When starting a small business, it's important to keep your business finances separate from your personal finances — particularly when it comes to expenses.
Tempting though it might be to use your personal credit card to buy a smartphone as you launch your business, that sets a dangerous precedent. If you don't treat your personal finances and your business finances separately, the law won't, either. This is known as "piercing the corporate veil." And it could mean, among other things, that you lose the liability protection that ought to come with incorporating.
Here are some tips on how to avoid that potentially disastrous scenario.
Don't Jump the Gun
Starting a small business can be stressful and time-consuming. It's easy to fall into "just-for-now" rationalizing. You'll purchase equipment and other startup essentials from your personal checking account. And then once you get up and running, you'll file all the proper paperwork to become a corporation and open a bank account dedicated to the business. No problem, right?
Wrong. You need all the necessary paperwork and permits in place, along with a bank account, before you record your first transaction. If you don't think you have the time or expertise to handle those steps yourself, consult a business lawyer or bookkeeping professional. If tax season rolls around and you determine you haven't done an adequate job of separating your personal expenses from your business expenses, there might be only so much a professional can do to sort things out.
Worse yet, if your business fails and leaves behind a mountain of debt — look out. You could be personally liable. In fact, you could lose everything you own, including your house.
There's No Such Thing as "On the Side"
Maybe your new business isn't supposed to be a full-time occupation. Maybe it's something you're going to operate as a sideline, on evenings and weekends, until you see if there's enough potential income to do it full-time.
It doesn't matter. You still need to keep the business separate to protect yourself. Otherwise the salaried job you're keeping as a hedge could end up being used to pay down your business debt. Also, if you have separate income streams, you'll need to treat them differently for tax purposes. In addition to providing liability protection, complete, accurate financial records could increase your business' value should you ever decide to sell it.
If your sideline "business" is really more of a hobby, such as being a DJ or playing music on the weekends, you're still entitled to deduct certain expenses, but also bound by certain IRS restrictions — the most important being that you must legitimately intend to make a profit. You can't deduct tens of thousands of dollars' worth of equipment, for example, if you don't realistically expect to ever make more than $20 per performance. And, as always, you can't comingle personal expenses with your business/hobby expenses.
On the other hand, if you believe your avocation could someday become your vocation, you should consider setting your sideline up as a protected business entity right from day one.When starting any small business, it's important to focus on the business part of the equation, not the small part. Read more on how to do that here.