Many small business owners understand that you cannot commingle your business and personal assets however some business owners are commingling their personal and business expenses without realizing the impact it could have. We will discuss what commingling of funds is, why you should avoid it, and how to correct it.
What is Commingling?
Commingling is when you are treating your business money as your own. Some examples of commingling are:
1. Only having one bank account for personal and business transactions
2. Paying for personal expenses from the business account
3. Depositing business checks into your personal account
4. Writing personal checks for business reasons or writing business checks for personal reasons
5. Transferring money between business and personal accounts without documentation
6. Using a personal credit card for business expenses or using your business credit card for personal expenses
Why Should You Avoid it?
When your business is set up as a separate entity, this protects your personal assets. This protection is called the “corporate veil” which means that there is limited liability between your business and yourself. When you commingle your business and personal funds, this may pierce the corporate veil and your personal assets may be at risk.
From an accounting stand point, it can make tracking very difficult and time consuming. When personal and business expenses are commingled you may not be able to see how your business is performing. This also makes tax time more challenging if you don’t track your expenses throughout the year and don’t know which transactions were personal and which you need for your business taxes. You may be under reporting your income or under reporting your deductions. Either way this can impact your tax liability.
How to Correct it?
The important thing to do first is to stop commingling now. The past transactions will be to be adjusted. The personal transactions need to be reclassified as Owners Draws or shareholder distributions. Some common expenses to ensure are classified correctly are meals, travel, vehicle expenses, and home office expenses.
Overall it is very important to keep your business and personal expenses separate. Setting up your business as a separate entity is for your protection and commingling of funds can pierce the corporate veil and put your personal assets at risk. Remember that this is more of a legal problem than a tax problem however your bookkeeper and/or accountant will love you if you don’t commingle your personal and business funds.