The Difference between Personal Expenses and Business Expenses
A Tax Guide for S Corporations

Separating personal spending from your S‑Corp’s deductible expenses is legally required for accurate tax reporting and to avoid reclassifications, payroll tax exposure, and penalties. A corporation may deduct only ordinary and necessary expenses paid or incurred in carrying on its trade or business, and owners must substantiate those expenses with records that meet IRS standards.

Below is a practical, legally grounded framework with citations and public links.

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1) Anchor your policy in the law: ordinary and necessary, and fully substantiated

  • Deductibility requires that an expense be ordinary and necessary in carrying on a trade or business (section 162). For categories Congress scrutinizes (travel, gifts, meals, listed property), special substantiation rules apply; if you don’t meet them, no deduction is allowed—even if the expense is business‑motivated. See IRC § 274 IRC § 274 and substantiation rules in Treas. Reg. § 1.274 Treas. Reg. § 1.274‑5A (amount, time/place/date, business purpose, business relationship; receipts required for lodging and for items ≥ $25 unless an exception applies).

  • Business meals are deductible only if not lavish or extravagant and the taxpayer/employer (or an employee) is present; section 274 also imposes exceptions and limits. See Publication 463 (Travel, Gift, and Car Expenses).

Practical steps:

  • Adopt a written expense policy mirroring section 274 elements (amount, date, place, business purpose, business relationship).

  • Require receipts and contemporaneous notes for travel, meals, gifts, and vehicle use; digital tools are fine, but preserve source data.

  • Train staff that deduction disallowance applies if substantiation fails—regardless of business intent.

2) Use an accountable plan for owner/employee reimbursements

An accountable plan prevents reimbursements from becoming taxable wages and enforces substantiation and timely return of excess advances.

Practical steps:

  • Adopt a written accountable plan requiring preapproval for advances, timely expense reports, and return of excess funds (e.g., 30/60/120 days).

  • Pay reimbursements through payroll only if accountable‑plan standards are not met (so amounts are properly taxed).

  • Tie policy to section 274 recordkeeping (Treas. Reg. § 1.274 Treas. Reg. § 1.274‑5A).

3) Keep corporate banking and cards separate; classify fringe benefits correctly

  • Segregate funds: use only corporate bank accounts and credit cards for corporate expenses; avoid mingling owner personal purchases. If a corporate card is used for personal spending, book it to a shareholder receivable and require prompt repayment (do not run through deductible accounts).

  • Fringe benefits provided to shareholder‑employees are generally taxable unless they meet a specific exclusion (e.g., working condition fringe). Mixed‑use items (e.g., vehicles) require allocation; personal use must be included in wages unless an exception applies. See Treas. Reg. § 1.132 Treas. Reg. § 1.132‑5.

  • Employer‑provided vehicles: Personal use is taxable; business use may be excludable under working condition fringe if section 274 substantiation is met. Valuation/allocation rules are covered in Publication 463 and Treas. Reg. § 1.132‑5.

Practical steps:

  • Require mileage logs and business purpose notes; allocate business vs. personal miles; include personal use value in W‑2 when required.

  • For cell phones, travel, and home office, reimburse under an accountable plan tied to documented business use (no blanket corporate deductions without support).

4) Apply the specific limits Congress imposed (so personal spending doesn’t sneak in)

Practical steps:

  • Pre‑screen expense categories with section 274 in mind (gifts, meals, travel/transportation); codify limits in policy and build your expense system to enforce them (e.g., cap gifts at $25, require meal attendee & business purpose, flag commuting).

5) Recordkeeping that stands up: “adequate records” and audit‑ready files

Practical steps:

  • Use standardized templates capturing date, time, place, amount, business purpose, and business relationship; attach receipts.

  • Require mileage logs for vehicles and agendas for travel showing business activities.

  • Audit records quarterly to confirm section 274 elements are present.

6) Pay owners correctly: compensation vs. distributions vs. loans

Practical steps:

  • Pay owner‑employees W‑2 wages for services; avoid using corporate payment of personal expenses as quasi‑compensation.

  • If the company advances cash for personal needs, document as a shareholder loan with formal terms—or, preferably, avoid such advances.

7) The vehicle trap: treat mixed‑use assets properly

Practical steps:

  • Keep contemporaneous mileage logs; allocate personal vs. business miles; include personal‑use value in wages per valuation rules unless an exception applies.

  • Treat commuting as personal, not business; do not deduct commuting costs.

8) Home office and mixed‑use items: qualify before you deduct

Practical steps:

  • Require an attestation and floor plan showing exclusive use, square footage, and business activities; reimburse proportionate expenses (e.g., utilities) with supporting calculations under your accountable plan.

9) Build compliance into your forms and filings

10) Quick checklist for S‑Corp owners

  • Corporate‑only accounts: Bank/card use limited to business; any personal charge booked to shareholder receivable and repaid.

  • Written policies: Expense policy incorporating section 274; accountable plan with timing & documentation requirements.

  • Substantiation: Receipts + notes for travel, meals, gifts, vehicle use; lodging receipts mandatory; record business purpose/relationship.

  • Gifts/meals/travel: Respect statutory limits ($25 gifts; meal rules; foreign travel allocation); disallow commuting and non‑deductible fringes.

  • Payroll: Pay owner‑officers W‑2 wages; treat nonaccountable reimbursements and personal‑use fringe benefits as wages.

  • Vehicles: Maintain mileage logs; include personal use in wages unless excluded; allocate business use precisely.

  • Home office: Ensure exclusive/regular business‑use tests; reimburse under accountable plan.

Bottom line

A tight accountable plan, rigorous section 274 recordkeeping, and disciplined classification of owner compensation and fringe benefits will keep personal expenses out of your S‑corp’s deductions. Capture business purpose, date/time/place, amount, and business relationship for every expense; enforce statutory caps for gifts and meals; and treat personal consumption (including commuting and vehicle personal use) as taxable wages or shareholder activity.

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