19 November 2024

The Important Reasons to Keep Your Business and Personal Finances Separate

By Ronald Smith

If you’re like me, you probably used your own money to start your business and didn’t think about having a separate bank account. But whether you started your business as a side project, wanted to try out a business idea, or are working on your own, mixing business and personal finances is never a good idea. When you start making money or have expenses, you’re taking unnecessary risks.

The Importance of Separating Your Business and Personal Finances

As my business grows, I’ve learned the importance of setting boundaries between my business and personal finances. Here’s what I’ve discovered:

Hobby or Business?

When it comes to starting a business, the IRS expects that you’re doing it to make money. However, hobbies are a different story – they may or may not bring in profits. If you do make money from your hobby, you’ll have to report it as income on your personal tax returns and pay taxes on it. The downside is that you won’t be able to claim any business expenses for the costs you may have incurred.

If you want to claim deductions for your business expenses, you’ll need to report your income or loss on a Schedule C (Form 1040). Keeping your business and personal finances separate is crucial. It shows the IRS that your intention is to run a real business, not just a hobby. This separation allows you to claim those deductions.

Deciding on a Business Structure

I want to talk about something really important when it comes to running a business – keeping your business and personal finances separate. This is especially true if you have set up your business as a corporation or Limited Liability Company (LLC). When you do that, your business is seen as a separate legal entity, which means you need to keep separate accounting ledgers and bank accounts for it. It might sound like a hassle, but trust me, it’s worth it.

Even if you have a sole proprietorship, where all the profits and losses are tied to you personally, it’s still crucial to keep your business and personal finances separate. Why? Well, let’s say the IRS decides to audit you. They will want to see proof of your business expenses and income, and having good records is key. It’s much easier to keep track of everything if you have separate financial records for your business.

But that’s not all. Having separate business finance records also makes it easier for you to manage your bills and take care of your tax responsibilities. It just simplifies things and keeps everything organized.

I want to let you know that it’s not just the IRS that can audit businesses. There are other government agencies at the state and federal levels that might request financial records for various reasons. These records could relate to things like registration, corporate compliance, employment, and sales taxes.

Getting CARES Act Funding

When the COVID-19 pandemic hit and the government introduced the CARES Act, businesses of all sizes scrambled to gather the necessary paperwork to apply for disaster relief funds. The businesses that were prepared with all their financial and legal documents had an advantage and had a higher chance of securing the funds. However, those businesses that weren’t able to demonstrate their profits and losses missed out on the opportunity. Additionally, some lenders required businesses to have dedicated business bank accounts, while others only accepted incorporated businesses.

If you were lucky enough to receive money from the Paycheck Protection Program (PPP) and/or the Economic Injury Disaster Loan (EIDL), you’ll eventually have to show how you spent the funds. Already, the Justice Department has taken legal action against businesses that misused the disaster relief money.

The PPP requires that 75 percent of the loan be used for paying employees, while 25 percent can cover rent, interest, and business utilities. EIDL funds must be used for fixed debts (like rent), payroll, unpaid bills, and other expenses caused by the disaster. When your lender asks for proof, it’s crucial to have separate financial records that show how the money was allocated correctly.

Independent Contractors and the AB5

But let me tell you, being an independent contractor is no easy feat. You’ve got to prove yourself, my friend. To be called an independent contractor, you have to show that you control your time, your tasks, and your techniques. You’ve got to work in a whole different industry and have your own business operations. And you know what? Keeping your personal and business finances separate really helps to back up your claim.

A lot of independent contractors are even changing the way they do business. They’re setting up fancy things like corporations or LLCs. That way, the money they earn goes to their business, not directly to them. It’s like saying, Hey, I’m not just an employee here!

I’m sure you’ve heard people talking about the gig economy and how it affects workers all over the country. Well, let me tell you, it’s a hot topic right now. People are really looking closely at how these workers are classified. But here’s the thing, if you want to protect yourself and your business, there are some things you need to do.

Protecting Your Business

So, here’s the deal. When you start a business, like an LLC or a corporation, you’re creating a separate legal entity. What does that mean? It means that the business is its own thing, separate from you as an individual. And here’s the cool part – if you set it up correctly, you won’t be personally responsible for any bad stuff that happens to the business. They call it the Corporate Veil or Corporate Shield. It’s like armor for your business.

But here’s the catch. To keep that armor in place, your business needs to be accountable for everything it does. That means keeping its own money separate, like in its own bank account. And it means keeping really good records of what the business spends and earns. It’s like treating your business like a separate person, with its own bank account and everything.

When we follow the rules and keep everything in order, the corporate veil does something really important – it helps protect business owners like you and me from having to use our personal things to pay for the company’s debts or legal problems. But there’s a problem – if a court decides that the corporation or LLC has ignored the separation that the corporate veil provides, it’s like they’re lifting or piercing the veil. And when that happens, the protection that the corporate veil gives us is no longer there. Yikes! One thing that can put our corporate veil in danger is mixing our personal money with the business’s money. That’s a big no-no! If the corporate veil gets pierced, it means that we – the people behind the business – become personally responsible for any of the business’s debts or legal issues. And that’s not a situation we want to be in.

There are several ways to pierce the corporate veil apart from not keeping the required LLC or corporate records, such as using business assets for personal reasons, using a company credit card for personal purchases, and personally guaranteeing or using personal property as collateral for a business loan.

It’s not just important to keep business and personal finances separate. The business should also conduct all business communication using its own name. This includes proposals, contracts, invoices, sales receipts, marketing materials, and all financial documents.

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