The Importance of Keeping Business and Personal Accounts Separate

For small businesses, a business bank account provides a more professional way of running your business in terms of managing your financials such as tax requirements and deductions, but it also provides protection from lawsuits. It is important to note that in certain situations, it might be difficult to separate the two. For example in the case of a sole proprietor where the individual and the business are one and the same. It is perhaps for this and other reasons that most accountants and business lawyers often advise that you should preferably always have a separate entity under which you conduct your business.

Here are three reasons to keep business and personal accounts separate:

Protection from Lawsuits: 

A small business protects itself more effectively by not combining business and personal funds. Separating a business and personal account means that the owner can't be held personally liable for the company's debts.

There are some exceptions, however, where the owner of a small business may become personally liable for the debts of the business. In such cases, the small business owner may have his or her assets or investments used to pay off the debts of the business.

This practice is also called 'piercing the corporate veil' which occurs when a small business owner fails to adhere to corporate formalities such as; keeping detailed records or holding annual meetings of stakeholders.

A small business is especially vulnerable to having its veil pierced due to its size and corporate practices. Making the mistake of combining assets or using the assets of the business for personal needs and vice versa is common among small businesses.

The risk with this practice is that the owner's assets are placed in jeopardy, especially in the event of a lawsuit. In other words, keeping your business account separate from your account is a protective legal measure

Taxes and Proving your business is not a hobby:

The IRS is picky about proving your business is a small business and not a hobby. If you have a separate bank account for your business transactions, you have a clean record to give your accountant at the end of the year.

It is, therefore, essential and for tax purposes to keep business and personal expenses and deposits in a separate bank account that can help one manage budgets and financial transactions more easily when tax season comes.

The laws are also clear regarding what differentiates a small business from a hobby therefore, only businesses are allowed to deduct expenses. The use of a personal account to manage your business transactions will in the eyes of the law consider your business a hobby, especially in the event of an audit by the IRS.

It is essential to set personal accounts separate from business accounts because business fillings must be filled separately from personal tax.

An incorporated business is expected to also maintain a separate business account irrespective of the type or nature of incorporation as it becomes its legal structure and is set apart from the individual who founded the business.

Keeping Track of Finances and Business Records:

Keeping a business account even as a small business is the best way to keep track of your finances and records of your business. It is therefore critical for a business owner to operate a business account because placing a barrier between the business and personal finances helps to make day-to-day transactions easy to follow and document. 

Furthermore, this means a business owner can track income and expenses more easily identify potential business deductions, maintain clear records for potential audits, and also potentially limit one's liability.

Operating a business account that is separate from a personal account also provides the extra benefit of securing lines of credit and cash management services. It, therefore, makes sense that building a relationship with a business banker familiar with your industry provides an extra avenue for gaining experience and expertise when needed.

The ability to obtain working capital for your business is vital to growing it, and business credit will be mandatory to secure larger business loans. Having your personal and business income blended makes it more difficult to provide your business income to banking agencies, making it more difficult to establish your business credit.

In conclusion

the importance of separating personal and business finances comes down to saving time. Hiring an accountant will come at a cost, but having a complete separation of finances equates to fewer billable hours, helping to save you a large amount of cash in the process. Acquiring a business accounting software is another option, as this will provide small business owners with options and guidance on maintaining their financial records.