A reader asks:
Recently I was hired as a bookkeeper for a small manufacturing business. My boss, the owner, uses the business bank account for personal use — and it’s driving me crazy! He withdraws money with a debit card for personal expenses. Last week his wife bought a big screen TV for their home using a blank check he signed from the business account. From one day to the next I never know how much money the business will have. I’ve explained that it’s best practice to separate business and personal funds, but he tells me it doesn’t matter since the business is an LLC and he is the sole owner. Who is right? My boss? Or me? And what should I do?
— Roxanne from New York
Excellent question, Roxanne. You happen to be right in this case.
Business owners should not use a business bank account for personal use. It’s a bad practice that can lead to other issues, including legal, operational and tax problems.
As the company grows, the problems will also grow. That is, if the company is able to grow. Many businesses operated in a fiscally-lax fashion don’t grow the way they should or could.
I suggest you provide the business owner with a copy of this article. It has all the reasons to help you convince him. At the end is a list of best practices to follow.
Why Not to Use a Business Bank Account for Personal
Here are 7 reasons why small business owners should not use a business bank account for personal use. Commingling raises the following dangers:
1. Makes it tougher to manage cash flow
The company’s cash flow situation becomes confusing and harder to predict when commingling business and personal funds.
For example, the business might not have enough funds when an important business bill comes due. Why? Because the owner chooses that precise time to pay personal expenses from the business account.
Some owners look at their bank balance, see there’s money there, and think they can spend it. This could lead to a cash flow crisis.
2. Erodes personal liability protection
An owner of a corporation or limited liability company (LLC) might be held personally liable for business debts due to commingling personal and business funds.
One of the motivations for owners to set up LLCs or corporations is to limit personal liability for business debts. But if the owner operates the business as if it doesn’t exist separately, such as by paying personal bills out of a business account, that protection could go out the window.
Courts have been known to “pierce the corporate veil”. This means they can hold the owner liable for business debts.
One-owner LLCs and corporations are most at risk of having the corporate veil pierced. Their owners assume separation of funds doesn’t matter because they are the sole owner. They think, ‘Who is going to object if I use my business account for personal use?’ A company creditor, that’s who.
If the company closes down leaving business debt behind, an unpaid creditor could pursue the owner with legal action.
3. Overstates or understates tax deductions
To qualify as business tax deductions, expenses have to be for business purposes. When you pay personal bills with a business bank account, it makes it harder to identify business expenses. As a result, you may overlook legitimate deductions. Or you could mistakenly categorize personal expenses as business, leading to penalties and a big tax bill from the IRS if you get audited.
This problem is compounded when owners don’t keep financial records up to date. Too many owners wait until once a year at tax time to categorize expenses.
By the time March or April rolls around, memory fades. They may have to sift through a drawer of receipts only to find that documentation is missing. Or perhaps they’ve forgotten whether something was business or personal. It’s fertile ground for errors.
4. Makes accounting unnecessarily complex
Maintaining accurate accounting records is harder when you commingle.
You have to do extra work to separate personal expenses from business expenses. You can’t just download the bank account transaction history to QuickBooks, Xero or Zoho Books, and know that all expenses are business related.
Instead, someone has to carefully comb through and re-categorize expenses. It’s an unnecessary manual step that saps business productivity. Besides, memory fades and makes it all the harder to re-categorize if you don’t get to it right away.
5. Leads to objections by other stakeholders
Shareholders, investors and business partners do not want you treating the business like it is your personal piggy bank.
The founder of WeWork discovered this the hard way. The high-flying company, once valued at $47 billion, filed for an IPO in the summer of 2019. The filing disclosures revealed the founder’s self-dealing, including personal loans he got from the company at below-market rates.
In other words, the founder was diverting company funds to personal purposes.
The company’s biggest investor forced him out as CEO. In the end, he had to resign from the company he founded!
WeWork is a high profile example. Remember, though, even in a small business with no plans for an initial public offering, stakeholders could sue for misappropriation of funds, fraud or breach of fiduciary duty. So if there are other owners or investors, paying personal expenses from a business account will eventually catch up with you.
6. Could negate part of the Subchapter S benefit
Commingled accounts can throw a monkey wrench into the best Subchapter S tax plan.
A Subchapter S is an election you make with the IRS to treat taxes as a pass-through and avoid double taxation of both the corporation and the owner.
Another advantage of a Subchapter S is that it can reduce employment taxes (Medicare and Social Security taxes) for the owner. Here is how it works. The owner becomes an employee of the company. As long as he takes a reasonable salary, the owner doesn’t have to pay employment taxes on corporate distributions over and above the salary.
However, if the owner takes non-salary distributions without keeping good track of how much he is spending, he could run afoul of the IRS. How? By taking distributions that far outstrip his salary. Tax law requires that the owner’s salary not be unreasonably low compared to profit distributions.
