Separating Business and Personal Finances
Many small business owners to mix up their personal and business expenses, and it makes life way more complicated.
It can seem so easy to pay for a personal expense on your business credit card or vice versa.
However, there are downsides to doing it that way, so it’s important to keep business expenses separate from personal expenses.
Table of Contents
Why is it important to separate personal and business finances
Let’s first talk about why it’s important before we dive into how to do it.
Taxes
When tax time rolls around, a business owner can spend an extraordinary amount of time digging through both personal accounts and business accounts to figure out their true tax deductions.
There are two downsides.
The first is that you miss out on business deductions you could be taking. That will lead to paying more in taxes.
The second is that you overestimate your deductions. If you get audited by the IRS, you could face fees and penalties.
It’s much easier to separate your business and personal expenses as they happen. It makes for a much easier tax season.
Personal Liability
You could be setting yourself for extra liability if you don’t separate your business finances from your personal finances.
When it comes time to secure funding from business loans or lines of credit, you could be unknowingly exposing your personal assets if your personal and business financials are intermixed.
Clarity on Business Profitability
Do you know how your business is performing? You won’t really know unless you keep your business finances separate.
Keeping everything separate will give you a good indication of the financial health of your business.
How to separate business and personal finances
It may sound daunting, but it is actually a fairly simple process. Here are steps you can take:
Set up a separate business entity
Consider setting up a separate legal entity like a limited liability company (LLC), an S Corp, C Corp or some other structure.
Small business owners should talk with a tax advisor, financial professional to see which legal entity would be best suited for your business from a tax standpoint.
A separate entity could also give you some personal protection from a liability standpoint, so consult a business attorney as well.
Now you’ll have a proper business structure set up.
Once you set it up, apply for an employer identification number (EIN) from the IRS after consulting with your accountant or tax professional for your unique circumstances.
Open up a business bank account
Now that you have your new business entity, it’s time to get a separate business account set up.
This checking account can be used for all of the revenue inflow and expense outflow for your business.
Business income should be deposited into this account, and you can pay your bills, salaries, business credit cards and other business transactions from here too.
Open up a business credit card
Get a credit card specifically for business expenses.
Any expense you have for business purposes should be put on this card. This should not be for personal use.
This will make tracking expenses in your business super easy.
If you’re not into credit cards, just get a business debit card that is attached to your checking account.
Reimburse yourself for business expenses in your personal account
As a small business owner, things can get hectic and you may at times mix personal and business funds.
Never fear! Simply reimburse yourself for the business expense immediately when this happens.
For example, if you buy some office supplies using one of your personal credit cards, transfer that same amount from your business to your personal bank account to reimburse yourself.
Keep track of how much you put into your business
It’s hard to predict where your business is going to end up, so it’s important to keep accurate financial records of how much you have put into the business.
Need help getting set up?
An example of separating business and personal finances
Let’s say you own a small business and you’re wondering what steps you need to take. Here’s a pretty common scenario I see with many business owners. Let’s use it as an example.
Common small business scenario
You have already formed an LLC as your business structure.
There’s no outstanding business loan or any other business debts.
The only payroll you have is your own.
You already have a separate account for your business and a business credit card.
Your business’s finances seem to be ok, but you’re not keeping your business and personal expenses separate.
Personal expenses are being paid on your business credit card and business expenses are being paid on your personal credit card.
Personal funds are being transferred into the business checking account when needed, then transferred back when the business needs money with no real records being kept.
You don’t really know what your true business financials are until your accountant puts together your tax return.
The problems
There are 3 real problems with operating this way as a small business owner.
You don’t know your financials
If you want your small business to succeed, it is imperative to know your financials. When you mix personal and business finances this way it makes it really hard to understand your profit and loss.
How much money are you making? Are you making any money at all? Are there any opportunities to invest more money or cut back on?
This is very opaque when you mix personal and business finances.
It’s hard to make clear-headed business decisions if you don’t know where you stand.
Taxes & Time
This really becomes a mess when tax time rolls around. You have to go through both your business and personal finances to find all of your tax deductions.
The time needed to compile this information goes up exponentially.
When you keep your business and personal finances separate, all you have to do is present the financial transactions from your business accounts. If it’s on the statement, it’s a business expense. Plain and simple.
But imagine now that you have to parse through your personal finances too, sifting through things like your meals. Was this business or personal? Now do this for an entire 12 month period!
You could miss out on some great business tax deductions or over-inflate them.
When you own a business, some personal expenses can become legitimate business expenses but there are rules to follow if you want to avoid getting in trouble with the IRS.
But keeping personal and business finances separate saves a ton of time. Wouldn’t you rather take that time and invest it in business growth?
What changes need to be made?
Honestly, the changes are pretty simple and don’t even require investing in reliable accounting software.
Everything is already in place. You have a separate entity for your business, you have a business checking account and credit card.
So what should this small business owner do?
Anytime they spend on the business, use the credit card or business bank account that is already set up.
That’s it!
As an added bonus, they could also keep track of the money they put in and the money they take out. But that will also be very easy to see because of having separate accounts for business and personal and using them propertly.
Separating business and personal finances is easy to do.
In the end, separating business and personal finances have so many benefits to owners of small businesses.
It helps gain clarity on the true financial health of your business, save you a bunch of time during tax season, and helps with liability protection.
If you’re having trouble keeping business and personal expenses separate, let’s have a conversation!
Tap the button below to set up a time for us to talk through your challenges, get you some quick solutions, and see if there are any next steps.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this information.