Knowledge Centre » The Golden Rule: Separating Business and Personal Finances


You’re at the warehouse store. In your cart that’s roughly the size of a compact car, you’ve got a printer, a few boxes of paper, some ink and a year’s supply of pens for your business. But, for home, there’s also cereal, milk, a closet organizer and a brand-name sweater that’s just a steal. (Besides, you’re getting the organizer.)

When you get to the register, do you do the right thing and ask for separate receipts? Or, desperately try to save five minutes by putting it all on one bill. (You’ll sort it out later, right?)

You know that separating business and personal finances is the right thing to do. But, sometimes you let it slide, just a little. You’re not alone. Nearly one out of every five business owners don’t have separate personal or business bank accounts.

Because committed to helping businesses build better financial health, we want to give you an overview of one of the 10 commandments of small business accounting — keeping your business and personal finances separate. We try not to get preachy, but in this case, it’s warranted. (Read on and you’ll see.)

Table of Contents

Is separating business and personal finances really a big deal?

Yes. Your business is your business and personal finance is something entirely different. If you’re the owner or founder, the two are inextricably linked. However, as a best practice, you want to have things set up so that the two are separate from the start and that they stay that way.

Don’t be afraid, but separating business and personal finances means you kind of have to learn to think like an accountant. Or, work with one and you’ll quickly learn why most independent business owners value their relationships with their accountant and/or bookkeeper so much. (If you behave yourself, they’ll let you keep your warehouse membership, too.)

Read more: Cash flow 101 — the basics.

What is commingling and how does it relate to business and personal finances?

Aside from sounding a little naughty, commingling is the formal term for mixing business and personal finances. Depending on your background and beliefs, it’s akin to living together before marriage.

Separating business and personal finances isn’t just a stigma thing. There are serious legal and financial consequences to getting this wrong, including:

  • Liability — Whether an entity or individual can make claims against you and your business. Depending on how your business is structured or the nature of the claim, your personal assets could be at risk as well.
  • Penalties and fines — If you make a mistake on your business or personal taxes because you’ve commingled your business and personal finances, it can result in penalties and fines. Most of which also accrue compound interest, regardless of whether they apply to your business or personal income.
  • Risk — Anyone evaluating the financial health of your business will see a lack of separation as a potential concern. This includes lenders, credit bureaus, vendors, investors or anyone interested in developing a professional and/or financial relationship with your business.

When you separate your business and personal finances through routine and processes, you’ll see the following benefits:

  • Accuracy and transparency — Your personal accounts will reflect personal expenses and your business accounts will reflect business expenses.
  • Better cash flow management — When things aren’t mixed, you’ll have a clear picture of the factors involved in your business and personal cash flows.
  • Easier tax filings — Proper management and tracking of business and personal income makes it simpler to file taxes and claim deductions. Better processes and recordkeeping also means fewer mistake and that you’ll be more prepared if you’re asked to provide documentation.

Read more: Understanding cash flow statements. 

Where do I start when it comes to separating business and personal finances?

Believe it or not, the first thing you should consider is your business structure. If you’re starting your own business, you need to know the legal and financial implications of whether or not you choose to incorporate.

A discussion of business structures can get very complicated very quickly. For the sake of simplicity, we’re going to stick with the difference between incorporated and unincorporated businesses in this post.

Sole proprietorships — separating business and personal finances and cash flow

The most common type of unincorporated business structure is a sole proprietorship. In fact, the term unincorporated business is almost synonymous with being a sole proprietor.

While sole proprietorship is the simplest business structure, it can also be a bit of a bugaboo when it comes to separating business and personal finances. As a sole proprietor, you’re entitled to all the profits from the business. This also ties you to all the responsibilities as well.

In the eyes of the tax authorities, a sole proprietor’s business and personal income are one and the same.

As such, a sole proprietor files their business taxes as part of filing their personal income taxes.

  • Because a sole proprietor’s business and personal finances are so closely linked, sole proprietors are also the most likely not to follow the golden rule of separating business and personal finances.
  • The result: Sole proprietors are more likely to be audited than any other type of business.

When a business owner fails to keep business and personal finances separate, it’s more difficult to provide the proper documentation to validate legitimate business expenses.

If the business owner hasn’t kept their business and personal finances separate, the audit process will take longer. Hint: Grumpy tax agents aren’t a good thing. (Ever tried getting out of the warehouse store without a receipt and your membership card?)

The good news is that with a few simple measures, like having a separate business banking account and credit card, it’s easier to track business expenses separately from personal ones.

Sole proprietors who work from their home are also able to claim the home office deduction, writing off a percentage of home-related costs as business expenses. Again, this has to be done the right way and when it’s done well it can deliver significant savings.

Two other considerations for sole proprietors are liability and employment taxes.

One of the main reasons businesses incorporate is to make the business its own legal entity. This greater separation means fewer implications for the owner’s personal assets in the event of any legal or corrective action. It’s also key if a creditor comes knocking at the door.

Another tax-time surprise that most self-employed sole proprietors encounter is self-employment taxes. If you’ve ever worked as an employee for another business, your employer would have deducted and or paid part of your employment taxes (income tax and taxes for pensions and social programs) throughout the year.

The hammer drops when the employer and employee are one in the same.

This is why sole proprietors have to pay these mandatory taxes — making both the employer and employee contributions. If you’re unprepared for this, it can be a major hit to your tax bill and your cash flow.

Incorporated businesses — business versus personal finances and cash flow

When a business formally incorporates by becoming a corporation, the process of separating business and personal finances tends to be more formalized. For instance, most corporations will have their own banking accounts and tax identification numbers (tax IDs) right from the start.

