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You\u2019re at the warehouse store. In your cart that\u2019s roughly the size of a compact car, you\u2019ve got a printer, a few boxes of paper, some ink and a year\u2019s supply of pens for your business. But, for home, there\u2019s also cereal, milk, a closet organizer and a brand-name sweater that\u2019s just a steal.\u00a0(Besides, you\u2019re getting the organizer.)<\/em><\/p>\r\n\r\n\r\n\r\n 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.\u00a0(You\u2019ll sort it out later, right?)<\/em><\/p>\r\n\r\n\r\n\r\n You know that separating business and personal finances is the right thing to do. But, sometimes you let it slide, just a little. You\u2019re not alone.\u00a0Nearly one out of every five business owners don’t have separate personal or business\u00a0bank accounts<\/a>.<\/p>\r\n\r\n\r\n\r\n\r\n\r\n 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 \u2014 keeping your business and personal finances separate. We try not to get preachy, but in this case, it\u2019s warranted.\u00a0(Read on and you\u2019ll see.)<\/em><\/p>\r\n\r\n\r\n\r\n Yes. Your business is your business and personal finance is something entirely different. If you\u2019re 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.<\/p>\r\n\r\n\r\n\r\n Don\u2019t 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\u2019ll quickly learn why most independent business owners value their relationships with their\u00a0accountant and\/or bookkeeper<\/a>\u00a0so much.\u00a0(If you behave yourself, they\u2019ll let you keep your warehouse membership, too.)<\/em><\/p>\r\n\r\n\r\n\r\n Read more<\/b>:<\/em> Cash flow 101 \u2014 the basics.<\/a><\/strong><\/em><\/p>\r\n\r\n\r\n\r\n\r\n\r\n Aside from sounding a little naughty, commingling is the formal term for mixing business and personal finances. Depending on your background and beliefs, it\u2019s akin to living together before marriage.<\/p>\r\n\r\n\r\n\r\n Separating business and personal finances isn\u2019t just a stigma thing. There are serious legal and financial consequences to getting this wrong, including:<\/p>\r\n\r\n\r\n\r\n When you separate your business and personal finances through routine and processes, you\u2019ll see the following benefits:<\/p>\r\n\r\n\r\n\r\n Read more:<\/strong><\/em>\u00a0Understanding cash flow statements.\u00a0<\/strong><\/em><\/a><\/p>\r\n\r\n\r\n\r\n\r\n\r\n Believe it or not, the first thing you should consider is your business structure. If you\u2019re starting your own business, you need to know the legal and financial implications of whether or not you choose to incorporate.<\/p>\r\n\r\n\r\n\r\n A discussion of\u00a0business structures<\/a>\u00a0can get very complicated very quickly. For the sake of simplicity, we\u2019re going to stick with the difference between incorporated and unincorporated businesses in this post.<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n\r\n\r\n\r\n 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\u2019re entitled to all the profits from the business. This also ties you to all the\u00a0responsibilities<\/a>\u00a0as well.<\/p>\r\n\r\n\r\n\r\n As such, a sole proprietor files their business taxes as part of filing their personal income taxes.<\/p>\r\n\r\n\r\n\r\n If the business owner hasn\u2019t kept their business and personal finances separate, the audit process will take longer. Hint: Grumpy tax agents aren\u2019t a good thing.\u00a0(Ever tried getting out of the warehouse store without a receipt and your membership card?)<\/em><\/p>\r\n\r\n\r\n\r\n The good news is that with a few simple measures, like having a separate\u00a0business banking account<\/a>\u00a0and credit card, it\u2019s easier to track business expenses separately from personal ones.<\/p>\r\n\r\n\r\n\r\n 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\u2019s done well it can deliver significant savings.<\/p>\r\n\r\n\r\n\r\n 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\u2019s personal assets in the event of any legal or corrective action. It\u2019s also key if a creditor comes knocking at the door.<\/p>\r\n\r\n\r\n\r\n Another tax-time surprise that most self-employed sole proprietors encounter is\u00a0self-employment taxes<\/a>. If you\u2019ve 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.<\/p>\r\n\r\n\r\n\r\n This is why sole proprietors have to pay these mandatory taxes \u2014\u00a0making both the employer and employee contributions. If you\u2019re unprepared for this, it can be a major hit to your tax bill and your cash flow.<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n\r\n\r\n\r\n This means that in a legal sense, a corporation\u2019s assets are more clearly differentiated from an individual\u2019s personal assets \u2014 even if the individual is the CEO. This separation is often called the \u201ccorporate veil<\/a>.\u201d<\/p>\r\n\r\n\r\n\r\n 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 \u201cpierce the corporate veil\u201d \u2014\u00a0meaning 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\u00a0cash flow<\/a>.<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n\r\n\r\n\r\n\r\n\r\n 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:<\/p>\r\n\r\n\r\n\r\n When you use your\u00a0business banking accounts<\/a>\u00a0for business all the transactions relate only to your business \u2014\u00a0as they should. It\u2019s easier to reconcile with your accounting software and it\u2019s a must-have if you\u2019re going to use a payroll service or apply for\u00a0financing. The bottom line: It makes your business look and acts like a business.<\/p>\r\n\r\n\r\n\r\n 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\u2019re 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.