Establishing your business as a legal entity is one of the most important aspects of protecting your business. But after you’ve done this, it’s also important that you continue to operate the business as its own entity, and not commingle your funds with those of the business or sign agreements in a personal capacity.
The first part in establishing and maintaining the legal entity structure is using the business name out when rather than your own. For example, when signing any legal documents, make sure it is clear it has been signed by the business that is that the business name is clearly included within the contracts. If you are signing this in a personal capacity, then you may subvert the benefits associated with your legal form.
Another aspect that it’s important to maintain the legal protections, is you not to commingle your funds that is to ensure that you are using this separate bank account for all of the businesses, and activities, and you are not putting company charges on your personal accounts or personal charges on the business account.
Why maintain a clear separation between business and personal activities
Maintaining limited liability status
One of the dangers of common commingling, your firm’s is that it starts to open a door that you will not operate the business as a separate business that is there is no distinction between the business and your personal firm’s friends. This can be a start to reduce or even eliminate the protections that having a separate legal entity brings.
For example, if someone is suing they may be able to make the case that there is no distinction between you and your firm. And in tune and look to sue for your personal assets. In addition to those of the company.
Similarly, if you have signed the contract as yourself without the company’s details on it. Then, individuals may come after you personally for any issues that they have with your services.
Easier Record Keeping and Correctly Recording Taxes
One of the other real dangers of commingling is that it makes it very difficult to disentangle the funds and very difficult to keep track of what the costs are very difficult to be able to file taxes at the end of the year. Comingling business and personal finances can cause significant issues when filing taxes that may result in you not taking deductions that you are eligible for, or erroneously claiming deductions on personal expenses.
Not claiming deductions on business expenses paid from personal finances
As a business, you will be able to write off many legitimate business expenses against your taxes, and in turn not have to pay tax on that proportion of the businesses’ earnings. As a simplified example, if you have annual earnings of $100,000, but have costs totaling $50,000, then income tax is typically only due on the profit – the difference between the revenue and your costs (it’s often more complicated than that with depreciation for example, but the principle holds).
This however requires keeping track of your expenses: if you are paying costs out of your personal account, then deducting your expenses becomes a lot more difficult. It is easy to lose track of what you have spent, potentially resulting in you not being able to write off the business expenses. Indeed, even if you keep records of what you have spent out-of-pocket, you run the risk of greater scrutiny on your costs, and concerns that these are not legitimate business expenses, again running the risk you will be unable to deduct expenses paid from personal accounts. Keeping these costs separate makes accounting for your costs a lot easier.
Incorrectly paying personal expenses from a business account
A connected danger arising from paying personal expenses from a business account is that you underpay your taxes, incorrectly deducting personal expenses as business costs. For example, paying groceries on a business account, and claiming this as a business expense for tax purposes, will result in you underpaying your taxes.
Failing to separate out your business and personal expenses heightens the risk of inadvertently claiming personal expenses as business deductions, which can cause you and your business significant problems, including greater scrutiny of other costs, fines, or even prosecution for tax evasion.
A final benefit for maintaining a clear business identity is to increase the professionalism of your organization. If you are making payments to/from a personal account it can reinforce to customers and suppliers that you are a small entity, potentially increasing concerns that they may have about transacting with your firm. With credibility often a key issue for startup organizations, creating a business account is an important step in establishing the reputation of your business.
Approach for maintaining a separation
Setting up separate accounts
One of the very first things you will want to do when operating a business is to establish company accounts (and to ensure that they are then used consistently. While it may seem daunting to have a company account, typically it is no more difficult than setting up a personal account – the bank will likely require details of your company registration and may need details on the activities that your firm engages in for their record-keeping, but overall the process is typically relatively quick.
Changing your mindset
One good way of getting around this is to think of yourself as an employee of the business. Especially when you are very small it’s very easy to lay just within your mind. Think of the business as being part of you. It’s worth getting away from this situation to move to a point where, and you see yourself as an employee of the business, just so happens to be warned that you own an employee.
It is natural when working for a company that that company would sign documents, it wouldn’t you personally be signing them. Similarly, it’s natural that a company would be for paying for things out of a company bank account, it wouldn’t have the expectations that the employees would pay for them out of their own pocket.
This is exactly the mindset that you want to have even with a business that you manage yourself. Keep a boost of the legal barrier there as well as a mental separation between the businesses that you are learning, and your own personal life and activities.
Being diligent about enforcing a distinction
One of the most important things is that you are diligent about actually enforcing using the separate business account. A common reason for comingling is laziness – you have the other card to hand in your wallet, or your online account is already setup with a personal/business account, making it easier to make the purchase on a different account.
Ultimately the time ‘saved’ by using a different account is likely to be dwarfed in the long run by having to unpick the problems (with associated costs of an accountant to help make corrections), or genuine costs associated with not claiming business deductions for expenses charged on a personal account.
Keeping business and personal activities separate is not difficult, but it does require some commitment. A key thing to remember is that in the long run, it is a lot easier to maintain the separation – unpicking a mix of comingled accounts is not an easy activity – and it can be crucial to maintaining your liability status.
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