When you own a business, it’s easy to think of the assets of the business as your assets. And while this is true to a point, it can cause a lot of problems if you start treating the business’ money as your own, using business accounts for personal purchases and vice versa. This is called commingling funds and it can lead to serious financial risks for you and your business.
Here are three major risks of commingling that you may not be aware of:
Endangering Your Deductions
When you mix business and personal expenses in the same bank and credit card accounts, you run the risk of losing legitimate tax deductions.
In order to deduct items on your taxes, you need to be able to support those expenses and prove they’re deductible business costs. With everything mixed together, it’s very unlikely you’ll be able to prove what’s what and the IRS may end up throwing out business expenses to ensure you’re not deducting personal expenses.
If you have a very small business – like a solopreneur – commingling can even endanger your status as a business before the IRS. One of the ways they determine if you have a serious business as opposed to a hobby that brings in some money is by looking at your bookkeeping to see if you track finances with a profit motive. Having your finances commingled could lead them to consider your income “hobby income” which may disqualify for you certain deductions and would prevent you from claiming any losses against other income.
Piercing The Veil
If your business is a bit bigger and incorporated, that incorporation offers you a certain level of protection from liability. If you should find your business in the middle of a lawsuit, your corporation protects your personal assets from the suit.
What you may not realize, is that commingling funds can effectively “pierce the veil” between your corporation and your personal assets. This can cause all your assets to be considered the same (ironically, this is what you’re doing when you commingle). When the veil is pierced, legal action taken against your business could also impact your personal assets, like your bank accounts or even your home.
Increasing Your Audit Risk
Another danger of commingling is the risk of audits. The IRS has promised to increase small business audits by 50 percent this year. If you find yourself in that group, commingled finances are just asking for trouble. They’re likely to cause the auditor to dig much deeper than they otherwise would, dragging out the audit process and causing a lot of undue stress. They can also lead to the disallowed deductions mentioned earlier.
Commingling can also increase your risk of an audit. If you find your personal income taxes being audited, and the auditor finds business expenses mixed in, it’s likely to trigger an audit of your business taxes as well.
Beyond Risk
While the three risks above are scary and more than enough reason to avoid commingling, you may think “It won’t happen to me.” Whatever the odds of staying out of trouble with the IRS, there is one problem that you’re 100 percent sure to have.
When business and personal finances are mixed together, there’s no clear way to see how your business is really doing. You’ll be left with an unclear and incomplete picture of your financial health and profitability because all of your financial reports and statements will be contaminated by expenses that have nothing to do with your business.
When you can’t make heads or tails of your financial reports, you’re left guessing or simply tracking your bank balance and hoping you’re making enough money. This is no way to run a business and will leave you with less profit than you deserve every time.
The Solution
The solution to commingling and avoiding all these issues is simple. Make sure that you have separate business and personal accounts and credit cards. Use business accounts only for business purchases and personal only for personal ones. If you do find yourself buying something for your business and only have your personal card available, make sure you talk with your bookkeeper to properly record the expense.
If you don’t have a bookkeeper helping with your business, it may be time to get help. Having everything set up correctly and following the right workflow will help you save money, make better business decisions, and save at tax time. The team at Pooley Accounting can help. Please call us at (706)-260-7808.
FAQs
Increased Legal Risk: If you're an LLC and mix your business and personal expenses, you could compromise your liability protection. This could put your personal assets at risk if your business is audited or sued. Tax Audits: Claiming personal expenses as business expenses can also trigger red flags with the IRS.
What happens if you mix business and personal accounts? ›
Managing your personal and business taxes becomes much more difficult when you have to separate each and every transaction. It can also lead to missing out on business deductions that lower your tax bill. It also means more work for your accountant, as well as more money spent on that process.
What are the risks of commingling funds? ›
Besides creating a potential legal nightmare, commingling can also obscure the true financial health of your business. It complicates financial statements, making it challenging to assess and value the company's performance accurately.
What is it called when you mix business and personal money? ›
Commingling is mixing your personal funds with your business funds, or using business assets for personal reasons. Although it is more common in small businesses such as LLCs, commingling is a common challenge for any small business owner.
Is it illegal to commingle business and personal funds? ›
You May Lose the Liability Protection Your Company Provides
However, commingling funds ends this protection in what lawyers call “piercing the corporate veil.” A pierced veil means creditors can take you to court, argue that your “business” and “you” are not separate, and come for your private belongings.
What does the IRS say about commingling funds? ›
The IRS does not require that you maintain separate bank accounts for your personal and business activities. But, they do encourage it. Commingling funds will cause more of a legal problem than a tax problem.
Can LLC owners mix personal and business accounts? ›
If you operate your business as an LLC, partnership, or corporation, your business' legal structure can shield your assets should you be involved in a lawsuit. If you mix your personal finances and business funds, you jeopardize your protection. So it is best to use a business bank account for corporate transactions.
Is it illegal to pay personal expenses from business account LLC? ›
It's not “illegal”. But there can be very bad consequences that could happen if you do so. First off, it's very bad from an accounting perspective. In an audit situation it could result in you needing to prove that all the other expenditures were, in fact, business expenses, and not your personal expenses.
What is unethical commingling of funds? ›
Commingling occurs when a lawyer holds his or her own funds in the same account that is holding client or third party funds. Commingling is, itself, a violation of the ethics rules and may subject a lawyer to discipline.
What are the implications of co mingling personal assets with business assets? ›
By keeping personal and business finances separate, you can protect your personal assets and limit your liability. Commingling funds can also hurt your business's credibility. If you mix personal and business finances, it can make your business look unprofessional and unorganized.
Let's look at some easy ways to do it.
- Put your business on the map. ...
- Open a business checking account and get a business debit card. ...
- Get a business credit card. ...
- Pay yourself a salary. ...
- Separate your receipts and keep them. ...
- Track shared expenses. ...
- Keep track of when you use personal items for business purposes.
Mixing business and personal expenses is one of the most common mistakes new business owners make. While it happens often doesn't mean that you cannot avoid it. Being able to separate your business and personal expenses will help you set sail your business without much hassle especially with the IRS audit.
Can an LLC commingle funds? ›
If you commingle funds, you could lose your LLC's or corporation's liability protection due to what is known as “piercing the corporate veil”. Having your “veil pierced” sounds like a bad thing. It is.
Can I fund my business with personal funds? ›
Investing your own, personal money into your business is one of the primary methods that business owners use to fund their business. Self-funding may seem like a simple, no-strings-attached way to get your business started, but there are still risks involved and things you need to be aware of.
Can I use personal funds to fund my LLC? ›
1. Contributed Capital: When personal funds are treated as contributed capital, they are recorded as an increase in the LLC's equity accounts. This method increases the owner's equity in the business but does not create a tax-deductible expense for the LLC.
Can I fund my business account with personal funds? ›
Step 3: Transfer Personal Funds Into Your Business Bank Account. Once you put your personal money into your business, you can classify it as either equity or a loan. Most business owners will list this transaction as equity, meaning the funds are a contribution and that the business doesn't owe you repayment.
How do you avoid mixing business and personal finances? ›
Let's look at some easy ways to do it.
- Put your business on the map. ...
- Open a business checking account and get a business debit card. ...
- Get a business credit card. ...
- Pay yourself a salary. ...
- Separate your receipts and keep them. ...
- Track shared expenses. ...
- Keep track of when you use personal items for business purposes.
If you have a sole proprietorship, to ensure FDIC coverage of all of your deposits, you should keep your personal and business checking accounts at different banks if the total sum of both accounts will exceed $250,000.
