The Importance of Separating Business and Personal Finances
Updated: May 4, 2022
You probably hear time and time again how important it is to separate your personal finances from that of your business. If you’re an LLC or corporation, then you must treat your business as a separate entity by having its own bank account and credit card. But if you’re a sole proprietor, it’s still important that you separate your finances, and here are some of the reasons why:
When you own a business, your tax situation becomes more complicated than the average person since you have to report your business income and expenses. If you’ve filed a Schedule C without separating your business and personal expenses throughout the year, then you know just how time-consuming it can be digging through a year’s worth of receipts and bank statements. Keeping your business finances separate makes for a less stressful tax season for you and your tax preparer.
In Case of an Audit
When you’re audited, having a clear line between your business and personal expenses can help speed up the process and verify your numbers. If the IRS audits your business, they will ask for documentation that supports your income, credits, and/or deductions that you claimed. If you’re bank statements and receipts have a mix of personal and business, it can blur the line when it comes to what’s for business. If you cannot prove to the IRS that a deduction is for a business expense, they may end up removing the deduction, resulting in a balance due
Understand Your Business Finances
When you share a personal and business bank account, all your finances are intermingled, making it difficult to see how your business is performing at a quick glance. Having a clear picture of your business cash flow gives you the ability to make better budgeting decisions about where you should cut back or invest more.
Business Credit and Financing
If you aren’t separating your finances, banks and other lenders may have a difficult time seeing how your business is performing on its own, making it trickier to be accepted for a loan. Just like how you have a personal credit score, your business can also have a credit score. When you have good business credit, lenders have a better understanding of your ability to pay back a loan. Keeping separate accounts will also reduce the risk of your business credit affecting your personal credit or vice versa.
Protect Yourself from Liability
When you open a business, you open a door to potential new liability. Keeping your business finances separate from your personal can help safeguard your personal assets. There’s a common phrase “pierce the corporate veil” which refers to business owners being held personally liable for business debts. This means the debt collectors can go after your personal bank accounts, home, investments, and other assets you may have if you aren’t treating your business as a separate entity.
Tips for Separating Business and Personal Finances
As you can see in these scenarios, not only is keeping your business and personal finances separate a smart idea, but it can also save time and money. Here are some of the things you can do to separate your business and personal finances. We’ll dig deeper into this topic in another blog post.
Open a separate bank account
Open a business credit card
Incorporate your business
Consult your bookkeeper or accountant
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Disclaimer: This post is meant for informational purposes only and should not be taken as legal, business, or tax advice. Please consult with your accountant or bookkeeper for more information based on your specific situation.