<\/p>\r\n\r\n\r\n\r\n Even if you\u2019re 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\u2019s a boost for both your personal and business cash flow. You\u2019ll know how much you have to live off each month and you\u2019ll be able to track how and when this comes out of the company\u2019s books as well.<\/p>\r\n\r\n\r\n\r\n If you set this up formally, a salary for a self-employed sole proprietor is called a draw. If you use payroll software, you\u2019ll 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\u2019ll have the right records and documentation.<\/p>\r\n\r\n\r\n\r\n In order to claim an expense as a deduction for either business or personal income taxes, the expense has to be\u00a0properly classified<\/a>\u00a0and documented.<\/p>\r\n\r\n\r\n\r\n 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 \u2014 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\u2019s not even considered a legitimate personal expense for tax purposes.<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n\r\n\r\n\r\n 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\u00a0home office expenses<\/a>, you need to know which expenses qualify and how you need to track them throughout the year. The same is true for\u00a0tracking business mileage<\/a>, maintenance and other vehicle expenses.<\/p>\r\n\r\n\r\n\r\n If you bring your family on a business trip, in most cases, you can only deduct the costs of your travel expenses.\u00a0(Unless your 5-year-old is an employee.)<\/em>\u00a0Bringing 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\u2019re too tired to cook, it probably won\u2019t be covered.\u00a0(Unless you\u2019re both employed by the company and you were working on a deadline.<\/em>\u00a0See? Gray area.)<\/p>\r\n\r\n\r\n\r\n Once you know which business and personal expenses you need to keep records for you can then create systems for tracking them \u2014 all while keeping your business and personal finances separate.<\/p>\r\n\r\n\r\n\r\n A process that\u2019s made easier with the use of expense tracking tools, like Forwardly. (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.)<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n\r\n\r\n\r\n 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.<\/p>\r\n Read more:<\/strong><\/em>\u00a0The 10 Best Businesses for Cash Flow.\u00a0<\/strong><\/em><\/a><\/p>\r\n\r\n\r\n\r\n Some historians believe the nursery rhyme\u00a0Baa Baa Black Sheep<\/em>\u00a0dates back to a\u00a0medieval wool tax<\/a>\u00a0imposed in 13th century England.<\/p>\r\n\r\n\r\n\r\n Separating business and personal finances makes it easier to monitor a company\u2019s cash flow. It also makes this process more accurate when un-related, personal expenses or income aren\u2019t there to cause confusion. In the same vein, personal financial management and budgeting are easier to when you don\u2019t commingle cash flows.<\/p>\r\n\r\n\r\n\r\n Tax time is a million times easier if you\u2019ve 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\u2019ve followed the rules.<\/p>\r\n\r\n\r\n\r\nIs separating business and personal finances really a big deal?<\/strong><\/h2>\r\n\r\n\r\n\r\n
What is commingling\u00a0and how does it relate to business and personal finances?<\/strong><\/h2>\r\n\r\n\r\n\r\n
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Where do I start when it comes to separating business and personal finances?<\/strong><\/h2>\r\n\r\n\r\n\r\n
Sole proprietorships \u2014\u00a0separating business and personal finances and cash flow<\/strong><\/h2>\r\n\r\n\r\n\r\n
In the eyes of the tax authorities, a sole proprietor\u2019s business and personal income are one and the same.<\/strong><\/h3>\r\n\r\n\r\n\r\n
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When a business owner fails to keep business and personal finances separate, it\u2019s more difficult to provide the proper documentation to validate legitimate business expenses.<\/strong><\/h3>\r\n\r\n\r\n\r\n
Two other considerations for sole proprietors are liability and employment taxes.<\/strong><\/h2>\r\n\r\n\r\n\r\n
The hammer drops when the employer and employee are one in the same.<\/strong><\/h2>\r\n\r\n\r\n\r\n\r\n\r\n
Incorporated businesses \u2014 business versus personal finances and cash flow<\/strong><\/h2>\r\n\r\n\r\n\r\n
Corporations are taxed as separate entities.<\/strong><\/h3>\r\n\r\n\r\n\r\n
Corporations are responsible for following the applicable tax timelines and reporting guidelines.<\/strong><\/h3>\r\n\r\n\r\n\r\n
Five ways to keep your business and personal finances separate<\/strong><\/h2>\r\n\r\n\r\n\r\n
1. Open business banking accounts.<\/strong><\/h3>\r\n\r\n\r\n\r\n
2. If a credit card makes sense for your business, get one.<\/strong><\/h3>\r\n\r\n\r\n\r\n
3. Pay yourself a salary.<\/strong><\/h3>\r\n\r\n\r\n\r\n
4. Know the difference between business and personal expenses.<\/strong><\/h3>\r\n\r\n\r\n\r\n
A business expense relates to the running of a business.<\/strong><\/h4>\r\n\r\n\r\n\r\n
Gray areas include the use of personal assets for business purposes along with travel and entertainment expenses.<\/strong><\/h4>\r\n\r\n\r\n\r\n
Travel and entertainment expenses also have to be directly related to business functions.<\/strong><\/h4>\r\n\r\n\r\n\r\n
5. Develop systems for tracking business and personal expenses.<\/strong><\/h3>\r\n\r\n\r\n\r\n
Businesses can track expenses in their accounting software.<\/strong><\/h2>\r\n\r\n\r\n\r\n
Apps for tracking personal expenses, like\u00a0Mint<\/a>\u00a0or\u00a0You Need a Budget<\/a>\u00a0(YNAB), fall under budgeting and personal finance.<\/strong><\/h3>\r\n\r\n\r\n\r\n
The moral of this post\u2026<\/strong><\/h2>\r\n\r\n\r\n\r\n
The golden rule of separating business and personal finances also has its origins in the real world.<\/strong><\/h3>\r\n\r\n\r\n\r\n
More money rules to follow<\/strong><\/h2>\r\n\r\n\r\n\r\n