Separating your business and personal finances makes bookkeeping and tax season much easier. In some cases, not separating your personal and business finances could raise red flags for the IRS and open you up to legal issues.
When you’re the sole owner and employee of your business, it can be hard to view your personal and business finances separately. But it pays off — financially and legally — to be careful.
Keeping your personal and business finances separated can help you keep track of potential tax deductions and credits, stay legally protected, and lower the chances of being audited by the IRS. So it saves you both money and time by staying organized.
Maintaining that separation goes beyond creating different bank accounts. Once you create your separate accounts, you need to know when to use each, how to use each and how not to use each.
What does separating your personal and business finances mean?
Separating your personal and business finances means having distinct lines between your business’ spending and your personal spending.
There are three main steps to officially separating your personal and business finances:
- Registering your business as an LLC and opening business bank accounts
- Using your business accounts for business purposes and personal accounts for personal purposes
- Keeping your books clean and fixing any payment mistakes
The business owners that struggle with this the most are usually one-person businesses. When you’re the person in charge of all of your personal money and your business’ money, it’s easy to treat them the same. But apart from paying yourself from your business and reimbursements, your accounts shouldn’t intermingle.
Why do I need to separate my personal and business finances?
It can take some time and extra effort to start separating your personal and business finances — especially if you’re not used to it. But here’s what can happen if you don’t do it.
1. You can’t measure your business finances accurately
Analyzing your books and pulling reports like your income statement and balance sheet are essential ways for you to measure your business's financial health.
Those reports all come from your accounting software. It automatically generates those reports based on the numbers you’ve recorded. So if you’re including your personal finances in those statements, you can’t get an accurate read on your business.
Errors could lead you to believe that your business is doing worse or better than it actually is. This can cause you to buy things for your business you can’t afford or maybe lose the chance get a new office space because you thought you couldn’t afford it.
2. You can be audited by the IRS
Mixing your personal and business finances isn’t a guarantee you’ll be audited, but it does raise red flags to the IRS and increase your chances of one. An IRS audit can be stressful and expensive.
When you’re using business money to use on personal expenses or vice versa, you’re telling the IRS that you’re no different from your business. Why does the IRS care? Because you might try to write off expenses from your business card that were really just personal expenses. Those deductions can add up — and the IRS can make you pay back any expenses they find that you should have owed.
You can lower your chances of an audit (for this reason) by keeping your different debit and credit cards organized.
3. You can get into legal trouble
Having an LLC is great because it can shield you from legal liability. But you can lose that shield if you start mixing your finances.
If your business gets sued for any reason, the other party can try to “pierce the corporate veil,” which means they’ll try to go after your personal assets even if they’re not suing your business directly. The other party can argue that even though you and your LLC are technically separate from each other, you’re not treating them as separate because you mix your finances.
You can risk losing any vehicles, real estate and other tangible property you or your business has at that point. So by just making sure your finances are organized, you can save thousands of dollars in personal and business assets.
4. You can mess up your taxes
Before you file your taxes, your books need to be in order. You can’t have clean books if your business bank account is muddied with trips to Disney, grocery expenses, your mortgage payments and more. You’ll need to remove all those expenses from your accounting software, which could take hours, days, or weeks if you’re busy running your business.
Mixing your personal and business finances could also lose you money when you file your taxes. For example, someone who uses their personal cards to pay for business expenses might forget to pay themselves back and record that in their accounting software. When they go to see how much they can write off, not all of their business expenses actually show up — so they pay more in taxes than they need to.
Your quarterly estimated taxes might be affected as well, if you have to pay them. Without calculating the right amounts, you might underpay your taxes and be charged penalties and interest.
If you realize those mistakes too late, you may have to spend more time filing an amended return or have a CPA do it.
6 ways to keep your finances separate
Mixing your personal and business finances together can cause tax, bookkeeping and even legal issues.
Here are a few ways you can start separating your personal and business finances today and save yourself from trouble.
1. Open separate bank accounts
You usually need an Employer Identification Number (EIN) to qualify for business bank accounts. Once you apply for and receive your EIN, the first thing you should do is open a business bank account.
At the very least, you need one business debit and credit card. If you want to be diligent and even more organized, you can set up separate business bank accounts for payroll, sales tax and savings on top of your main account for operating expenses.
Some business bank accounts require a minimum opening deposit — so make sure you have at least a few hundred dollars to put down right away.
2. Don’t mix your bank accounts
Once you open your business bank accounts, you have to actually use them the right way. That means using business cards for business expenses and personal cards for personal expenses.
If an expense is both ordinary and necessary for your business, then you can usually be considered a business expense — which means you should use your business card. But if you’re not sure which card to use for a purchase, use your best judgment and stay on the safe side.
3. Keep your debit and credit cards separate
It’s possible — and common — to mix up your personal and business cards by accident. Making your cards all different colors or designs can help you avoid this. Make sure they’re not all gold, platinum, silver or any other common card color. And if they do look similar, try putting a small sticker on your cards to help you differentiate them before a purchase.
4. Know how to fix mixed bank accounts
If you use the wrong card for any reason, it’s not a terribly difficult mistake to fix here and there. All you need to do is pay yourself back. You can do this from your phone in just a few seconds or reimburse yourself from your business.
However, that can become a huge time suck if you use the wrong cards regularly. As a business owner, you probably have several other things on your plate already. Spending hours or days before tax season trying to find every dollar to reimburse yourself probably isn’t how you want to be spending your time.
So when you do use the wrong type of payment, reimburse however much you spent as soon as possible to the right account. It’s important that the cash flows directly from one account to the other. If you accidentally charge $50 to your personal bank account that’s meant for your business account, you can’t just make another $50 purchase on your business account to even it out.
5. Keep your receipts
You’re not required to keep your receipts in many instances. But having them on hand and separated could help you keep track of whether expenses were personal or business-related.
You don’t need to keep physical receipts stuffed inside a shoebox somewhere. There are apps like Dext that will help you keep digital copies of your receipts and notes to go along with them. You can also use your bank’s app or your photos app to track your receipts, as long as your photos are timestamped.
Keeping and separating your receipts is helpful if you frequently use the wrong cards and have to make reimbursements. It’s also helpful if you want to stay organized and check that you haven’t paid anything incorrectly before tax season by skimming through your receipts.
6. Don’t use personal payment apps for business transactions
Some business owners try to avoid paying business fees from PayPal, Venmo and other payment apps, by opting for personal accounts instead of business ones. So when a customer or client sends you payment, they’re paying you directly — not the business.
Using personal payment accounts instead of business ones can help people suing you make the case that your business isn’t really separate from you. That can also “pierce the corporate veil,” which allows people to go after both your personal and business assets.
Ideally, small business owners should consider switching to other payment platforms designed for businesses like Stripe or Square altogether. But if you are sticking with apps like PayPal or Venmo, make sure you’re switched to their business setting.
The bottom line
Separating your personal and business finances can take extra legwork from you. You’ll need to register your business as a legal entity and create different bank accounts. Then, you’ll have to keep using your bank accounts correctly.
But taking those steps can protect you from legal and tax issues — like losing legal protection or being audited by the IRS.
Need help separating your finances? Schedule a free call with a DiMercurio Advisors team member and learn how to so you can be ready to file taxes and keep your books clean.
