After all the hard work it takes to create a product or sell your service, the last thing most of us want to do is have more administrative hassles. But, for several reasons, you need to pay attention to keeping your personal and business bank accounts separate to avoid the commingling of funds.
When you finally make that sale and collect that check (if you’ve ever been in business, you know the difference between making a sale and collecting the money), you want to spend it.
I understand, but let’s look at what commingling of funds means and the potential impacts to your limited liability company (LLC) or corporation.
What is the commingling of funds?
Commingling of funds means that you’re treating your business’s money as your own. Some ways to commingle funds are:
- Bank deposits made payable to your business from a client are deposited into your personal bank account.
- Making withdrawals from your business checking account to pay personal expenses without documentation.
- Depositing personal money to pay for business expenses.
- Using the same bank account for your business and personal needs.
- Writing business checks for personal expenses.
- Using a personal credit card for business expenses to get points.
- Moving money back and forth between your business and personal accounts without documentation.
The problem with commingling 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.
All that work you did to form an LLC or corporation — filling out Articles of Organization/Incorporation, paying filing fees to the state, etc. — will be for nothing as far as protecting your assets from creditors if your corporate veil is pierced.
There are several factors that courts look at when deciding whether to pierce your company’s veil and hold you personally liable for company debts and lawsuits. One important factor is the presence of commingled funds. If you treat your business’s money the same as your own, then you risk the exposure of your personal assets.
This means that you didn’t keep up the necessary formalities to preserve your LLC or corporation as a separate legal entity.
Create a professional mindset with a separate business account
Mixing business and personal funds is sloppy.
It’s bad legally for the reasons above, in addition to simply being bad business.
It also makes accounting difficult and inaccurate. Accounting is more than just doing your taxes.
Accounting tells you how your business is performing, what is doing well, and what needs improvement. Sloppy record-keeping and accounting mean you can’t figure out which parts of your business are winners and which are losers. You won’t know which products have the highest gross margin, or which ads bring the highest return on investment.
You’ll simply be flying blind. That’s why you need a separate business checking account and a decent piece of small business accounting software. There are a lot of good options that will be more than adequate for small online businesses to larger and more complex businesses.
Being diligent in separating and tracking business income and expenses and keeping the books and records clean will be a huge benefit when it comes time to prepare the business tax return.
You can’t deduct what you can’t document.
Keeping track of business income and expenses is crucial to minimizing taxes and maximizing deductions. A tool like the ZenBusiness Money app can make this easy.
Most small business owners pay more than the law requires because they don’t have a system for keeping track of expenses. A separate bank account to run all your business transactions through is a “poor man’s” way of tracking all your expenses. You can simply use your bank statement as a list of all your business expenses.
How do I correct the commingling of funds?
Maybe you have already started your LLC or corporation and made the mistake of commingling funds. Recognizing the mistake early makes it easier to fix. To get started, you’ll need to identify the transactions that were personal. Some common expenses that are a high priority with the IRS include travel, meals, entertainment, vehicle expenses, and home office expenses.
Those expenses that should be personal can sometimes be reclassified. They could be changed to be a fringe benefit compensation or a loan to the shareholder. The loan to a shareholder is a bit trickier and may not be the best to do without help from a CPA.
In summary, commingling funds can cause more of a legal problem than a tax problem. Your primary reason for forming an LLC or corporation in the first place was likely to reduce the your personal liability risks. Commingling funds jeopardizes that protection.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.