Generally, business owners know to keep their business assets and personal assets separate, but there are a handful of business owners that can't seem to keep from mixing these two categories. After all, it's all their money, right?
Not entirely. In fact, mixing business and personal assets is a bad idea, both legally and logistically. Let's face it, setting up an LLC or Corporation can be a significant administrative hassle.
With that hassle in mind, the last thing that you want is to create another administrative headache. So, if you have set up a business entity or are planning to, it is critical to keep the limited liability of your company intact. This is what we call the "corporate veil," or, in simpler terms, it is the liability shield between the business owner and the business.
When you mix your business and personal funds, creditors can access your personal assets through your company. This mixing of assets is called "commingling."
What is the commingling of funds?
Commingling of funds occurs when you are treating your business' money as your own, whether buying or selling. When you commingle your funds you are using your business money as your personal money and vice versa. Some common commingling examples are:
- Moving money between business and personal accounts without proper documentation
- Depositing personal funds to pay business expenses
- Depositing business funds to your personal account
- Writing business checks for personal expenses
- Using a personal credit card for business purchases to earn more points
- Withdrawing money from your business account to use for personal expenses
- Using only one bank account for business and personal expenses
This is far from an exhaustive list, but you get the idea. Commingling funds is something you should never do as a business owner. You need to draw a line between business and personal expenses. Any of these activities constitute the commingling of funds and can jeopardize your corporate veil.
Why you should not commingle funds
As we discussed, if you commingle funds you could lose the liability protection from your corporate veil. We cannot stress the importance of keeping your corporate veil intact enough. However, when you participate in any of the examples listed above, you are piercing your corporate veil. The work (and money) you used to create your business and limit your liability will be for nothing! Once you start commingling your personal assets become liable, and creditors can reach those assets with ease.
There are several factors courts consider when deciding whether to pierce your company's veil and hold you personally liable for lawsuits. One of the most important factors includes the presence of commingled funds. That is, if you treat your business's money as your own, you risk exposing your personal assets. In doing so, you did not take the necessary steps to keep your business entity separate from yourself, and your personal assets will be liable.
How to avoid commingling funds
We understand the temptation to commingle funds, especially as a small business owner. You want to get paid, and you need to make purchases for your business. These everyday needs arise often, and you want to take care of them as quickly as possible. However, there are several reasons (stated above) why you should deposit business checks into your business account and purchases supplies from your business account.
The first step you should take to avoid commingling funds is to create a separate bank account and document all deposits, withdrawals, and expenses. This documentation will prove you have not been commingling funds and can benefit your business in many other ways.
These benefits include better record keeping that can give you valuable insight into your business's performance. Additionally, you will be able to write-off more business expenses because you will be able to document each expense. When you use one account for personal and business expenses, it can be very difficult to explain which expenses are business-related and which are personal. Thus, by avoiding commingling, you will be able to improve business performance, lower your tax bill, and keep your personal assets protected.
How to correct commingling of funds
It is possible that you have started your business and have already made the mistake of commingling funds. It is vital that you recognize this mistake early and correct it as soon as possible. You will need to begin by identifying transactions that were personal. Common personal expenses include travel, meals, entertainment, vehicle expenses, and home office expenses. Any expenses that should be personal can be reclassified into different categories. For example, you can change certain expenses to "fringe benefit compensation" or "loan to the shareholder." However, reclassifying these expenses can be tricky, and we recommend enlisting the help of an experienced CPA.