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As a business owner, it’s important to establish a distinct separation between your personal finances and your business finances.
By ensuring that your finances – and credit – are separate, you limit your personal liability, save time and reduce stress and boost your business’s professional image.
Whether you’re just starting a business or own an existing business, here are several tips to help separate your personal and business finances:
1. Apply for an Employer Identification Number (EIN). An EIN is a nine-digit number used by the Internal Revenue Service to identify a business. An EIN is needed to hire employees, open a business checking account and more. Business owners can apply for an EIN for free through the IRS.
2. Open a business checking account. The best way to keep personal and business funds separate is to have two different checking accounts. With a dedicated business checking account, you can pay bills, deposit cash, collect invoice payments, and buy equipment without having to run a cash-only operation, or by having to pull from your personal bank account.
3. Establish your business entity type. 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.
Separating business and personal finances is required for LLCs and corporations, but not for sole proprietorships. Sole proprietorships don’t need to separate finances because they’re considered an unincorporated legal entity. This means all of the sole proprietorship’s profits, losses, and liabilities are tied to the owner.
Ironically, this means it’s even more important for a sole proprietorship to be separating business and personal finances. If you’re audited by the IRS, the burden of proof is on you to disclose your business expenses and income. Therefore, sole proprietors, more than anyone, should prioritize separating business and personal finances.
4. Establish credit/open a credit card in your business’s name. Building good credit is important. 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.
5. Pay yourself a salary. Paying yourself a salary from your business creates a more formal boundary between your business and personal finances. By paying yourself a salary, you establish when and how you will take money out of your business, rather than just pulling from your business finances whenever you need to.
6. Separate receipts. Make sure that you’re not combining where you store business receipts and where you store personal receipts. If you were to be audited, the IRS would want to look at your business receipts, and if you can’t separate them from your personal receipts, you’re in trouble. Keep in mind that having a business bank account and business credit card (that you only use for business purposes) will make the whole process of separating receipts a lot easier.
To learn more about this topic, visit:
https://www.sba.gov/blog/5-ways-separate-your-personal-business-finances
https://www.clearviewfcu.org/Learn/about-financial-wellness/Blog/6-Ways-to-Separate-Your-Personal-and-Business-Fina
https://www.fundera.com/blog/separate-business-and-personal-finances
