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.
