In a startup’s early days, many founders struggle with deciding how and when to make their business activities “legitimate”—especially when they are still trying to decide whether or not to fully commit to the project as a new business. While some hesitation is understandable, putting off the process of separating your business’s finances from your own can create unnecessary complications down the road. Keeping business and personal finances separate is key to making sensible accounting decisions, paying taxes, and handling audits.
Your finances need to be legible to many stakeholders
Early on in your business’s history, when you and your cofounders are the only people engaged in your startup’s operations, it may seem redundant to keep track of what you spend money on. How could you forget that you paid your AWS bill or consulted with a lawyer?
In actuality, these things don’t only matter because of their impact on your bank account balance—they’re part of your company’s financial history, which means they’re subject to examination down the road from people who have a legal right to look into them: specifically, the IRS, your bookkeepers, and eventually, investors. Each of these three audiences will appreciate the accuracy and completeness of your record-keeping.
The IRS also places a lot of importance on the appearance of separation. Because the business’s legitimacy is a prerequisite for deducting business expenses, showing the IRS that you conduct your business in a legitimate way helps avoid triggering an audit during tax season.
Fortunately, there’s a very easy way to ensure that all your business-related transactions are kept in one place.
A business bank account makes record-keeping easier
The biggest step in separating your finances is opening a business bank account. Most banks offer some type of business-optimized account solution, with various features and fee structures that differentiate them from consumer/personal accounts. These may include access to a business line of credit, payment processing, or the ability to have multiple people sign or deposit checks.
Regardless of features, all business bank accounts deliver a number of benefits purely by providing a clean divide between your personal and business finances. One of these is to contribute to the appearance of legitimacy for the IRS’s benefit, as we know. But even for you (and your cofounders), this division makes it much easier to understand the state of your business’s finances.
If all of the cash you’re spending as well as the revenue coming in live in one account, the balance of that account is a good proxy for your business’s financial health. While it may not provide any forecasting or analysis, your bank account balance can still give you early signals if you’re headed for trouble and help you find the cause by presenting all your transactions in one place, without requiring you to filter out all the noise of personal spending.
As another added benefit, the separation makes it clearer that the business’s financial health is separate from your own. Transactions between you and your business (such as paying yourself) must be at “arm’s length” to protect yourself (and the business) in the case of an audit or lawsuit, and the clear delineation between the two parties is a step in the right direction.
Clean records mean easier deductions
At tax time, you’ll be able to claim a number of deductions for business expenses for things like entertaining clients or traveling for work. To claim the deductions, you’ll need to be able to prove they were work-related. If these transactions took place from a business bank account or on a business credit card, it will be more obvious to the IRS that they were part of your business’s operations.
Note that simply paying for dinner on your business credit card doesn’t mean it passes the test: the IRS wants to know that you incurred the expense with the main purpose of conducting business, so simply taking your friend out to a restaurant doesn’t count.
You can also deduct the use of your home office, provided you don’t use the home office for any other purpose. As with the business expenses, your eligibility for this deduction will be easier to prove if you pay for the utilities and equipment through your business’s channels rather than your own.
For any business expense to be deductible, you have to be aware of it so you can claim it when you file. If your business transactions are all listed in one place, it’ll be easier to spot the expenses that you can write off at tax time.
Clean records save money later
One of the best benefits of keeping clean records and distinguishing your business’s finances from your own is that it reduces complexity when you need to hire financial management professionals. As your business grows, you’ll want to engage the services of someone who can help you keep records in accordance with the law and make sense of your business’s financial health.
To provide their services, your startup’s accountant or bookkeeper will have to establish a starting point for the records they keep by going through all the expenses and income your company has already experienced. If you’ve been keeping your business’s transactions separate from your own, this project will be substantially less complicated than it will be if you have been using the same account for yourself and your business. If they’re mixed together, your accountant or bookkeeper will have to sort through your personal finances to separate out the transactions that are related to your business, which can take quite awhile.
Separating the two may be annoying for your accountant or bookkeeper, but more importantly, it’ll be expensive for you. Starting from a clean and complete bank account record of your business’s financial history will go a long way towards keeping costs down.
Since any business will have to consider all of these angles, it makes sense to keep records from day one. If you open a business bank account immediately after you incorporate your startup, you’ll be starting its financial history at the same time as its legal history. Then, when it’s time to pay taxes, hire a CPA, or court investors, you won’t have to do the messy work of extricating your personal expenses and payments from your company’s costs and revenues. It’ll save time and help you maximize your deductions, but perhaps even more importantly, it’ll save your business money down the road.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.