by Tony Smith, Managing Director at Company Debt
Many entrepreneurs use their personal savings to start their new business and their personal credit score to get a start-up loan. However, as the business thrives and grows, drawing a line between personal and business finances is vital to stay on the right side of the law and to make sure that the IRS gets its share of those profits.
If the thought of separating your business and personal accounts gives you a headache, here’s what you should do to ease the pain.
Consider a Limited Liability Company (LTD).
A business can be set up as a separate legal entity, such as a Limited Liability Company (LTD) or a corporation, which makes them legally distinct from their owners. This means that there are two clear separate entities, which are the corporation and you in the eyes of the law.
When you’re a sole proprietor, you’re deemed an unincorporated business with no legal distinction between it and you. All profits and losses and liabilities are tied to the sole proprietor or business owner personally. One of the risks you run as a sole proprietor is that you can be held personally liable for the outstanding debts of your business and your assets can be seized to pay your debts.
It’s definitely worth sitting down with your accountant or a tax adviser to consider whether it’s worth establishing a separate business entity or staying as a sole proprietor, which is the simplest structure to manage. Your adviser will look at the impact that incorporation would have on your taxes and financial plan as well as discussing what insurance coverage would be appropriate. By setting up a LLC, your personal finances would immediately gain a new level of liability protection, which could come in useful if your business is sued in the future.
Get separate bank accounts.
One of the easiest ways to open a business account is to go to the bank where you have your personal account and ask to set one up. All business transactions should run through this account, and if you’re careful and draw on the business account for all business expenses by the end of the tax year, all your income and expenses should be in one place, making record keeping and tax filing much easier. By looking at your bank statements, you’ll have an accurate picture of your business’ finances. Keeping good financial records and staying organised will also make it easier to provide proof to the IRS of your business’ expenses should you get audited.
Classify expenses properly.
When you’re a business owner, keeping track of all your business expenses and knowing how to classify them correctly so that you can take advantage of any deductions can be complicated. It’s tempting to try to write off entertainment, food and travel, amongst other as business expenses, but the simple fact is that meals with friends and family don’t qualify as business-related expenses. By classifying your expenses properly you can avoid basic record keeping problems and minimise the risk of an audit.
Get a business credit card.
Applying and qualifying for a business credit card as a new business can be tough, but like a separate bank account, a credit card can only help with record keeping and give you something to show the IRS if you’re audited. Another benefit is that the interest on a business credit card can be written off as a tax deductible business expense.
Although credit cards can be one of the most expensive way of financing a new business, they can help you to build up a credit history for your business that is separate from your own personal credit history that will enable you to boost your borrowing power, making lenders more keen to lend to you.
By having a separate bank account, credit card and record keeping software for your business, these will give you most of what’s needed to file your taxes and show the IRS that your business really is a business.
Set a budget.
Having a bank account and credit card for your business are a good start to separating finances, but creating a budget is another way that you can stay organized and keep your finances in order. At first, you may not see the relevance of a budget to keep your finances separate, however, sticking to a budget can avoid delving into your personal finances when something unexpected happens that hasn’t been planned for. Emergencies do happen, and even the best laid plans don’t always work out as intended. However, by setting a budget, it reduces the risk of running into avoidable costs that force you to dip into your personal finances to pay.
Pay yourself a salary.
It’s a simple fact that by putting yourself on payroll, making the necessary payroll deductions and writing your paychecks from the business account, your personal and business finances are more likely to be separate. Paying yourself a set salary helps to stay within the boundaries and ensures that you’re paying the IRS its share through payroll taxes.
Sole proprietors, LLC owners and members of partnerships are generally ineligible to receive a salary via payroll. However, to stay on top of finances, you should consider setting up your personal draws in the same way as paychecks, with the same amount taken at regular intervals.
Get professional help.
If you have any concerns that you are misclassifying expenses or you’re having trouble keeping your personal and business finances separate, it’s best to call in a professional accountant. He or she will be able give you tips on how to organise your finances better, guide you through the classification of expenses, the tax impacts of business transactions, and much more.
A professional accountant will help you establish a system that works for your own individual circumstances and help you to keep your books clean and clear.
Finally, if you haven’t yet separated your finances, now is a good time to start.
Tony Smith is Managing Director at Company Debt. Tony’s firm helps company directors by implementing effective business insolvency solutions, and providing free business debt advice.
