Starting a business is a learning experience, and one of the most common mistakes new entrepreneurs make is failing to keep their business and personal finances separate.
Entrepreneurs expose themselves to legal complications and tax headaches when they don’t separate the two. For instance, if your business ever faces legal complications, you don’t want to bring your personal finances into the mix. Plus, you’ll easily manage bookkeeping and file business taxes if you keep everything separate.
Here are 8 of the best ways to separate your company and personal finances. Let’s dive in!
1. Obtain an EIN
An employer identification number (EIN) is a nine-digit number that the IRS assigns to your business. Think of this number as the business version of a social security number.
Obtaining an EIN is the first step to separating business and personal finances. It’s the number the IRS uses to identify your business, and every financial item will come back to your EIN, not your social security number. It creates a distinct line between your personal finances and your business ones.
As an entrepreneur, you’ll need this number for several reasons, the most common ones being:
- To file business tax returns
- To open a company checking or savings account
- To establish the type of company you own
- To apply for a company credit card
Once you have an EIN, you’ll no longer have to use your social security number for company-related purposes. It is one of the first steps entrepreneurs should take when deciding to launch their startup.
If you don’t already have an EIN, setting it up is accessible through the IRS EIN portal. But you’ll first need your business entity type, which brings us to the next step.
2. Define Your Business Entity Type
Your business entity type can be anything from an LLC to a corporation. Establishing this structure will formally deem your company as a legal entity separate from your social security number.
By incorporating your company, you’ll also be able to file tax returns separately from your personal ones. By doing so, you’re giving your business a layer of legal protection.
There are many types of business entities to choose from, but most entrepreneurs choose one of these six:
- Sole proprietorship
- General partnership
- Limited liability company
- Limited partnership
- S Corporation
- C corporation
Because the type of entity you claim can affect your company valuation and tax status, it may be helpful to discuss this designation with a CPA before filing for an EIN.
3. Open a Business Bank Account
You’ll want to keep track of any money going in and out of your company efficiently. A great way to do this is by opening a company bank account and strictly using it for business transactions.
A business bank account will prevent you from taking money from your personal finances to make a purchase or depositing a company check into your personal checking account.
With a company checking account, you can deposit money, pay bills, collect invoice payments, purchase equipment, and more! You’ll do this all while keeping your personal finances separate.
4. Apply For a Business Credit Card
When running a business, there will be transactions you’d prefer to put on a credit card. If this is the case, don’t use your personal credit card. Instead, open up a company credit card. It will help separate company transactions from personal expenses and help build your business credit score.
Why should you build your company’s credit score? Think about why we build our personal credit score. We want better terms on loans and financing options. The same concept applies to business credit.
Let’s say you plan to expand in the future and need a loan. Having a solid business credit history will help you secure the financing your company needs and with better terms.
A few benefits of having a good company credit score include:
- Lower interest rates on loans
- Lenders may agree to better terms
- Keeps company and personal finances separate
- Your company will be financially stable
5. Pay Yourself a Salary
Instead of pulling money from your business account whenever you need it, pay yourself a salary. It’s crucial even if you’re the only person working at your company because your salary will impact your tax filing status.
A self-paid salary could mean transferring money biweekly from your company checking account to your personal checking account. The point is to show those transactions happening through the bank.
When you pay yourself, you’re controlling when you take money from your company instead of taking it whenever you need it. A good rule of thumb is paying yourself a fixed percentage of the company’s profit. This way, your compensation will adjust according to your company’s performance.
6. Separate Receipts
Suppose you’re shopping for business supplies and realize you could use some things for the house. When this happens, always separate your receipts by purchasing home and business items separately.
Don’t combine items because if the IRS audits you, they’ll ask to look at your business receipts. You’ll find yourself in muddy waters if you can’t separate them from your personal ones.
Remember that using your business credit card or bank account will make it easier to track receipts in case your company gets audited. You can quickly pull up statements to provide proof of purchases and transactions—another benefit to keeping company and personal finances separate!
7. Understand the Difference Between Personal and Business Expenses
Let’s say you run your business from home. You likely have a home office, use your personal vehicle to attend meetings, talk to clients using your cell phone, and reply to work emails using your home’s internet connection.
Do these count as company expenses? Absolutely! Take note of these scenarios and expenses. Track down whenever you use personal items for company purposes. By doing so, you’ll be able to write off some expenses come tax season.
Educating yourself on what qualifies for business expenses is a great first step. Get in touch with MI Tax CPA to learn more.
8. Educate Other Team Members
If you’re being mindful of the tips mentioned above, but your team members aren’t, there’s no point in trying to separate company and personal finances. The result will be the same: running the risk of legal complications and difficulty filing a tax return for your company.
The solution is to educate other members of your company. Make sure your stakeholders are all on the same page on why separating these finances is essential. Running a company is a team effort, so explain what qualifies as a business expense and what doesn’t.
To streamline things, it will help if you work out a system with your team to ensure everyone correctly separates company and personal expenses. A systematized approach will make things easier come tax season and give you peace of mind that you’re doing everything possible to keep your finances separate.
Need Help With Your Finances? Give Us a Call
It’s easy to get personal finances tangled up with your company finances. Keeping the two separate is vital regardless of the type of business you own. It will save you from headaches brought forward by legal complications.
With the tips above and the help of a reputable CPA, entrepreneurs can be confident that their company and personal finances stay separate.