Last Updated on September 21, 2020
Many business owners consider their business an extension of their life. To this type of business owner, there is little to no difference between work and play because they enjoy what they do on a daily basis.
If that sounds like you, there’s absolutely nothing wrong with that until you start commingling personal and business finances.
While the boundaries of most parts of your business flow seamlessly into your life, your finances need to have a hard stop for legal, tax, and peace-of-mind purposes.
However, if you’re not sure if you’re commingling your funds, you’re in the right place. Keep reading to learn what it is, what it looks like, why it’s bad, and how to avoid it going forward.
Let’s get started!
What Is Commingling of Funds?
Commingling of funds happens when a business owner treats the business’s money as his/her own. While it may feel natural to combine your personal and business finances, it’s much better to keep them separate. Take note that sole proprietorships and partnerships don’t have to worry about commingling, it’s only important when you create a separate legal entity for the business (corporation and Limited Liability Company)
Now you know what it is, but seeing it in action is a different story. Here are some of the most common commingling situations you may be familiar with:
- Directing payments from clients into a personal bank account
- Using income from your business accounts to pay for non-business-related expenses, such as paying for a grocery trip with the business credit card
- Leveraging one bank account for both personal and business use
- Paying for business expenses with personal funds, such as paying for a business meal with a personal credit card.
- Moving money between your business and personal accounts without any documentation
The missing link in each situation is proper documentation. As a business owner, you shouldn’t move money around without documenting where it’s going and where it came from. Otherwise, you’re commingling.
You Shouldn’t Commingle Funds — Here’s Why
The situations we talked about don’t sound that bad, especially if you’re on your own or running a small business. After all, your business is how you make money. So, why shouldn’t you have easy access to the revenue your business generates?
Actually, you can and should.
But you still have to document everything and keep a clear separation between yourself and your business. And the long-term consequences of failing to do so far outweigh the short-term benefits of blending these two worlds.
Commingling Pierces the Corporate Veil
One of the main reasons people form LLCs for their business is to draw a line between their business assets and personal assets. And commingling your funds from one side of that line to the other removes that level of separation you worked so hard to establish.
You didn’t follow through on your promise to treat your business as a separate entity. And once you pierce that corporate veil, your personal assets are no longer personal.
This opens up your personal assets, bank accounts, etc. in the case of bankruptcy, debts owed, or claims filed against your business.
Which… is one of the biggest reasons why it’s important to uphold that level of separation.
Difficulty Claiming Certain Tax Deductions
Tax season isn’t the time to get your finances in order — they should always be in order. And whether you outsource your bookkeeping, hire in house, or do it yourself, clear documentation may mean the difference between saving money at tax time vs. paying more than you should.
It’s harder to prove your eligibility for certain tax deductions if you don’t keep your personal and business transactions separate. And every missed deduction is a missed opportunity to save money.
Furthermore, it’s hard to understand the financial health of your business when you don’t have a clear picture. Commingling muddies those waters and may make it harder for you and your team to make educated business decisions.
Increased Scrutiny from the IRS
As a business owner, you’re at higher risk for an audit by the IRS. And the more money you make, the higher risk you are. Furthermore, the IRS can examine your tax return if they find any indication you’re doing something wrong.
Specifically, they’re looking for cases of business income you make and don’t pay taxes on or overstated business expenses. Commingling your funds means you have a higher chance of accidentally (or intentionally) doing this, so this behavior raises quite a few red flags for the IRS.
Additionally, commingling personal and business funds may risk turning your personally separate property into the property of the business.
So your best bet is to avoid it at all costs.
How to Avoid Commingling Funds
Now you know why you shouldn’t commingle personal expenses with the business, so let’s talk about avoiding it. There are a few easy things you can do today to help keep that sought-after separation between you and your business.
These action items include:
- Setting up a business bank account. Having a separate bank account for your business is perhaps the most important step.
- Investing in bookkeeping software to provide detailed accounting information
- Planning time to record transactions weekly or monthly (as frequently as possible)
- Documenting the reason behind every transaction from one account to another
How Do I Correct the Commingling of Funds in an LLC?
If you’re currently struggling with commingling funds as an LLC, fixing it now is much easier than fixing it later. It’s essential to tie up any unknown transactions to set a clear foundation to build upon moving forward.
To get started, go through every transaction you have and decide if it’s personal or business. Pay special attention to things like travel, food, supplies, and entertainment as the IRS looks closely at these types of expenses.
Then, treat personal or unknown transactions as fringe benefits, subject to payroll taxes (similar to paying yourself).
I recommend hiring an accountant or tax specialist to go through this process with you and/or business partners. They can help sort everything out and also provide excellent advice on keeping your business and personal finances in order going forward.
Lastly, follow the steps above to put a system in place to avoid commingling funds in the future.
Final Thoughts on Commingling of Funds
As a small business owner, it’s easy to get into the habit of treating your business as your life because that’s usually how it feels. It’s not always easy to draw the line between your personal life and your business.
However, your finances require a hard line. Don’t let your LLC filing go to the wayside. Take the time to put together a process that helps maintain that level of separation between yourself and your business.
Future you will be glad you did!