 15 every year, and filed using the standard tax return form is Form 1040. But when you're also a small business owner, several different tax forms are required to report your business income. The date to file your return may vary, depending on your business structure. 

Regardless, all businesses must report and pay federal tax on any income earned. Partnerships have a slightly different process. They file an annual information return and each partner reports their share of profits or losses on their individual return. 

Tax season can sneak up on the best of us, which is why the IRS offers businesses and individuals the option to request an extension to file their returns. It’s important to note that you still need to pay any owing taxes at the regular deadline. The extension is only for filing.

Income tax forms & filing dates

Here are the tax forms and filing deadlines required for each business structure to report their annual income:

Keep personal and business banking separate with Relay

Separating your business taxes from your personal taxes begins as soon as you open shop. By keeping your business and personal expenses distinct using separate accounts, you'll be able to protect your assets, streamline bookkeeping and have clearer visibility into your finances.

In addition to no-fee business checking accounts, Relay equips business owners with money management features, detailed transaction data, and best-in-class accounting software integrations, so you can keep track of your cash flow to the penny. See for yourself and open an account with Relay today.