Separating Business and Personal Expenses
Commingling is risky.
One of the most important things you can do as a small business owner is to separate your business expenses from your personal finances. According to a 2015 TD Bank Survey, 56% of small business owners use their checking account for both personal and business expenses.
This is called: commingling. And it's not about going to a party and working a room.
Commingling funds is one of the most common accounting mistakes accountants see – even though most small business owners know they should keep things separate. Setting up a system to partition your business financials can save you time and money and a whole bunch of headaches down the road.
Here’s a look at why it’s important to avoid commingling funds and the best practices for keeping funds separate.
These Funds Aren’t Ready to Mingle: Costly & Legal Implications
Listen, I get it: Tracking business and personal financials adds just one more item to your already-full task list. Throwing all your income and expenses into one pot – and promising yourself that you’ll sort it out later – can seem like the easier option. The problem is that later rolls around, and you’ve forgotten the details of the transaction. Was this a personal or business expense? If it was both, how much was on the business side? Because you can’t remember the particulars, you (or your accountant) takes a guess.
Untangling the mess can become very costly and time-consuming to clean up. Do you want to pay your Accountant at his/her hourly rate to sort through your mess?
The IRS doesn’t require business owners to maintain separate personal and business accounts. However, they do require you to document business expenses for tax deductions. Creating an organized record-keeping system makes it easier to identify and provide for tax-deductible expenses, helping you minimize the amount you pay in taxes. It is also extremely helpful in the event of an audit as you don’t want to be in the position of defending every expense and having to prove its legitimacy as a business expense. Clean records make IRS auditors more comfortable that you are doing things on the up and up.
Blurring the line between personal and business expenses also opens you up to legal issues. For LLCs and corporations, your personal assets are protected by the limited liability of your company, known as the “corporate veil.” Commingled funds could allow creditors access to your personal assets, an action called “piercing the corporate veil” in the case of a lawsuit or legal dispute.. When the veil is pierced, you can become personally liable for the corporation’s debts.
Remember that the IRS can go back 7 years in an audit – if they suspect foul play. Do you really want to go back 7 years and try to remember what that $ 20 ATM withdrawal was for?
How do you keep funds from becoming commingled? Here are some suggestions:
Set up separate accounts.
The easiest way to avoid commingling funds is to set up a dedicated business checking and savings account. If you need credit, apply for a credit card issued to the company. You’ll know that all income and expenses on the account statements will be related to the business, making them easy to track. The kicker is, you have to use these accounts ONLY for business related expenses. If you take the time to set up separate business accounts but still mix personal, that defeats the purpose of this step. You must be diligent in drawing the line and keeping those things separated.
Online banking makes it incredibly easy to transfer money between accounts. If you make a transfer from your business checking account to your personal account – or vice versa – document the reason. It’s also important to document withdrawals you make from your business checking account to pay personal expenses. We recommend keeping books in a program like QuickBooks Online. Tracking transactions with an accounting system will help legitimize your business, give you better reporting and budgeting capabilities, and allow for better backup should you ever be audited by the IRS.
Divvy it up.
If you have a cost that is partly business and partly personal, divide the cost between the two and record appropriately. For instance, say you are attending an industry conference and tacking on a few vacation days while you’re there. Use your business credit card for business-related expenses on your trip for easy sorting out later. Again, this is where an accounting system will really help track specific expenses related to your business.
Don’t wait to record the transaction.
The best way to avoid commingling funds is to record transactions as soon as you can – before you forget who the money came from or went to and what it was for. If you find yourself scrambling to get this done on a weekly or monthly basis, it could be time to hire someone to help with your accounting. Again, by ensuring your personal and business funds stay separate, you’ll save yourself (and your accountant) a lot of time and stress later.
Stop Procrastinating and Make your Business a Priority
One thing we’ve found – as business owners ourselves, with busy schedules outside of work – is that procrastination can be debilitating, especially when it causes extra work in the future. When it comes to avoiding commingling funds, it is best to set aside the 30 minutes it will take at the bank to setup your extra business accounts if that means avoiding hours and hours of
clean-up or the cost of paying an accountant to go through and clean it up later. While you may be busy making connections and schmoozing at industry events, hustling hard to get new leads and building your list of prospects, your business accounts are never ready to mingle. Save yourself time and cost, and potential legal trouble, by establishing dedicated accounts early on, practicing diligent documentation, and avoiding procrastination as much as possible. By exercising some best practices from the onset, you’ll avoid major pitfalls for yourself and your business.
Laziness in this practice could cost you thousands of dollars in the future. Not just a hang-over.
Here’s what you need to open a business account:
Tax Identification Number (TIN) – also known as Employer Identification Number (EIN) for registered businesses. (It takes less than 15 minutes to apply for and receive an Employer Identification Number (EIN). It’s also free at IRS.gov. Don’t get scammed by sites that charge a fee to give you a tax identification number.)
Legal paperwork with registered business name.
Business Checking Account (1) – to pay for business expenses.
Business Savings Account (minimum of 2) – the first one for Tax savings and the second one for future savings / investment purchases. Or to put money aside for a Reserve Account.
Business Credit Card (1) to pay for business expenses.
By opening a dedicated business bank account, you can easily see the financial health of your business and be 100% confident that you are only deducting business expenses come tax time.
If you don't have an Employer Identification Number, please register for an EIN on the IRS website: Apply for EIN Online
It's not hard. It just takes a bit of time but you may save THOUSANDS of dollars later.