The truth is that you need to do it if you want your business to succeed.
Separating your business finances from your finances can also help protect you from liability lawsuits. It can also give you tax advantages and build up a solid credit history for your business.
So, let’s look at what makes separation so essential and how it will impact both sides of your financial life.
The Distinct Entities: Business and Personal Finances
When building your credit, it’s essential to understand the distinct entities of business and personal finances. Business credit is used as a measure of viability for a company. On the other hand, personal credit measures an individual’s ability to pay back any debts incurred in their name.
Business and personal finances are distinct entities that refer to managing financial resources in separate contexts. While they share some common principles and financial fundamentals, they differ fundamentally regarding purpose, structure, and management. Here’s a breakdown of the distinctions between the two:
- Business finances: The primary purpose is to support and sustain a company’s operations, growth, and profitability. It involves managing income, expenses, investments, and capital to ensure the business’s success and financial stability.
- Personal finances: On the other hand, personal finances are focused on an individual or family’s financial well-being. They involve managing income, expenses, savings, and investments to meet personal goals and ensure financial security for the individual and their family.
- Business finances: Businesses typically have a separate legal and financial structure from their owners. They may be structured as sole proprietorships, partnerships, corporations, or other entities, each with its financial responsibilities and obligations.
- Personal finances: Personal finances are tied to an individual or family and are not subject to the same legal separation as businesses. Personal assets and liabilities are usually closely linked to the individual’s name.
- Business finances: Business income primarily comes from selling products or services to customers, clients, or other businesses. It may also include investments, loans, or grants related to the company.
- Personal finances: Personal income typically comes from various sources, including salary or wages from employment, rental income, investment returns, and government benefits.
- Business finances: Businesses are subject to corporate income tax, separate from personal income tax. Business owners may also have personal tax obligations related to their salaries or dividends from the business.
- Personal finances: Individuals are subject to personal income tax on their earnings, investments, and other sources of income. Personal tax obligations are separate from business-related taxes.
Financial Management Tools:
- Business finances: Businesses typically use specialized accounting software, financial statements, and financial experts such as accountants and financial analysts to manage their finances.
- Personal finances: Individuals may use personal finance apps, budgeting tools, and financial advisors to manage their finances effectively.
The Benefits of Separation
There are many reasons why it’s best to keep your business and personal credit separate. Still, the most crucial benefit is that it allows you to establish each independently. For instance, most lenders look for a credit score between 300-850 for personal credit.
Suppose you have low personal credit; it should not affect your business credit, and separation can help. Separation has many more benefits, such as the ones listed below:
Building Business Credit
Business credit is a separate entity from personal credit. When your business and personal finances are not intermingled, a problem with one of your accounts won’t affect the other.
Business credit can be used to get loans and other financial products for your business. It’s also essential for building a positive business reputation. When lenders see that other banks trust you enough to lend money, they’ll be more likely to trust you, too!
The best part? Business credit can help save money in the long run by getting better loan rates than personal lenders. You can also get a business loan based on your credit score. According to Nerd Wallet, if your credit score is above 750, you can get any business loan. Some available options are bank business lines of credit, bank loans, and SBA loans.
However, this also means that if your credit score is poor and connected with your business credit, it can impact your company. For instance, lenders can deny your loan application based on your poor personal credit. Hence, it is vital that if and when you start a company, you build business credit without using personal credit.
According to eCredable, building business credit will only take six months to a few years. Hence, you should try to build a separate business credit instead of relying on your credit for business purposes.
For you to deduct business expenses on your taxes, they must be related directly to your business activity. Suppose you buy a new computer from Amazon and use it at home and in your office. In that case, only half of that expense is deductible. However, the entire cost would be deductible if you buy a new computer for work specifically.
Here’s how having separate business and personal credit can help you maximize tax benefits:
- Clarity in deductions: When you have separate business and personal finances, it’s easier to track and document business expenses for tax purposes. You can clearly distinguish between personal and business expenses, ensuring you claim all eligible deductions for your business. This clarity reduces the risk of mixing personal and business expenses, which can lead to audit triggers and complications with the IRS.
- Compliance: Separating your business and personal finances is often a requirement to maintain legal and tax compliance. This is especially true if you operate as a legal entity such as a corporation or LLC. Commingling funds can jeopardize your limited liability protection and may lead to tax penalties.
- Maximizing business deductions: You can build a strong business credit history by maintaining separate credit for your business. This can enable your business to qualify for loans, credit cards, and lines of credit. The interest and fees associated with business credit can be deductible, reducing your overall tax liability.
- Reducing taxable income: Properly separating business and personal expenses can help minimize taxable income. Deducting legitimate business expenses can lower your taxable revenue, potentially resulting in a lower overall tax bill.
- Capitalizing on business tax credits: Certain tax credits and incentives are available exclusively to businesses. You may be better positioned to take advantage of these credits by maintaining a distinct business credit history.
- Audit protection: Separating your business and personal finances demonstrates that you’re running your business legitimately and organized. In the event of an audit, this separation can provide a layer of protection by showing that you’re following proper accounting practices.
How to Keep Business & Personal Credit Separate
If you want to keep business and personal credit separate, here are some tips that can help:
Get an EIN to Keep Business & Personal Credit Separate
You should get an EIN if you run a business and have employees. The EIN is the Employer Identification Number used to identify your business for tax purposes. It is also a representation of the physical location. EIN is also mandatory for all companies by the law. According to census.gov, all businesses in the US must have at least 1 EIN.
Businesses need to keep their finances separate from their professional ones because it helps protect against identity theft and fraud. In addition, having separate credit scores can help you qualify for better loans in the future when expanding into new markets.
Establish a Separate Business Entity
Another thing you can do is to establish a separate business entity. Instead of getting business money in your personal savings account, create a different account for your business. Register your company according to the state and federal rules. This can also have benefits for your business.
For example, you can save on taxes by deducting expenses related to running the company. Additionally, you can reduce liability by separating personal assets from the business’s.
To get started with this step:
- Create an LLC or corporation by filing paperwork at your local courthouse or online through an attorney’s office. A domestic LLC with a minimum of 2 members is classified as a partnership for Federal tax purposes. It can be treated as a corporation if it files Form 8832. They have all kinds of books on how exactly this works, depending on where you live, so check them out!
- Open up bank accounts under each company name so that any income generated goes into these accounts rather than directly into yours. This will help prevent tax issues when claiming deductions against losses sustained while operating said enterprises.
We hope this article has helped you understand the benefits of keeping your business and personal finances separate. We also want to ensure you know how easy it is to do so! All it takes is time, effort, and organization, but once you get it all set up, everything will run smoothly from there on out.