New business owners may seek to keep things simple and co-mingle their business and personal finances. This is a BIG mistake. Here’s why, and what you can to do to appropriately separate your financial activities.
Why and How to Separate Your Personal and Business Finances
Why Keep Finances Separate?
There are important financial, legal and tax reasons to separate your finances:
- Financial. It’s difficult to know how well your business is doing if you can’t easily eyeball a bank balance devoted to your company. You may run into cash flow problems using a single account for business and personal expenses. Also, having a separate credit card for the company helps to build business credit scores.
- Legal. If your business is a corporation or a limited liability company, you can lose the personal liability protection you sought by setting up such an entity by co-mingling your finances. The reason: If you don’t respect the separate legal status of the entity, creditors may not have to and can go after your personal assets to satisfy their claims. There’s a legal doctrine called “piercing the corporate veil,” which means courts can ignore your entity’s status for purposes of your personal liability for any claims against the business if you haven’t observed the formalities of a separate business entity.
- Tax. For federal income tax purpose, the law requires you to keep good books and records. This can only be done if you have a business bank account into which you deposit income and from which you pay expenses. A rookie mistake is thinking you can remember what expense is for business, such as a meal, when it comes time to prepare your tax return; you can’t — and it can cost you tax deductions!
How to Keep Finances Separate
It’s really a no brainer. All that is needed to keep your business affairs untangled from your personal money matters is to have a separate business bank account and a separate business credit card. If you choose to use PayPal, also set up an account for your business.
You also need separate accounting for your business income and expenses. So, for example, if you use Quicken or Mint.com to track your personal expenses, use a separate accounting solution, such as QuickBooks, for your business.
To make sure you input expenses into the correct accounting solution, be sure to keep business receipts separate from personal expenditures. This can be done using separate files for paper receipts or separate online folders for e-receipts. Online options, such as Shoeboxed can help you keep track of business receipts.
If you use a home office, business with personal matters can all too easily get mixed up. In order to claim a home office deduction, the space must be used regularly and exclusively for business. Incidental personal use may not kill the deduction, but it’s better to keep personal things out of the home office area.
If you use a paid professional to prepare your tax return, ask that you receive separate invoices for services related to your business and personal income and expenses. For example, if you’re self-employed, an itemized bill enables you to take a business deduction for the cost of preparing Schedule C; the balance is deductible only on Schedule A if you itemize.
Keeping your business and personal life separate is extremely helpful. It’s easy to do. It merely requires a little housekeeping to set things up properly, and then to follow through.