The one simple piece of advice that every person that becomes self-employed or runs a small business has likely heard is that you need to separate the personal from the business. If you’ve heard this little nugget, then you’re probably eye-rolling along with me. Part of the reason it’s so cringey is because it’s so off base, if you do separate the two sides much, then you’re ignoring key self-employment financial tactics.
But it’s a cliche that I find is not only false, but an impossible ask. When someone runs their own, one-person business or has a company with a few employees, the ability to separate business finances from the personal finances is nearly impossible. Sure, from a structural and legal standpoint, you must have tools in place to keep a line between your personal and business affairs.
But for your finances, the entities will remain intrinsically intertwined for as long as you operate the business. When your business does well, it will have an impact on the personal. When the business performs poorly, you will feel it in your own finances.
I’m here to tell you that it isn’t a bad thing. By admitting the fact, you can now plan for it. The other option is to ignore reality, only to be blindsided when something negative occurs. Or to constantly live in a state of worry without a plan while you try to separate the two parts of your life.
Instead, accept the fact that the two are intertwined in a myriad of ways.
When running your own venture, one way to build long-term wealth is to ensure you have funds you’re setting aside for retirement. This has a two-pronged effect.
First, it grows your overall financial picture, since you have dollars set aside for when you no longer work. These funds will grow based on the way you’re investing, so they provide a resource not linked to the success of your business.
The second, and sometimes overlooked reason, is because it saves you on taxes. The more you’re stocking into these accounts, the less you’re charged by Uncle Sam (up to the contribution limits).
This has real world implications on how much money you have to funnel into your personal needs. It protects you long-term and gives you a sense of security, even if your business fluctuates wildly.
There are plenty of other ways, beyond retirement savings, to protect your money. This includes having the right structure for your organization. With the right planning, you can reduce the amount that you and your family pay each year.
Since many self-employed individuals file as LLC, they’re essentially a sole proprietor in the eyes of the IRS. For small businesses with a few employees, they remain an LLC, and it depends on how they choose to get taxed. But in both cases, there are options to be taxed as an S-Corp, which can reduce the overall amount of self-employment taxes (Social Security and Medicare) that you pay.
I recently wrote about the importance of this S-Corp election – as well as talked about who should do so. You don’t have much time, if you want to make this selection for 2023.
Again, if your organization reduces its tax base, then it gives it more wiggle room during tougher periods. This wiggle room can protect the personal side of things, depending on how deep the business suffers.
When someone says how much they’re paid, they’re usually talking about the salary. When someone who is self-employed states how much they make in revenues, it’s not much different. Sure they have expenses that they can write off, but there’s an inherent link between how much the company gets paid and how much you earn for the year. The fewer employees, the more closely this number is linked.
How large or fast this number is growing can have a one-to-one impact on how you view your own financial picture, what goals you believe you can achieve and whether or not you feel successful or content. It’s vital to recognize that or else it can have dramatic impact on your personal finances.
For example, if a business struggles to get off the ground and you place a significant amount of debt on a credit card, whose credit score will suffer? The business, which is you. Your ability to suddenly find credit in a pinch will be hurt.
Recognizing these pulls, urges and feelings towards the solo or small business is key to success. In part, because if you recognize the pull, you may be able to prevent yourself from making a mistake during a moment of panic.
Next time someone tells you to separate the business and personal, tell them to try and separate their salary from their finances. See what they say.