When assessing your filing obligations as a taxpayer, it is crucial to determine whether your activity falls under the category of a business or a hobby. This comprehensive guide will help you determine if your activity qualifies as a business and what your requirements are based on the type of corporate entity you have. We'll also let you know how Accracy can assist you in managing your blended personal and business accounts. Stay informed and ensure compliance with our expert guidance.
Is It Just a Hobby or a Serious Business? Assessing Your Activity for Tax Qualification
In general, taxpayers are allowed to deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is one that is common and accepted in your trade or business, while a necessary expense is appropriate for the business. An activity qualifies as a business if it is carried out with the reasonable expectation of earning a profit.
The IRS presumes an activity is carried out for profit if it generates a revenue for at least three of the last five tax years. However, the determination depends on the facts and circumstances of each case.
To assess whether your activity qualifies as a business, consider the following factors:
Profit Intention: Your time and effort invested in the activity should indicate an intention to make a profit. A genuine profit motive is a key indicator of a business.
Dependency: If you rely on income from the activity to cover your living expenses or financial obligations, it is more likely to be considered a business.
Losses: Evaluate whether losses are beyond your control or a result of the start-up phase. Demonstrating changes to improve profitability showcases a business-like approach.
Knowledge and Expertise: Possessing or having access to the necessary knowledge and expertise to run the activity successfully suggests a business endeavor.
Past Profits: If you have previously made profits in similar activities, it supports the case that your current activity is a business.
Profitability: While occasional losses are acceptable, the activity should generally make a profit in some years, or you should have a reasonable expectation of future profit.
As your hobby transitions into a full-fledged business venture, the structure of your business will dictate how you handle personal and business finances. Whatever path you take, Accracy has made it easy to connect your personal bank accounts and credit cards used for business transactions. The information flows into Accracy securely and in real time when you connect your eligible accounts, allowing us to handle recording transactions. We'll add the data to correct ledgers and with just a few clicks from you, we'll ensure your books are in order. And better yet, you'll gain a more complete picture of your business faster, with relevant transactions from all accounts automatically flowing into Accracy.
In the world of sole proprietorships, where there's no legal distinction between the owner and the business, there is no legal requirement to maintain separate accounts, but it's still wise to keep personal and business transactions separate. Establishing a dedicated business bank account allows you to track income and expenses distinctly, making it easier to see what money is coming into your business and what's going out. Remember to maintain separate records for business and personal transactions, invoices, and receipts.
For partnerships, it's important to have a clear separation between personal and business finances. Create a separate business bank account to handle all partnership transactions. To ensure smooth operations, partners should define their roles, responsibilities, and capital contributions in a written partnership agreement. Additionally, each partner should maintain separate records for personal and partnership transactions.
Limited Liability Company (LLC):
LLCs benefit from having a dedicated business bank account to manage income and expenses. LLCs are separate legal entities that offer liability protection to you as an individual. So if your business ever runs into challenges, your personal assets are protected. In order to keep enjoying the benefits of liability protection, it is important to separate your business and personal finances. Not doing so can make your personal finances vulnerable.
Corporation (C-Corporation or S-Corporation):
When it comes to corporations, maintaining a clear distinction between personal and corporate finances is essential. Opening a corporate bank account and conducting all business transactions through that account ensures separation. Keep detailed financial records, including income, expenses, and shareholder equity, specific to the corporation. Adhering to corporate formalities, such as holding regular board meetings and documenting corporate resolutions, adds an extra layer of compliance. Similar to LLCs, corporations are separate legal entities that offer liability protection. So if your business ever runs into challenges, your personal assets are protected. In order to keep enjoying the benefits of liability protection, it is important to separate your business and personal finances. Not doing so can make your personal finances vulnerable
The Small Business Administration (SBA) provides a wealth of resources and information tailored to assist small businesses. By accessing their website, entrepreneurs can access valuable guidance covering diverse aspects of business operations, including financial management. Take advantage of the website's search function to find relevant articles or guides pertaining to your specific entity type.
