Why it's Important to Separate Business and Personal Finances

Separating Business and Personal Finances

One of the most vital aspects of running a business is maintaining accurate records of your income and expenditures. This is the only way to get a good read on your business' performance.

For this reason, keeping your business finances separate from your personal finances is a must. Serious complications can result if you do otherwise.

Why It's Important

There are several reasons to be proactive about distinguishing between business and personal finances. Tax implications are foremost. The IRS allows business owners to claim deductions for business-related expenses such as travel and supplies, but you must have the proper documentation to support it. If your business is audited, the IRS will look closely at each expense to verify that it is indeed related to the regular operation of the business. When there is no clear paper trail in terms of what the expenses were for, or how you paid for them, it becomes more difficult to validate the deduction.

A separation is also important when considering your liability for debts. If your business is structured as a corporation or limited liability company, keeping the two separate works to your advantage, if a creditor takes action against you for an unpaid debt. When there is no clear distinction between business and personal finances, creditors are in a better position to claim your personal assets to satisfy a debt.

One final consideration is your business credit. You may be able to get a business credit card based on your personal credit history alone, but you will need a separate business credit profile to secure larger business loans or establish vendor lines of credit.

How to Separate Business and Personal Finances

Separating your business and personal finances is not a difficult task. Taking the following actions can draw a clear line in the sand between the two.

Establish a separate legal entity

Keeping your business and personal finances separate, is much easier when the business is its own legal entity. If you have a new business, it's important that you clearly define which structure you will use to operate, i.e. a sole proprietorship, corporation, LLC, etc.

After you've established the business's legal structure, you can move on to creating an Employer Identification Number or EIN. Also called a taxpayer identification number, this is what the IRS uses to track your business earnings, and it's the same number you will use to file your business tax return at year's end. The IRS allows you to apply for an EIN online at no charge.

Open bank accounts specifically for your business

Once you have an EIN for your business the next step is opening separate spending accounts. To open a business bank account as a sole proprietor, you'll need your EIN and your Social Security number. Partnerships are required to also present a copy of the partnership agreement. For a corporation, you'll need an EIN and a copy of the articles of incorporation on file with your state business agency. If you're using a "doing business as name, you'll need to provide the bank with a copy of your DBA certificate. The bank will also need a business address and a copy of your business license if one is required in your state.

Implement a dedicated accounting system

Having a separate checking account can help with tracking your business income and expenses, but it's helpful to have a more comprehensive accounting strategy in place.

Hiring an accountant or bookkeeper allows you to pass the burden of handling your business finances on to someone else, but it does come at a cost. When you're comparing your accounting options, pay close attention to the fees involved and the range of services the bookkeeper or accountant offers.

If you're comfortable with a DIY approach, there are a number of tools available for tracking your business income and expenses. QuickBooks, for example, allows you to sync up your bank and credit card accounts for easy expense tracking. You can also use the software to create invoices, accept payments and process payroll.

Establish business credit

While you can use a personal credit card or small business loan to finance your business, it can muddy the waters significantly. Opening separate lines of credit for the business simplifies things.

The easiest way to establish credit for your business is to open a business credit card but, that requires a personal guarantee. This guarantee means that you are personally responsible for any debts incurred by the business in case of default.

Aside from obtaining a business credit card, you will need to set up business credit profiles with the appropriate credit reporting bureaus. This includes Dun and Bradstreet and the small business divisions of Equifax, Experian and TransUnion. Your business credit activity as well as your vendor lines of credit would be reported to these companies and used to formulate your business credit score.

Use Caution When Commingling

Blending your business and personal finances can create unnecessary headaches, particularly with regard to your tax filing. If you do have to commingle your finances for any reason, take care to preserve accurate records delineating which expenses fall under the business umbrella. You will spare yourself a future dilemma.