The information in this article is up to date through tax year 2019 (taxes filed in 2020).
As a small business owner, it’s hard enough to manage the day-to-day tasks of your company. So why would you complicate things by mixing personal and business finances? It’s not only more work for you to keep up with, but it can also prevent you from receiving business-related tax deductions since there’s not a proper division between finances. Luckily, separating your personal and business finances is quite simple. Here are a few tips to help you do it.
Register Your Business as a Separate, Legal Entity
If you start a business by yourself or with a partner without registering it, you’ll either be categorized as a sole proprietorship or partnership. The problem with these two business structures for your situation is there’s no legal separation between you and your business. To make a distinction, it’s recommended you set up a limited liability company (LLC), C corporation or S corporation. A business structure makes your company look more legitimate and also offers personal asset protection that a sole proprietorship and partnership can’t provide. Each structure has its pros and cons, so do some research to see which one best suits your needs.
Get an Employer Identification Number (EIN)
Consider obtaining an Employer Identification Number from the IRS, which is like a Social Security number for your business. An EIN is not required if you’re a solopreneur or answer no to any of these questions provided by the IRS, but it’s strongly recommended. For one, it will protect your Social Security number. Filling out business-related forms using your Social Security number puts you at risk for identity theft. An EIN is much safer to use since it’s only utilized as a federal identifier. Additionally, you can’t change your business structure, establish a retirement plan or open a business bank account without an EIN.
Set Up a Business Bank Account
After you receive an EIN, open a business checking account. This is one of the most important actions you can do to differentiate your personal and business finances. The IRS usually looks to see if you have a separate checking account to determine whether your endeavor is a hobby or true business. A business bank account also makes it easy to organize financial records, file your tax forms and check the monetary health of your company.
Before you set up an account, be aware that most banks impose a minimum monthly balance. This means you have to keep your bank account balance above a certain amount per month – i.e. $1,500 – to avoid a monthly maintenance fee. If you’re unsure whether you can meet these types of requirements, set up another personal checking account and designate that as your business account.
Consider a Business Credit Card
If you’ve been making business-related purchases on your personal credit card, you should switch over to a business credit card. You run the risk of maxing out a personal credit card since it has a limited credit limit compared to a business credit card. Plus, using a business credit card helps further separate your personal and business finances all while building your company’s credit score, which you can use to get loans and finance equipment and other purchases as you grow.