Business and Personal Finances: You Gotta Keep 'Em Separated

By Christina Saad

If you’re a first-time entrepreneur, you may have used your personal finances to launch your business, without first setting up a separate bank account. While that is a fairly common practice, now that your business is taking off, separating your business and personal finances should be at the top of your to-do list. Although this process may seem daunting at first, it’s necessary for the long-term success of your business. By separating your finances, you’re setting your business up for tax advantages and higher profit margins, whilst reducing the potential risk to your personal assets. In addition, having your customers write checks out to your business, rather than to you, will strengthen your professional image. 

Detaching your business and personal finances is not only incredibly wise from a business strategy standpoint, it’s also critical for legal and tax reasons. If you’ve registered your business as a corporation or Limited Liability Company (LLC), by law you must keep your finances separate from your business’. Furthermore, for sole proprietorships, separating your finances can prevent future issues with the IRS. Separating your finances can also help you in unexpected ways. Just this year, when the federal government passed the CARES Act to provide disaster relief funding for businesses, the businesses that received the first crack at the money were the ones that already had their financial and legal paperwork organized. Not only did those with disentangled finances have the advantage in this regard, they also had the upper hand in situations where lenders would only grant disaster relief funding to those with business bank accounts. If you’re still not convinced, continue reading to learn more about the importance of separating your finances. 

 Your choice of business entity

f you’ve set up your business as a corporation or LLC, your business is considered a separate legal entity and therefore requires a separate bank account and accounting ledger. Forming an LLC or a corporation means your business is regarded as its own legal entity and, as such, you will not be held personally liable for decisions of the corporation. Shareholders, officers, and directors are protected from personal liability as well. This protection is referred to as the “corporate veil”, however, a court may choose to pierce or lift the corporate veil if it determines that the corporation or LLC has compromised the separation between personal and business. Mixing personal and business finances is likely to put your corporate veil in jeopardy. Another easy but critical step you should take to mitigate this risk is conducting all business correspondence using the business’ name. 

On the other hand, if you’ve structured your business as a sole proprietorship and all profits and losses are personally tied to you, it’s still essential to keep your personal and business finances separate. In the event that the IRS decides to audit you, they will mandate that you provide proof of your business expenses and income. Without separating your finances, you run the risk of the IRS auditing both your business and personal records. Beyond that, other federal and state and federal agencies may also ask for financial records in regard to registration, corporate compliance, employment and sales taxes. Separating your finances will make it easier to record-keep, saving you time and a future headache. 

Taxes

To properly file taxes, you must keep careful track of all business expenses. To do this, it’s critical to store your receipts – for everything from office expenditures to operational and inventory purchases -- in an organized fashion. The best way to avoid mix-ups between your personal and business receipts is by creating a separate business account, and keeping a collection of business-only information. 

If you’re hoping to claim business expenses as deductions, you must report any income or loss on a Schedule C (Form 1040). In order to receive such deductions, you must prove that you are running a business and not merely engaging in a hobby. One of the best ways to signal to the IRS that you are indeed submitting business, not hobby, expenditures is to keep your personal and business finances separate. 

Business Credit

Building your business credit is another incentive for detaching your business and personal finances. By building your business credit, you will gain the ability to obtain working capital for your business that is vital for its growth. Without it, you will likely have to sign personal guarantees for leases, loans, and lines of credit. Building your credit score will help you avoid personal guarantees and even secure larger business loans.  If your business and personal finances are blended, it’s more difficult for you to provide your accurate business income to banking agencies, which will provide barriers to establishing your business credit. 

 Tips for Separating your personal and business finances

 1.     Consider registering your venture as a C Corp, S Corp, or LLC. 

The legal structure of your business will dictate everything from your risk and liability, to how the IRS will retrieve your business taxes. Ping us to help you make the right decision!

2.     Open a business checking account. 

This will streamline cash flow and make record keeping much more efficient. Opening a business checking account also lends itself to easy finance tracking. 

3.     Apply for a business credit card.

 A business credit card will help you eliminate the need for personal credit cards for business purposes. There’s even a chance you may be able to deduct card costs, such as an annual fee, if you are using a credit card exclusively for business purposes.

4.     Set a budget.

Preparing and sticking to a budget for your business can prevent you from delving into personal finances due to poor planning. 

5.     Pay yourself a salary.

Paying yourself a salary will help you stick to your personal budget, prevent you from haphazardly pulling money from the business, and will give you a better chance of your business succeeding. 

 As always, ping Taylor Law PLLC for any of your small business legal needs.