Untangling Your Personal and Business Finances
As a business owner, you want to start on the right track and make decisions from the beginning that will allow your company to grow and flourish while minimizing potential issues. One of the first things you should do is to open a separate bank account in the business name and use this account solely for business income and expenses. The point is to maintain separation between your personal banking and finances and those of your business. There are several reasons why we make this recommendation.
Add legitimacy to your business:
A separate business account shows that your business is valid, legal, and functional. This adds peace of mind for customers purchasing a product or service from your business. And it ensures separation for you, as the owner, from the transactions of the business. When a client writes a check or issues a payment to the business it builds credibility. Separating finances shows financial discipline, that you can separate and maintain multiple financial accounts to keep business items separate from personal. Financial discipline can be important when seeking funding from outside investors.
Protect your Limited Liability Protection:
By mixing personal and business finances you increase the risk of losing your limited liability protection. By blending your finances, if something happens to the business, you are taking the risk that it could spread to your personal assets. If you are willing to blend the money, it appears that you are willing to blend the risk. And if a legal matter threatens your business assets, you are allowing others to look at your personal assets as well. One of the reasons you started down the path of LLC or S-Corp ownership was the liability protection it provided. Why risk that because you have not separated your finances?
Avoid piercing of the corporate veil:
If you are operating as an S-Corporation you want to avoid piercing of the corporate veil. The corporate veil is the barrier between the corporation and the shareholders. It is what protects the owners and members from the liabilities of the company. A court may “pierce the veil” and hold a shareholder legally liable for the actions of the company. Several factors come into play when determining whether to “pierce the veil”, but one of these factors is the failure to maintain separation between the company and the shareholder(s).
Maintaining accurate records:
It can become overwhelming, confusing, and frustrating, at year-end, to try and separate what was a personal expense and what was an allowable business expense if you are running all the income and expenditures through your own personal bank account. This leads to issues for bookkeeping and maintaining accurate records. Allowable expenses may be overlooked, and deductions missed on the tax return. You may incur additional expenses since you will most likely be paying a bookkeeper or accountant to sort through the mess and determine which transactions were for personal, business, or both. And you may have a harder time proving which expenses were for the business if you get audited.
Avoid a secondary audit on your personal return:
If all your business and personal finances are tangled and going through the same account, you are allowing the IRS to look at both the business and personal transactions. This creates a limited audit trail and may raise additional flags. If the original audit was to review the books of the business and the information you provide the auditor comingles that information, you may open a door for a secondary audit on your personal return. It also allows the auditor to question the expenses of the business and force you to prove the legitimacy of the deductions.
Easy tracking of business receivables and payables:
Shared accounts may complicate your records for tracking business receivables and payables. You could misappropriate a bill to your business that was paid from personal, or vice versa. Or you may tie an invoice payment for services offered to your personal income rather than that of the business. This can lead to inaccuracies such as an over or understatement of liabilities, or income.
Depending on your business structure, having separate accounts may be a requirement. For example, if your business is a corporation, partnership, or LLC, it is its own legal entity. This means you must maintain separate accounts. It is no longer an option for you to run everything through your own personal accounts.
Building a business credit:
Once you have separate accounts set up you can start looking at ways to build credit for your company. Many banks provide credit cards to members, including businesses. Building credit for your company provides you with a means to fund operations, buy equipment, or cover overhead as your business gets on its feet. It also means the debt will be in the business’ name and not your own.
The best way to ensure that your personal and business finances are separate is to open separate bank accounts. Have a checking and savings account in your personal name for personal funds, and separate accounts in the business name to deposit customer payments and pay business expenses. We recommend opening company accounts as one of the first steps you take after forming your business. Of course, if you did not take that step, we can help you do so now.
When you first formed your business, you covered the business expenses before generating revenue. You most likely used your personal funds to cover these costs. It is time to reconcile the start-up costs and reimburse yourself from the business. If you are an S-Corp, you receive a paycheck from your company, and reimbursements are relatively easy. They can be done through payroll using your business accountability plan. If you’re not an S-Corp, you can write a check to yourself from the business bank account for reimbursements.
Not a Formations customer yet? We can help get you set up and draft a business accountability plan right from the start. Schedule your free consultation call! We are here to help.