Mixing business and personal sounds like fun, but it can be pretty messy. When you’re mixing business and personal expenses, you’re putting yourself at major risk for an IRS audit, which is the opposite of fun. To ensure you don’t end up with a stressful audit, you should know how to define and separate business and personal expenses.
Business expense vs. personal expense
According to Publication 535 from the IRS, a business expense must be “both ordinary and necessary”. An “ordinary” expense is one that is common and accepted in your trade or business. A “necessary” expense is one that is helpful and appropriate for your trade or business.
For example, say you’re self-employed and running a cooking website as a small business. You can write-off the fancy cutlery you bought (if you’re using it for your business). But you couldn’t write-off a new television. You can deduct business expenses even if they are not indispensable to your business.
If you deduct personal expenses as business expenses, the IRS may conduct an audit. They may then ask you to remove the incorrect deductions and pay the balance.
Generally, you cannot deduct personal, living, or family expenses on your tax return. But what if you have an expense that is partly business and partly personal? You can divide the cost in half, and deduct one half as a business expense.
Avoid triggering an IRS audit
When you’re mixing business with personal expenses, your personal expenses can get confused with your business expenses. Sometimes it seems innocent, like extending a business trip for a week to include a vacation. But danger lurks when you are unsure of what you can deduct as a business expense, or you find yourself in a gray area.
In order to be certain you don’t trigger an IRS audit, consider the following:
- Never use your business credit or debit card for personal expenses.
- Keep business and pleasure trips separate. If combined, keep particular days for business and other days for family/friends.
- Don’t be tempted to write-off personal purchases (e.g., games, printer, computers, etc.) as a business expense unless you are using them to make a profit.
Other dangers of mixing business and personal expenses
Deducting business expenses as personal has another big danger: back taxes. If the IRS discovers that you deducted personal expenses as business expenses, they may charge a penalty for claiming false deductions and demand payment of the balance with penalties and interest if the filing deadline has passed. The unpaid balance after removing the false deductions will be treated as back taxes if you do not pay them before the filing deadline.
Instead of sorting out expense receipts later, it is advisable to separate your business and personal expenses for better organization and less stress at the time of tax return preparation.