Separating Business and Personal Money When You Work for Yourself
The one-man contractor who runs the business through his personal checking account is not saving time. He is paying for it later, in a worse tax return, a weaker loan application, and in the worst case a liability problem that the business structure was supposed to prevent.
Separating the two is a short afternoon of admin. Here is what actually needs doing and why each part matters.
Open a business account, even as a sole proprietor
You do not need to be incorporated to open a business checking account, and you do not need to wait until the business is a certain size.
The reason to do it early is record-keeping. Every deductible expense you fail to identify at tax time is money you hand over unnecessarily, and reconstructing that from a personal statement full of groceries and fuel is where people give up and under-claim.
If you are an LLC or a corporation, the account is not optional in practice. Running company money through a personal account undermines the separation that the structure exists to create, and that separation is the whole point of having formed it.
Pay yourself deliberately rather than by withdrawal
Money should move from the business account to your personal account on a schedule, in a recorded transfer, in an amount you decided in advance.
That habit does two things. It makes the business’s real cash position visible, because the balance stops being a mix of company money and your grocery budget. And it forces you to confront whether the business actually supports the income you are taking out of it.
How you should pay yourself depends on your structure, and it has tax consequences — an S corporation owner has different obligations from a sole proprietor. The IRS sets out the distinctions in its guidance on small business and self-employed tax topics. It is worth twenty minutes with an accountant before you set the pattern, not after two years of it.
Set tax money aside as it arrives, not at year end
Nobody withholds tax on your behalf. If you are self-employed you owe income tax and self-employment tax, and in most cases you are expected to pay it through the year rather than in one lump.
The practical version is a second business savings account that receives a fixed percentage of every payment that comes in, on the day it comes in. That account is not yours. It is the government’s money sitting in your custody.
The percentage depends on your bracket and your state, so ask rather than guess. The IRS explains who needs to pay quarterly and how to work out the amount on its estimated taxes page. Underpaying through the year can carry a penalty even when you settle up in full at filing.
Keep the paperwork a bank will want to see
Sooner or later you will want credit — equipment, a vehicle, a line to bridge a slow month. What a lender asks for is consistent, and it is easier to have been keeping it all along.
- Business bank statements showing regular, separated activity
- Two years of returns, if you have them
- A profit and loss statement that ties to the bank activity
- For contractors, a list of contracts in progress and what is still to be invoiced
The reason mixed accounts hurt here is that an underwriter cannot tell revenue from a personal transfer. Applications get declined for illegibility as often as for weak numbers.
Do not let the business live on a personal card
Funding a business through personal credit cards is common, understandable, and expensive. It puts high-interest debt against your personal credit file, which affects your ability to borrow for anything else, including a mortgage.
If you have already done it, treat unwinding it as a priority rather than a background task. Our guide to how personal loans work covers the trade-offs of consolidating, and the wider picture for owner-operators is in managing your business finances.
What to do this week
Open the business checking account. Move your invoicing to it so new income lands in the right place from the next job onward, and leave the historic mess where it is rather than trying to reconstruct it.
Then open a second account for tax and set a standing transfer of a fixed percentage of every deposit. Two accounts and one rule removes most of the problem.
If you are also thinking about how the business income interacts with your own budget, our notes on building a personal budget and on entrepreneurship and business finances cover the other side of the line.
Run a trade, a contracting firm or a local service business? We publish guest contributions from owner-operators. See our small business write for us page.
