6 Ways to Separate Your Personal and Business Finances
- Limiting personal liability — Your business is your home away from home. Protect them both by keeping their finances separate.
- Saving time and reducing stress — Your records will be better organized and if you are audited, you’ll have all the answers.
- Boosting your business’s professional image — Customers who don’t know you personally will expect to pay a company, not a person. Likewise, paying a vendor with a personal check does not look professional.
Here are six ways to separate your personal and business finances:
- Apply for an Employer Identification Number (EIN). An EIN is a nine-digit number used by the IRS to identify a business. You need an EIN if you hire employees, open a business bank account, start a tax-deferred pension plan, plan to incorporate or form a partnership or LLC, or represent an estate that operates as a business after the owner’s passing. Apply for free through the IRS.
- Open a business checking account. This one’s obvious. While it takes some effort upfront and a real commitment, paying your expenses through this separate account will automatically unscramble much of your record keeping.
- Determine which structure is best for your business. Each structure has specific legal and tax obligations and protections. The most common business structures are:
- Sole Proprietorship — This is the simplest form and is best for businesses owned, managed, and operated by one person. However, it doesn’t offer liability protection.
- Partnership — This is for startups owned and operated by two or more people who invest capital to start the business. It doesn’t offer liability protection, either.
- Limited Liability Company (LLC) — An LLC is a middle ground between a partnership and a corporation. As the name states, it does offer a limited degree of liability protection, but it requires more cash to start.
- Corporation (a.k.a. C Corporation) — This is owned by shareholders and overseen by a board of directors. Because it operates as a separate legal entity, it has certain rights and liabilities. It does offer its owners limited liability, but setup is expensive and complex. Also, C corporations are subjected to double taxation. The corporation pays taxes on income, and then the shareholders pay on the portion of the income that they receive.
- S Corporation — This is similar to a C corporation, but is a subchapter of a corporation. It avoids double taxation. Unlike a corporation, only shareholders pay tax on income that is “passed through” to them. You can learn about the pros and cons of each structure on The Balance Small Business.
- Obtain a business credit card. Building good credit is important for your business, too. When you wish to apply for a loan or a line of credit, financial institutions like to see that your business has a proven repayment track record. Business credit scores from the three business credit bureaus range from 0 to 100, with 100 being the best.
- Pay yourself. Payment should be enough to cover your living expenses. How you pay yourself depends on your business structure. If you have a sole proprietorship or a single-member LLC, you take money as a draw. Partnerships and LLCs with multiple owners are paid via distributive shares. Owners of C and S corporations are paid via pre-taxed salaries.
- Keep business receipts separate. Create a tracking list for business expenses that includes the date, amount, and description of the expense. Group and tally like expenses together, such as office supplies, raw materials, gas mileage, parking fees, shipping costs, utilities, and contractor repair or investment costs. Developing a good habit of maintaining these records on regular basis will make tax time much easier.