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The Risks of Mixing Business and Personal Finances
Why Mixing Business and Personal Finances is a Bad Idea
Separating your personal and business expenses helps prevent multiple problems, like risking your personal bank accounts if your business goes into debt. It may help eliminate the need to make personal guarantees when applying for financing, and it can reduce complications with the IRS if you or your company gets audited. By not separating them or commingling business and personal finances, you may also miss out on tax deductions, as expenses can get lost in the mix.
Whether you’ve been putting it off because it is a lower priority, or you are a solopreneur and are about to restructure into an LLC, here are some reasons why mixing your business and personal finances is a bad idea.
Personal Risks
When your finances are combined, you may face personal risks financially and increased stress if things go badly, which no business owner wants. By splitting your finances into business and personal accounts, you can better protect your personal assets and nest egg.
Personal Guarantees
Having a separate business bank account allows lenders, credit card companies, and other financial institutions to see how much cash flow your business has separate from your own finances. When your personal and business accounts are combined, they’re going to have a harder time seeing if you qualify for a small business loan, as the lender cannot easily split your personal and business finances.
When it is hard to split them, you’ll likely be asked to make a personal guarantee on the loan. Personal guarantees are when you agree to leverage your personal assets like your 401K, your car, or your home if your company defaults on the business loan. Personal guarantees are very common, but not always required when a business can demonstrate its ability to pay back the loan without risk.
Losing Your Personal Assets
In some instances where your company goes into debt or gets sued, your personal assets may be at risk if it is too hard to determine what is a personal asset and what is owned by your business. If you’ve ever heard the term “piercing the corporate veil,” this could apply here too as it is similar.
Piercing the corporate veil is a legal concept where a court may decide to remove the protections of an LLC and hold business owners, shareholders, and other stakeholders personally liable for the actions of the business.
Business Problems
It’s not just personal assets and headaches that can happen when you don’t have separate personal and business accounts. Your business will likely begin facing obstacles that don’t need to exist.
Building Business Credit
The three business credit bureaus Experian, Dun & Bradstreet, and Equifax use your business debt to build a business credit score for your company. If you don’t separate business accounts from your personal accounts, the bureaus may not get as accurate of a read, making it difficult to begin building a business credit score for you.
Business bank accounts don’t show debts for your business, but business credit cards, lines of credit, and business loans can be reported on. To get these financial products, chances are you’ll need at least a mix of a business bank account, an LLC, and likely an EIN.
Without a business credit score, you may not qualify for some of these products, at least not on business merit alone. So having separate business accounts (like business credit cards) from your personal accounts helps your company build your business credit score and potentially qualify for commercial financing.
Applying for Loans and Credit Cards
Taking a small business loan, getting a business credit card, and other financial products will require proving your business is creditworthy. When you don’t have your personal and business assets split into separate accounts, it becomes harder for financial institutions to tell what belongs to you and what belongs to your business.
The more they have to work to find what your business has in assets or cash flow, the less likely your company will be able to get financing, especially without you making a personal guarantee. You can make it easier to get financial products and services when you have your business and personal finances separated, as it’ll be clear your business can make payments without needing funds from your personal accounts.
Vendor and Supplier Issues
Some clients, suppliers, and vendors may put a red flag on payments or checks that come from personal accounts versus a business account. In some cases, they may decide not to do business with you, as working without a business account can signal that your business cannot stand on its own.
IRS and Taxes
Tax time can become even more time-consuming, and your business being audited may go from stressful to a nightmare situation if your personal and business finances are mixed.
Doing Taxes and Missing Deductions
When it comes to doing your taxes, you’ll need to go through your credit card statements, receipts, and debit card payments to find what was and was not for business. If you can’t remember, you may not be able to write off meals, equipment or supplies, and some travel that could have been tax deductions.
When your business credit cards and bank accounts are separate, you get an easy list of everything that you spent on your business, so nothing goes missing and you don’t have to second-guess yourself.
Income Tracking
If vendors are making payments to your name versus your business name, the lines could get blurred for your accountant when they are doing personal and business taxes, depending on your company’s structure.
When you get paid for something outside of your company or receive a large personal check, you don’t want it to get mixed up with your business taxes and payments, and vice versa. Having a separate business bank account and personal bank account keeps your income and your business’s revenue separated and easier to track and sort when doing taxes.
Accountant Costs
When your accountant charges by the hour, having to sort through and separate personal and business accounts adds time and work to their schedule. Your accountant may have flat-fee pricing for straightforward tax returns or charge on a per-form basis, but complex situations take problem-solving and time to complete.
Time is not on their side during tax season, and having to split commingled finances makes your personal and business taxes complex. When this happens, your accountant may add an hourly rate on top or switch the project to hourly, costing you more money each year until you split your personal and business finances.
Audits
If your business gets audited by the IRS, you may need to prove that all of the deductions were actually for running your business and not for a hobby or personal use. When your accounts are combined, you’re going to have a much harder time proving this. For that reason, combined accounts may be a red flag. In situations where you cannot prove something was a business expense, you may lose deductions and potentially be subject to fines or penalties.
Legal Issues
Aside from piercing the corporate veil, there are other legal issues that can arise if you don’t keep your business and personal accounts separate.
Legal distinctions
Maintaining separate accounts might be required depending on your company’s legal structure. For example, if your business is a corporation, it is a distinct legal entity from yourself. This means you must maintain separate accounts. Conversely, if you operate a sole proprietorship, there’s no legal distinction between your company and yourself. However, it’s still best to keep two sets of accounts.
Separating business and personal finances, including credit cards and bank accounts, is not one of those things that you should wait to do. The right time to separate them is when you start your business. You’ll have an easier time building business credit, obtaining financing, and getting through tax time. You’ll also be in a better position to defend your returns if you ever get audited by the IRS. But if you haven’t yet, don’t worry. You can still take the necessary steps today to set up your business for future success.
QuickBridge does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
