Separating Business and Personal Finances

Dividing business and personal finances can help small business owners avoid common tax mistakes and provide legal protection. Opening a bank account dedicated solely to a small business will make the business appear more trustworthy to customers, lenders, and even investors. A business bank account can also help a small business owner manage cash flow, accounts receivable, and accounts payable. Additionally, a separate business account can help a small business build good credit and support the business as it grows.

Below are ways to separate business and personal finances and help minimize difficulties.

• Apply for an EIN – You can apply for and obtain an Employer Identification Number (EIN) online via the IRS.gov website. The EIN can be used to set up your business type, apply for bank or credit card accounts, and file your business tax returns.
• Register your business – Choosing your business entity structure will determine ownership, liability, and tax requirements. These requirements can vary by state. Choose your entity type carefully; conversion to a different business structure in the future can result in tax consequences.
• Open a business bank account – The IRS recommends that all small business owners maintain a separate bank account. You can open as many accounts as you wish for your small business provided the bank approves your application.
• Apply for a business credit card - While it is legal to pay for business expenses on a personal credit card, personal credit cards do not build business credit and are harder to track business expenses on. Business credit cards can also offer benefits to small business owners that are generally not available on consumer credit cards.
• Pay yourself – Business owners can draw money directly from the business or receive a salary with payroll taxes withheld. The method you use will be dependent on the business entity structure you select.

Tax Deductions & Benefits

Tax time is perhaps the biggest motivator to separate business and personal finances. Small business owners can deduct a variety of qualified business expenses on their tax return for purposes of lowering taxable income. These deductions include, but are not limited to, business use of your car, rent, utilities, retirement contributions, and health care expenses. Using an accounting software to track your expenses will be well worth the time and expense when tax time rolls around.

Legal Liability

Establishing a business entity—LLC, partnership, S-Corp, or C-Corp—determines personal risk, liability, and tax responsibility. Even though an entity structure can provide legal protection, it is the responsibility of the business owner to separate business finances from personal finances in order to safeguard personal assets and limit personal liability. Sole proprietors are not considered to be separate legal entities, and profits, losses, and liabilities are tied directly to the owner. Thus, it is even more important for a sole proprietor to separate business and personal finances.