What can happen is that the owner loses track of how much he is taking out of the company for personal purposes. This is easy to do when you mix personal and business expenses and don’t have good accounting controls.
As Nolo.com states, “If the IRS concludes that an S corporation owner has attempted to evade payroll taxes by disguising employee salary as corporate distributions, it can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties.”
7. Makes it harder to profit and grow
The more disciplined a business is about finances, the greater the likelihood of success. If you are loosey-goosey handling bank accounts, it can cause your business to lack fiscal discipline in other ways. And that puts an unnecessary impediment in front of you.
Any financial reports may show an inaccurate picture of the business, because they may include personal expenses. How in the world can you generate a useful Profit and Loss statement (P&L) without clean data?
At the very least you will have to stop to clean up your data first. This robs you of real-time reporting capability.
Overall, by mixing personal and business funds and not maintaining discipline, it becomes harder to manage the business toward profits and success.
Best Practices for Business and Personal Expenses
Most small businesses start out with the owner using her personal funds to start the business. So, from the owner’s standpoint it may seem perfectly fine to keep mixing personal and business. In fact, according to one survey, 27% of business owners admitted using the same account for business and personal.
But it’s not fine to commingle funds once the business is operating. Follow these 8 best practices:
Separate Business and Personal Bank Accounts
A small business owner should always have two checking accounts: a personal account and a business account.
It’s so much easier when you keep your business and your personal life separate and well organized. Read more from tax expert Barbara Weltman on why you need to separate your business finances.
Take a Salary
The owner should set herself up with a salary. If it’s a corporation or Subchapter S, the owner should be made an employee. For a sole proprietor, she could simply set up a regular withdrawal or transfer every two weeks into a personal account.
This enforces the separation of funds. Taking a salary is the main way to break the habit of dipping into business accounts for personal expenses at irregular intervals.
Take Profit Distributions in Lump Sums
Sole proprietors and LLC owners commonly take profit distributions over and above their salary. This is accepted practice.
But the best way to do this is to take distributions as planned lump sums.
Do not take them as irregular ATM withdrawals or by paying personal bills here and there. It makes planning much harder. Plus, the funds are more likely to get frittered away instead of being earmarked for important purposes such as a SIMPLE or 401k retirement plan.
Make distributions a planned event once or a few times a year. Build them into your tax and retirement planning. Make them part of your growth strategy.
Use Separate Credit Cards
Another poor practice is when the owner uses the same credit card for both personal and business.
This causes accounting confusion. It can lead to mistakes when it’s time to claim tax deductions.
It also adds extra steps to your bookkeeping. You can’t simply download your monthly transaction history into your accounting software and have all business charges in one place. Just like with your bank account records, you have to manually sort through them.
Apply for a business credit card as soon as you have revenue coming in regularly. It will also help establish a separate credit history for the business.
Keep Good Records for Taxes
Keep your tax records up to date throughout the year. The impact of procrastination can be costly.
Good recordkeeping helps you stay out of tax trouble. Often it isn’t bad intent that gets small business owners into hot water with the IRS and other taxing authorities. Rather, poor bookkeeping and lack of documentation cause unnecessary problems. It’s a forced error.
Poor record keeping can also cause you to pay more in taxes.
Good tax planning becomes difficult when you don’t have a clear financial picture. So you’re likely to arrive at tax time only to discover there were strategies you could have employed to reduce taxes. But because you didn’t have good books and the ability to look ahead before the tax year ended, you missed out.
Manage to a Budget
In business you’re more likely to thrive and be successful if you set goals and a budget.
This includes setting a budget to pay yourself a “salary.”
Don’t just pull out money from your bank account in dribs and drabs. You will lack a clear picture of what your monthly expense burn rate is for the business. Your burn rate should be burned into your brain!
As an owner, you also need to know how many sales you have to make each month to cover your burn rate.
You are much more likely to meet your goals if you always know EXACTLY what it takes to make a profit each month. In short, you must always know:
- how much your business needs to earn, and
- how much it can spend.
Be sure to run a monthly Profit and Loss statement and other financial reports. They help you stay on track.
Always Pay Obligations Timely
When you don’t pay obligations when they are due, that’s a key time when questions arise over personal use of business funds. Everything may go along fine with no one raising objections UNTIL the business stops paying.
Rule of thumb in business: pay everyone you owe on time. You will avoid a large chunk of legal entanglements this way.
Respect Other Stakeholders
If you have an investor, a business partner, shareholders or members in an LLC — be extra scrupulous in funds handling. Respect that they have a right to know how business funds are being used and a say in it.
By separating business and personal, and following best practices, it keeps everything above board. It also helps avoid the appearance of impropriety.
In conclusion, dipping into a business account every time the owner needs a little extra cash is a terrible way to run a business. Be a smarter business owner.
All answers to reader questions come from the Small Business Trends Editorial Board, with more than 50 years of combined business experience. If you would like to submit a question, please submit it here.