Set Boundaries between your Business and Personal Finances to Avoid Commingling Funds.
No matter whether you have used your asset as the capital investment for your startup or personal credit score to get a startup loan, creating a clear boundary between your business and personal finances is important to avoid unnecessary hurdles. Commingling Funds occurs when you use the same accounts for both personal and business purposes.
Why I am stressing this point is you might have started your business without thinking about making a profit, a part of which might be reaped by IRS. During the tax time, using a personal account for business might create confusion and increases the time spent on separating your business and personal transactions.
So, it’s mandatory to separate your business and personal expenses regardless of the types of business you run. Recent reports from the National Federation of Independent Business states that cash flow and money management are two of the most common reasons small businesses fail. Without proper tracking and separating your business and personal expenses, you will run the risk of mismanaging your funds.
7 Reasons Why is Commingling funds is a Terrible Idea
- It is difficult to determine the profitability and financial efficiency of your business if you commingle your personal and business finances.
- You will waste a lot of time and mix up a lot of potential deductions when trying to separate personal expenses from business expenses.
- You run the risk of a creditor piercing the Corporate Veil.
- If you are audited there will likely be increased scrutiny.
- When you apply for lending banks will have a hard time determining your creditworthiness.
- If you decide to sell your business coming up with an accurate valuation will be very time consuming if not impossible.
- If you have multiple owners you run the risk of embezzlement or improper use of business funds.
Steps Involved in Separating Personal and Business Expenses to Avoid Commingling Funds
Before keeping your business and personal finances separate, you should analyze the structure of your business first. The structure of your business can affect how you should be legally handling business and personal expenses.
- Corporation: If your business is an entity owned by shareholders, it is mandatory to keep your business and personal finances separate. If you do not, you run the risk of creditors piercing the corporate veil (or going after the shareholders personally).
- Limited Liability Company: An LLC is a hybrid structure and works more like a corporation, but profits and losses are passed through. Similar to a corporation, funds should not be commingled in order to maximized the personal liability of the owners.
- Partnership: General partnerships do not offer limited liability to their partners. WIth that said, it is still a good idea to not commingle funds so that you can maximize tax deductions.
- Sole Proprietorship: There is no liability protection for sole proprietors. Similar to a Partnership, sole proprietors should keep separate business and personal bank accounts to maximize business deductions.
If your business is run as a sole proprietorship, there would be no complex issues in handling the expenses of the business. But, when the expenses and profits are shared by a partnership where two or more people, you should set boundaries between your personal and business expenses to avoid unnecessary legal problems. Not only you, but all parties should carefully separate finances to get the legal protection you always wanted.
Get a Business Credit Card and Business Bank Account
Getting a credit card for your business allows you to prevent the use of personal credit cards and protects your personal credit. This also helps you to build strong credit cards that boost your borrowing power. Having a good credit qualifies you for lower interest loans.
Also, opening a business checking account helps you to gain a clear insight on the total expenditure of your business during the tax time. Reviewing your bank statements becomes easier with a separate banking account for your business.
General Requirements for Setting up a Business Bank Account
Many banks will require the following documents to open up a business bank account:
- Entity Formation Documents ( Articles of Incorporation, Articles of Organization, Formation Minutes and Resolutions, Statement of Information, etc.)
- Business Address
- Fictitious Business Name Statement
- Tax ID (EIN) number or Social Security Number (if operating as a sole proprietor)
Tip: Keep in mind that many banks may require additional information. It may be a time saver to bring in all business owners and corporate documents when opening up a bank account.
It is Easier to Track Expenses When you are Not Commingling Funds
It is surprisingly not uncommon for this cardinal rule to simply be ignored by business owners. This can cause huge problems when it comes time to file your taxes to the IRS. Save receipts, keep them organized and track your expenses to take advantage of every deduction you can come tax time. Getting in contact with a CPA and a business law attorney can save you time and money in the long run.
Pay Yourself a Salary
To carry out your personal expenditure, you should fix a specific amount as salary every month from the business. Transfer this amount to your personal account for your personal expenses. When paying yourself a salary you should run it through a payroll system so that all applicable taxes are taken out. If you have an additional profit that exceeds your salary you may want to consider re-investing in your business or taking an owner draw. This will not affect the profit and loss statement of your business account. Again, it is highly recommended to consult with an accountant or CPA in order stay in compliance with all local, state, and federal tax requirements.
Hire a Business Lawyer and CPA
Hiring a business lawyer and a CPA allows you to manage your finances efficiently will guide you through classification of expenses, separating finances, taxation impacts, deductible transactions, and more. They also enable you to maintain your books clean and clear and manage taxes, all while helping you avoid the commingling of funds.
The Bottom Line
Muddling up both personal and business expenses always result in a mess at tax time. Additionally, it may add to unnecessary personal liability. But, setting up clear boundaries between these expenses and consistently maintaining them is fundamental and takes your business to the next level.