Most business owners know to keep their business assets separate from their personal assets. However, there are a lot small business owners that do not. This is a bad idea, both legally and logistically. Look, I get it, you've worked hard to sell your service, and the last thing you want to do is have more administrative hassles. But, for many reasons, you need to pay attention to keeping your personal and business bank accounts separate to avoid the commingling of funds. This is a very important step to keep the limited liability of your business in tact. In law, there is a business concept called “corporate veil,” meaning the liability shield between the business owner and the business. When you commingle your business and personal funds, creditors can “pierce the corporate veil,” and get into your personal assets through liability through your business. This the the main reason to avoid commingling your funds, although there are also tax reasons.
Now, let’s discuss the legal reasons you why you should not commingle your business and personal funds and the ways to avoid commingling.
How do you “commingle,” and what is “commingling?” When you commingle your funds, you are treating your business funds as your personal money, whether buying or selling. Some of the most common ways to commingle are:
Transferring money between business and personal accounts without documentation.
Writing business checks for personal reasons/expenses, and vise versa.
Having only one bank account for personal and business needs.
Depositing business checks into your personal bank account.
Withdrawing money from your business account to pay personal expenses without documentation.
It is very important to keep your corporate veil intact. As discussed above, when you commingle, your corporate veil can be pierced. Essentially, all the work that you did when forming the L.L.C. or corporation, such as filling the Articles of Organization, paying attorney or filing fees, and perhaps drafting the Operating Agreement, will be for nothing as far as limiting liability. Creditors can reach your personal assets if you commingle, and there in lies the problem with commingling.
How to avoid commingling. First of all, the impulse to put your business check into your personal check is understandable for a small business owner. After all, you want to pay yourself and buy more supplies for the business to grow more. However, there are several reasons why you need to deposit the check into the business bank account, and then pay yourself, and also buy business supplies out of the business account.
The first thing you should do is create a separate bank account if you have not already and document all expenses, withdrawals, and deposits. Documenting allows you to become a better bookkeeper for your business, and/or keep better records for taxes. Having better accounting by keeping separate bank accounts and only using business funds for business expenses can help you see how your business is performing, and seeing where you need improvement. It also allows you to keep your personal funds separate and helps create a personal budget since you will not be seeing business funds in your bank account.
Reducing Taxes. One last benefit we will mention is the benefit to your taxes (and it's easier for your CPA). One big benefit is that the IRS does not allow you to deduct business expenses that you cannot document. When you have one business account for personal and business expenses, it is hard to explain to the IRS what you need to deduct and for what purpose. The IRS is a lover of documentation, and by keeping track of your business income and expenses in its own business account is crucial to help minimize taxes and maximizing your deductions.
Create a professional mindset with a separate business account.
Mixing business and personal funds are sloppy and it's not professional.
It’s bad legally for the reasons above, in addition to simply being bad business.
It also makes accounting difficult and inaccurate. Accounting is more than just doing your taxes.
Accounting tells you how your business is performing, what is doing well, and what needs improvement. Sloppy record-keeping and accounting mean you can’t figure out which parts of your business are winners and which are losers. You won’t know which products have the highest gross margin, or which ads bring the highest return on investment.
You’ll simply be flying blind. That’s why you need a separate business checking account and a decent piece of small business accounting software. There are a lot of good options like Quickbooks, Xero, Wave, and others that will be more than adequate for small to medium sized businesses. I personally use Quickbooks for all of my clients selling both services and products.
Being diligent in separating and tracking business income and expenses and keeping the books and records clean will be a huge benefit when it comes time to prepare the business tax return.
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