Keeping personal and business expenses separate is imperative, especially if you want to avoid a tax season headache
When starting your own business, it’s tempting to hit the ground running, and to worry about the little things later. Your business’ finances, however, are no small detail.
The most straightforward — and crucial — step towards making sure your business’ finances are on track? Creating a barrier between your personal and business finances.
Separating personal and business expenses, in particular, is one of the most important maxims you’ll read again and again. No matter how often you hear it, it will be tempting to ignore, especially for sole proprietors who spend their own income on business expenses anyway. But this tenant of business finances is a tenant for a reason.
To help convince you to get an Employer Identification Number (EIN), set up a business bank account, and access a business credit card — rather than using your Social Security number (SSN) and your personal bank and credit cards — we’ve outlined 5 compelling reasons to separate your personal and business expenses.
It will save your mind during tax season …
The most important reason to separate your business and personal expenses from the get-go? Tax season. Your first tax season as a business owner will be varying degrees of difficult, and occasionally insanity-inducing, depending on how you set your finances up from the beginning. No matter what, you’ll need to get a feel for finding deductible business expenses now that you’re self-employed.
However, if you’ve been intermingling your personal and business expenses within the same accounts all year, that will add an additional layer to filing your small business taxes. You’ll need to sift through bank statements to filter out your business expenses. Depending on how long you’ve been in business and how frequently you spend on business purchases, this could take as long as a few days’ worth of work.
After that initial filter, you’ll need to pinpoint deductible expenses — like workspace, materials, and transportation costs. If you set up separate accounts for your business spending from the get-go, you’ll only have to worry about this second step. Devoting your time and energy to pinpointing your deductible business costs — rather than sifting through all of your expenses first — can help you maximize your business tax return and avoid costly fees from the IRS.
… As well as your accounting budget
Some business owners choose to leave all the work for their accountant to handle. Accountants typically earn an hourly median wage of $26, so setting up separate business accounts can save you from burning money during tax season.
Having a separate spending account for your business expenses means your accountant won’t need to spend time identifying potential business expenses and confirming them with you. If you choose to use an accountant, put their expertise and time towards identifying deductible expenses — rather than sifting through your bank statements. You’ll access the returns your business expenses merit, and your business’s accounting spend will shrink before your eyes.
It will give your business more clout
As you interact with vendors, clients, and partners, you’ll often need to hand over financial information to pay and get paid. If you’re sending information for your personal accounts, it might be a red flag for some stakeholders. The more paranoid set might think you’ll pocket the money for yourself without funneling it back into your business. Others might simply think you’re not willing to perform the basic due diligence of setting up your business finances — even if you’re a sole proprietor.
On the other hand, if you provide information for accounts that run under your business name, then you’ll indicate professionalism and financial acumen. This is especially true if you’re operating as a sole proprietor — creating your own business accounts for your freelance career will set you up well for tax season, but it will demonstrate your responsibility and know-how to stakeholders, as well.
It will help you build business credit
The crucial steps towards separating business and personal expenses are also crucial steps towards building a solid business credit history — and that’s no coincidence. These steps will help establish your business as a financial entity that’s separate from you as an individual, even if you’re a sole proprietorship operating under your own name.
Having a business bank account as your professional home base for your finances, for instance, indicates to business credit bureaus that the money you’re handling is indeed for a business. Accessing a business credit card that reports to business credit bureaus will further solidify your business’s separate borrower status. Plus, spending responsibly on this business credit card can help you solidify your business as a responsible borrower.
Finally, an EIN — or an Employer Identification Number — works much like an SSN for a business. An EIN will not only separate the business from the personal, but it will also act as the identification number for your business credit score. A good-to-excellent business credit score can help you access low-cost business loans and potentially avoid personal guarantees on future business financing options.
It will protect you from legal fallout
Finally, as you might know from the process of filing your paperwork for your LLC, partnership, S-corp, or C-corp, there are advantages to operating as a business rather than a sole proprietorship. For example, your separate business entity receives legal protections that your personal self may not.
If you mingle your personal and business finances, however, you “pierce the corporate veil,” which invalidates those protections. That can leave you personally liable if another company or a client brings a lawsuit against you and wins a judgment. Your personal credit score will tank, and your personal assets may be up for grabs. No thanks!
Separating your personal and business expenses: Next steps
Now that you’re familiar with the four most important reasons to separate your personal and business expenses from the get-go, what’s next? To start the process, you’ll need to apply for a business tax ID number, or EIN. You can use your EIN to open up a business bank account or apply for a business credit card. Set your accounts up, and start spending (responsibly)!