It’s all too common for home-based business owners like you to intertwine their business and personal finances, especially if you’re a sole proprietor.
Even if you’re in the launch stages of your business, it’s crucial to draw a line between these two parts of your financial life. Separating your business finances from your personal finances will help your business appear more professional and save you tax and liability headaches down the road.
Ernest Walker is an IT Consultant based in Columbus, GA who runs his business, Silver Lining Consulting LLC, from home. “I had heard the horror stories of people mixing the two and their life being turned upside down with litigations where the personal assets of the owner were being taken to fulfill the obligations of the business,” he says. “I didn’t want to be that person.” So, after doing some additional research on Nav.com, he decided an LLC was the way to go.
Here’s why and how you may want to consider incorporating and separating your finances:
Tax Reasons
Why:
To be deductible, the IRS says an expense must be both “ordinary and necessary.” The IRS also says that it’s important to separate business expenses from personal expenses. If you run personal and business expenses through the same account, it’s going to be that much harder to document which expenses are personal, and which ones are for your business. If your business is a corporation, it’s especially important to keep your business finances separate because your business is considered a separate legal entity.
If the IRS decides to audit you, the burden of proof is on you to document your business expenses and income. It will be easier to do if you maintain proper records and independent accounts.
How:
- Apply for an Employer Identification Number (EIN). You’ll use it instead of a Social Security number for your business and you’ll need it if you hire employees down the road.
- Open a business checking account and use it to deposit income for your business, and to pay expenses
- Use business credit cards instead of your consumer cards for your firm’s purchases.
- Set up accounting software exclusively earmarked for your business or hire a bookkeeper to maintain your financial records
Liability
Why:
As a home-based business owner, it’s crucial to clearly distinguish your company as an autonomous entity to limit your liability. It’s one of the main reasons companies go through the trouble setting up a corporation. Operating as a corporation will afford you legal protections that you don’t get when you’re a sole proprietor.
However, even if you’ve incorporated, commingling your business and personal funds could jeopardize the legal protections that incorporating offer.
Ever heard of “piercing the corporate veil?” If someone sues your business, they may try to prove the distinction between you and your business isn’t definitive. They’re attempting to “pierce the corporate veil” so that the courts will set aside the limited liability of your company. If they’re successful, you, and other directors or your shareholders, may be held liable for the company’s actions.
If the line between your business and personal finances is blurred, it’s far easier for a petitioner to prove that you should be liable.
How:
If you’re operating as a sole proprietor, you may want to consider incorporating. First, determine how you want to structure your business. Then create a legal identity such as an LLC, S-Corp, C-Corp, Non-profit, etc. An accountant or attorney, or organizations such as SBA or your local Small Business Development Center can offer guidance so you can choose the best route for your venture.
If you have incorporated already, continue to maintain the distinction between you and your company. Avoid paying any personal expenses out of company funds. If you accidentally do so, ask your accountant for advice on how to document that.
Professionalism
Why:
If you’re serious about your home-based business, you don’t want clients to think it’s just your hobby. Separating your finances can help your business appear more professional.
Clients who purchase goods or services from your firm will take you more seriously if they make payments to your company. The same is true for vendors and other business partners.
How:
Some of what we’ve already covered will up your professional game, like having a business checking account and business credit cards.
When it comes to getting paid, be sure to invoice promptly and professionally. Consider offering a small discount for prompt payments, and always follow up quickly on late payments.
According to research by Fundbox, it takes the average small business 21 days to get paid and 81% of small business invoices are 30 days past due. If you provide your clients with goods or services without getting paid upfront, consider checking business credit on them first. A history of late payments or other negative information may be a red flag.