Corporations are taxed as separate entities.

This means that in a legal sense, a corporation’s assets are more clearly differentiated from an individual’s personal assets — even if the individual is the CEO. This separation is often called the “corporate veil.”

If an incorporated business defaults on a loan or faces any other corrective action, in most cases, only the corporation can be held accountable. Note: It is possible to “pierce the corporate veil” — meaning incorporated businesses need to be aware of the liability laws in the geographic and regulatory areas in which they operate. A loss or penalty in this area can definitely hinder cash flow.

Corporations are responsible for following the applicable tax timelines and reporting guidelines.

This includes payroll taxes with required employer contributions, payment and reporting guidelines. Employers in the United States often have to manage employment taxes on a federal, state and local level. Mistakes at any stage of this process can be costly.

Five ways to keep your business and personal finances separate

As stated above, corporations often have systems in place, simply by the nature of what they are. Sole proprietors, partnerships, cooperatives and the startups of the world are the ones who really struggle with separating business and personal finances. If you resemble these remarks, these tips are for you:

1. Open business banking accounts.

When you use your business banking accounts for business all the transactions relate only to your business — as they should. It’s easier to reconcile with your accounting software and it’s a must-have if you’re going to use a payroll service or apply for financing. The bottom line: It makes your business look and acts like a business.

2. If a credit card makes sense for your business, get one.

Just like having a business banking account, using your business credit card just for business expenses is a better way to separate business and personal finances. You can also take advantage of rewards programs. Note: Make sure that you’re able to pay off the monthly balance. Otherwise, the interest charges could outweigh the benefits. A credit card is best for short-term purchases. If you need to fund a large, long-term business expense, make sure you know all your options ranging from a line to credit to small business loans.

3. Pay yourself a salary.

Even if you’re the only employee, paying yourself a set amount each month is another best practice for separating business and personal income. First, it gives you a consistent income. Second, you also set a consistent expense for the company. It’s a boost for both your personal and business cash flow. You’ll know how much you have to live off each month and you’ll be able to track how and when this comes out of the company’s books as well.

If you set this up formally, a salary for a self-employed sole proprietor is called a draw. If you use payroll software, you’ll automate the process of moving the money from your business to your personal account. It will also help you manage your employment taxes and when business and personal income tax time comes around, you’ll have the right records and documentation.

4. Know the difference between business and personal expenses.

In order to claim an expense as a deduction for either business or personal income taxes, the expense has to be properly classified and documented.

A business expense relates to the running of a business.

Tax deductions for the costs of owning or leasing office or retail space are examples of legitimate business expense. A personal expense is just that — it relates to your private life and has nothing to do with the operation of your business. In other words, grabbing a quick lunch during the work day is not a legitimate business expense. In fact, it’s not even considered a legitimate personal expense for tax purposes.

Gray areas include the use of personal assets for business purposes along with travel and entertainment expenses.

Having a home office, running a business from your home or using your personal vehicle for business are examples of using personal assets for business purposes.

Wherever you do business, there are specific rules for the definition of business use and the number of expenses you can claim. For instance, if you plan to claim home office expenses, you need to know which expenses qualify and how you need to track them throughout the year. The same is true for tracking business mileage, maintenance and other vehicle expenses.

Travel and entertainment expenses also have to be directly related to business functions.

If you bring your family on a business trip, in most cases, you can only deduct the costs of your travel expenses. (Unless your 5-year-old is an employee.) Bringing a spouse along on a business dinner will likely be accepted as a business expense. But, if you and your spouse go out to dinner because you’re too tired to cook, it probably won’t be covered. (Unless you’re both employed by the company and you were working on a deadline. See? Gray area.)

5. Develop systems for tracking business and personal expenses.

Once you know which business and personal expenses you need to keep records for you can then create systems for tracking them — all while keeping your business and personal finances separate.

Businesses can track expenses in their accounting software.

A process that’s made easier with the use of expense tracking tools, like ForwardAI Predict. (The best way to find these tools is to look in the app store for the accounting software you use. If you have an accountant, he or she will probably recommend a tool like this.)

Apps for tracking personal expenses, like Mint or You Need a Budget (YNAB), fall under budgeting and personal finance.

Remember personal tax deductions are a lot more limited and specific. Think child -and health-related costs or improvements to your home to make it more accessible or energy efficient.

Circling back to the previous bullet, the key is knowing which expenses business and which ones are personal. If you know this in advance, you know whether it applies to your business or personal finances. Business expenses should flow through the business using business banking accounts and/or credit cards. In turn, personal expenses should pass through personal banking accounts and/or credit cards.

Read more: The 10 Best Businesses for Cash Flow. 

The moral of this post…

Some historians believe the nursery rhyme Baa Baa Black Sheep dates back to a medieval wool tax imposed in 13th century England.

The golden rule of separating business and personal finances also has its origins in the real world.

Separating business and personal finances makes it easier to monitor a company’s cash flow. It also makes this process more accurate when un-related, personal expenses or income aren’t there to cause confusion. In the same vein, personal financial management and budgeting are easier to when you don’t commingle cash flows.

Tax time is a million times easier if you’ve kept your business and personal finances separate. So is building a credit history for your business or yourself. Both your business and personal risk profile will be stronger if you’ve followed the rules.

More money rules to follow

Monitoring business cash flow and knowing your risk profile is another mark of good financial behavior. This is why ForwardAI Predict is making it easier to understand these concepts by offering these tools free of change.

This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.


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