Separating business and personal money

In short

A friend of mine ran a small landscaping outfit for six years out of one checking account. You have probably done something close to it yourself. Open a separate checking account in the name of your business, and let every dollar of business income land there. Pay every business cost from that account, and never buy groceries with it. When you want money for yourself, move it over on purpose, and write down what kind of move it was. Keep the receipts and the bank statements for as long as the IRS tells you to. This one habit will make tax time calmer, and it will help protect you if someone ever sues the business.

The whole of it

What it is

I once watched a man dig through a shoebox of receipts at a kitchen table, looking for one lunch he was sure was a business lunch. He never found it. If you own a small business, you have probably felt a little of that same dread.

Separating business and personal money means keeping two sets of books and two sets of accounts. One is yours as a person. The other belongs to the business. Money does not wander between them by accident. It moves when you decide it should, and you leave a note about why.

Sole proprietors, LLC owners, partners, and corporation owners can all do this. The steps differ a little by business type, but the habit is the same. Your business gets its own bank account, its own card, and its own paper trail.

Some folks think this only matters once a business gets big. It matters most at the start. Habits set in the first year tend to stick around.

How it works

You have probably heard that a business needs a bank account. The reasons are worth knowing, because reasons are what keep a habit alive.

Start with the account itself. Most banks ask for your business name and your tax ID. That could be an Employer Identification Number, which the IRS issues for free, or your Social Security number if you are a sole proprietor with no employees. If your business has a formal name, bring the paperwork that shows it. Ask the bank about monthly fees and any minimum balance before you sign. Fees vary from bank to bank, so compare a few.

Next comes a card. A business credit or debit card keeps every swipe on one statement. You can also ask your bank about a business credit card, and read its interest rate and fees closely before you apply.

Then comes the part people skip. When you pay yourself, you make a transfer, and you know which kind it is. If your business is a sole proprietorship or a single member LLC, that transfer is usually called an owner draw. It is not a business expense, and it is not a wage. If your business is an S corporation, the owner who works in the business has to be paid a reasonable salary through payroll. Ask a tax professional how your business type handles it, because the rules differ.

Last, you keep records. IRS Publication 583, Starting a Business and Keeping Records, explains what to save and how. IRS Publication 535, Business Expenses, explains which costs count. Both are free at irs.gov. The IRS also has a page on how long to keep records, and you can find it by searching that phrase on irs.gov. The answer depends on what the record shows.

The numbers, and where to find yours

A few figures matter here, and I will not guess at them. Some are set by law and change over time.

The IRS sets a standard mileage rate for business driving each year. It is the current figure, which the official source publishes each year. If you drive for the business and want that deduction, you need a log of your trips. A mixed personal and business account makes that log harder to trust.

The IRS also limits how much of a meal you can deduct. The current share is the current figure, which the official source publishes each year. Keep the receipt and note who you met and why.

Some rules about how long to keep records are also set by the IRS. The general period for most returns is the current figure, which the official source publishes each year. Some records need to stay longer, so check the record keeping pages on irs.gov to see which period fits yours.

Your own numbers live in three places. One is your bank statement. Another is your accounting software or spreadsheet. The third is last year's tax return. If you have no return yet, your first year's statements are where the story starts.

A worked example

Let me tell you about a woman named Marisol. She runs a small bakery that sells at farmers markets. Last year she kept everything in one account, and she felt lost when her tax preparer asked for her expenses.

This year she opened a business checking account. In March, she took in 4,200 dollars in sales. She paid 1,300 dollars for flour, butter, and packaging. She paid 400 dollars in market booth fees. She paid 150 dollars for a permit.

Here is her math, with every input shown. Sales of 4,200 dollars minus supplies of 1,300 dollars minus booth fees of 400 dollars minus the permit of 150 dollars leaves 2,350 dollars. That is 4,200 minus 1,300, which is 2,900. Then 2,900 minus 400 is 2,500. Then 2,500 minus 150 is 2,350.

That 2,350 dollars is her profit for the month before taxes. It is not what she gets to spend. She still owes income tax and self employment tax on her profit. Because she is her own boss, no employer holds any back for her. The IRS explains estimated tax payments in Publication 505, Tax Withholding and Estimated Tax.

So Marisol moved 1,500 dollars from the business account to her personal account as an owner draw. She wrote "owner draw, March" in her notes. The other 850 dollars stayed in the business account. She kept it there to cover future tax payments and a slow month.

When tax time came, her preparer had one clean statement. It took a short meeting instead of a long week.

Where it goes wrong

I have made this mistake myself, so I will not scold. The most common slip is small. You pay for a business item with your personal card because the business card was in the other pocket. Then it happens again. Soon the line is a blur.

Another slip is paying yourself in odd amounts at odd times, with no note. Six months later, you cannot say whether a transfer was a draw, a loan, or a repayment. Label each one.

A third slip is treating the business account like a personal piggy bank. If you own an LLC or a corporation, mixing funds can weaken the legal protection that entity gives you. Courts sometimes look at whether an owner kept the business separate from personal life. This is called piercing the veil. It is not certain in any case, and the details depend on your state. A local attorney can tell you how your state sees it.

A fourth slip is forgetting taxes. Money in the business account is not all yours to spend. Set aside a share for taxes as income arrives.

A fifth slip is throwing out records too soon. Keep what the IRS says to keep.

Fix any of these and you are back on the road. A messy year does not make you a bad owner.

Questions to answer before you leave this page

Do you have a bank account that carries only your business name and only your business money? If not, what is one bank you could call this week to ask about fees and requirements? Do you know which kind of business you run, and how that changes the way you pay yourself? When you last moved money to your personal account, could you say what the transfer was? Where do you keep your receipts, and could a stranger follow them? Have you set aside anything for taxes, and do you know where to read about estimated payments? And who could you ask, a tax professional or a local attorney, if a question comes up that this page cannot answer?