Legal / Startup Life

Understanding Why You Should Separate Your Business And Personal Finances

I have insinuated this point in previous articles and I think by now, I am at least partially preaching to the choir. However, for the sake of being thorough — we should briefly talk about why you should separate business and personal finance. I’m going to give you both a legal take and a personal take on this issue. I will also suggest a couple of best practices to help maintain separation. 

Let’s talk about legal issues first. It is now March, and that means we are midway through tax season, because of this, the IRS should be on your mind. Mingling your personal and business finances is particularly problematic when it comes to the IRS -for two reasons: First – it invites an audit and makes one easier to justify. When you mix your personal and business funds for your business, it makes your business look more like what the IRS calls, a “hobby”. Tax law does not allow you to write off expenses and deductions for a hobby and you don’t want to lose those credits. Second – when and if you are audited, or even in the case of preparing your own taxes, mixed finances make deductions, losses, and income difficult to calculate. Beware, this could create a nightmare when doing your taxes.

Outside of taxes, you can lose the limited liability protection – which is one of the main reasons to create a business entity in the first place. If you do not observe what the law calls, “the corporate formalities,” which means a strict separation between personal, business finance and appearance, (i.e. you mingle funds or simply do business in your name instead of the businesses’), you are creating a situation where someone or some entity coming after you can “pierce the corporate veil” and hold you personally liable. This is particularly problematic when it comes to loans, credit cards, etc. You do not want business liability to be your personal liability and subject your personal income and assets to being taken away.

On to my personal take on why you should separate personal and business funds. First of all – if you don’t separate your business from your personal finances or otherwise, it just appears unprofessional and makes people question you. Outside of situations like paying for a business meal, whipping out a personal credit card to pay for something looks suspect to a customer or one of your suppliers. Second – while it may seem harder to just use your own accounts, it’s much easier than trying to separate things out later when it is time to. Finally – I like to keep my information private. I don’t want to expose my personal account or any other information voluntarily; or be forced to disclose my accounts in legal discovery because I used it for business purposes. I am now going to leave you with a few best practices:

1)  Keep separate accounts! Sign up for your employer identification number (EIN) with the IRS. It is your business’s social security number and you can use it to open accounts without any of your own information. Get a business bank account and a business credit card and do not abuse that credit card.

2)  Keep transactions between you and the business at “arms length!”  That means the transactions made clearly separate you personally from the business as an entity. This is really helped by the third best practice.

3) Create and keep records! Create records commemorating dealings (money you put in investments or loans); money taken out (salaries, wages, reimbursements); and money for space (like a home office—you could do a rental agreement). Meeting minutes and deal write ups are your friends, they explain things, refresh your memory, and protect you when you are under scrutiny.

One of the biggest benefits of having a legal entity is that it gets to be its own person in the eyes of the law. Let it take all that risk, not you.

Disclaimer: The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice. The law changes frequently and varies from jurisdiction to jurisdiction. Being general in nature, the information and materials provided may not apply to any specific factual and/or legal set of circumstances. No attorney-client relationship is formed nor should any such relationship be implied. Nothing on this blog is intended to substitute for the advice of an attorney licensed in your jurisdiction. If you require legal advice, please consult with a competent attorney licensed to practice in your jurisdiction.

Photo by Viktor Bystrov on Unsplash

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