How Accracy Can Help
At Accracy, we understand the complexities of starting and running a business and that blending personal and business finances is sometimes inevitable even if it's not in line with your business structure. Our seamless solution caters to your unique needs, providing the tools to still maintain proper and compliant books. Whether you operate as a sole proprietorship, partnership, LLC, or corporation, Accracy has you covered.
If you're a new business owner who's ready to open a business bank account, here are some things to consider:
Research Business Banking Options
When it comes to business banking, your options generally fall into two categories: traditional banking and digital banking (also known as neo-banking).
What are the differences between the two? Most notably, digital banking platforms operate wholly online, whereas traditional banks have physical branch locations where customer service is provided—think big banks like Wells Fargo and smaller, neighborhood credit unions.
A lot of first-time small business owners simply open a business account with the same institution where they have a personal account, and this is usually a traditional bank. This can be expensive because traditional banking usually comes with account fees.
When you're deciding between traditional and digital banks, consider:
Gather Necessary Information and Documentation
Opening a new bank account for your business does require you to provide some personal and business details. You may not need all of the following, but here's what we recommend you have ready:
Personal:
Business:
Additionally, depending on your business entity, you may be asked to provide the following:
Choose the Right Account Types and Structure
Make sure the bank you choose can support the way you want to collect and organize your money. If you need multiple checking accounts to compartmentalize income and expenses (like the Profit First method) then make sure your bank lets you create more than one checking account. Additionally, if you do want to open a business savings account, then make sure your bank offers business savings accounts and an interest rate that will be meaningful to you. You should also look out for minimum balances and opening deposit requirements specific to savings accounts.
Update Your Financial Processes
Once you have your new business bank account, you'll want to make it the center of your financial operations.
We recommend that you start by moving your operating capital out of your personal account and into your new business account.
Incoming payments
Next, make sure all incoming payments are redirected to your new account. If you collect money through payment processing tools—like Stripe or Shopify—then you'll need to make sure your new bank account is set up as the deposit account for each tool. You'll need to keep your new account and routing number handy to make these updates in each tool.
If you collect payments from customers—like ACH transfers, wires or checks—then the businesses or individuals that pay you will need to update the banking details they have on file. Send them your new account and routing number by email and make sure they've made updates on their end before they send your next payment.
Outgoing payments
You'll want to make sure all outgoing payments are coming out of your new business account and not your personal bank account.
A good place to start by updating all card transactions—like monthly software subscriptions. Make sure each vendor is updated with your new business card details. You can create a checklist of the vendors that you need to update by looking at your monthly bank statements and picking out the business transactions that need to be moved over to your new account.
If you have any other types of withdrawals—like pre-authorized ACH transfers—we recommend moving those to your new account once all of your card transactions are moved over.
Maintain Accurate Financial Records
Once your new bank account is up and running, you'll need to implement processes for keeping accurate financial records of business transactions—including income, expenses, receipts and invoices.
If your records are organized, you'll save yourself a lot of time (and peace of mind) when it comes to bookkeeping, tax preparation, and financial analysis.
For accurate recordkeeping, you'll want to connect your banking platform with your accounting software from day one. This will speed up bookkeeping and reconciliations for your accountant or bookkeeper, and help ensure that your books are clean.
Look for a banking platform that offers role-based access so you can safely and securely give your financial advisor access to banking. This will ensure that your financial advisor, or internal finance team, can make payments, forecast expenses, and prepare for tax season with ease.
Ready to choose the right business bank for your business?
Accracy recommends Relay as a no-fee, online business banking option. Relay is banking truly built for small businesses. Relay helps entrepreneurs get crystal clear on their cash flow. They know that money is your means to make it, and it's why they offer:
Create a Relay account for free. Relay is offering Accracy customers a $50 sign-on bonus. All you have to do is create a Relay account and deposit at least $1 USD into your account.
Relay is a financial technology company, not an FDIC-insured bank. Banking services and FDIC insurance provided through Evolve Bank & Trust and Thread Bank; Members FDIC. The Relay Visa® Debit Card is issued by Thread Bank pursuant to a license from Visa U.S.A. Inc. and may be used everywhere Visa® debit cards are accepted.
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