10 Steps to Separate Your Personal and Business Expenses
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Mixing your business and personal finances is not only headache-inducing but can also cause issues when tax season arrives. However, it’s never too late to get your business back on track.
In this guide, you’ll learn ways to separate personal and business expenses and why you should open a business bank account.
Differences Between a Business and Personal Bank Account
Personal bank accounts are designed for individual use and your day-to-day life. Some uses include:
- Paying utility bills
- Depositing paychecks
- Online shopping
- Taking out money at an ATM
- Sending personal payments to friends or family
On the other hand, business bank accounts are solely used for transactions related to your business, including:
- Depositing payments from clients or customers
- Paying suppliers
- Paying employees
- Purchasing business-related items
- Covering operating expenses
Furthermore, business checking accounts allow you to create debit cards for your employees and process credit card payments from your customers.
Another difference between business and personal bank accounts is how you create the actual account. Business bank accounts will require specific documents from your business entity. They also typically have minimum deposit requirements, minimum balance requirements, and monthly fees.
How to Keep Business and Personal Expenses Separate
To separate your business and personal expenses, follow these ten easy steps:
1. Get an EIN Number for Your Business
The first step in separating personal and business expenses is applying for an employer identification number or EIN. An EIN is a 9-digit number given to your company by the Internal Revenue Service (IRS).
You can then use the EIN to:
- File income tax returns
- File payroll tax returns
- Establish a business entity
- Open a business bank account
- Apply for a business credit card
It’s a business version of your Social Security number. Once the IRS assigns you an EIN, you won’t have to use your SSN for business duties. This division allows you to begin separating personal and business expenses.
2. Set Up Your Business Entity
With your new EIN, the next step is to create an LLC or corporation. Having an LLC or corporation allows your business to stand as a separate legal entity. With this done, you will be able to file your business tax returns separately from your personal tax returns.
3. Get a Business Bank Account
The third and most crucial step of separating personal and business expenses is to open a business bank account. Opening a business bank account allows you to manage your company's finances easily. If you’re using personal account for business expenses, it can get confusing fast.
As you’re opening a business bank account, you’ll have to choose between a checking or savings account. We recommend starting with a business checking account as they are more suited for day-to-day transactions.
4. Apply for a Business Credit Card
After you’ve created your business bank account, the next task is to apply for a business credit card. Using your personal credit card for business expenses impedes the goal of separating personal and business expenses. You’ll also be able to start building your business credit score.
Business credit scores are different from personal credit scores and are essential for financing. You’ll need an adequate credit score to increase your credit line and get approved for business loans.
5. Create a System for Keeping and Separating Your Receipts
Keeping your business receipts separate from your personal receipts is an important element of how to separate business and personal money. If the IRS ever audits your business, they will need to look at your business receipts.
6. Create a Budget for the Business
Creating a set budget for your business avoids situations where you have to use your personal bank account in the future. By having and following a strict budget, your business will have set boundaries on how much it can spend.
7. Pay Yourself a Set Salary
Using a business bank account to pay yourself a set salary offers an official boundary between your personal and business finances. Set yourself a monthly salary and transfer that amount from your business account to your account each month.
8. Learn the Difference Between Personal and Business Expenses
One of the significant errors businesses face is treating personal expenses as business expenses. Although it’s tempting to write off as many tax deductions as you can, there are hefty penalties if you do so.
In general, any expense directly linked to earning income for your business is a business expense. Anything that is purchased to be used by the company qualifies as a deductible business expense. Don’t put personal expenses on business accounts.
9. Log When You Use Personal Items for Business
Items that are mixed between personal and business use can be partially deducted. For instance, if you buy a computer used for business 50% of the time and private use 50% of the time, you can only deduct 50% of the computer as a business expense.
It’s vital to keep track of when you use personal items for business so that you can maintain an accurate log for deductions. Need a business bank account to make this easier? Check out NorthOne.
10. Teach Other Members of Your Business How to Track Business Expenses
If you’re the only person who understands how to track business expenses at your company, you can still face potential issues later on. For this reason, it’s essential to educate your employees and partners about the difference between personal and business expenses.
You want to avoid situations where employees misuse their business credit cards for personal expenses and muddy the company's finances. Everyone should be learning how to record personal expenses from business accounts.
Why Is Separating Personal and Business Expenses so Important?
The two most important benefits of separating personal and business expenses are tax convenience and personal liability.
Having a dedicated business checking account allows you to keep track of all of your company's finances in a single place. If you were to use a personal bank account for your business, you would need to manually separate each business and personal expense.
Furthermore, using a personal bank account for your business puts your personal assets at risk if somebody sues your company. Since your personal and business accounts are tied to one bank account, it will be difficult for the courts to differentiate between your personal and business funds.
When You Should Separate Your Business and Personal Finances
You should separate your business and personal finances as soon as possible. Although there might not have been any issues yet, you are leaving yourself open to many problems in the future by combining your finances.
Do All Businesses Need to Separate Their Personal and Business Accounts?
Although separating personal and business bank accounts is legally required for LLCs and corporations, it’s not required for sole proprietorships.
However, anybody who owns a business should create a dedicated business bank account. It will make your life much easier in the long run and has no significant downsides whatsoever.
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