While commingling could save time in the short term, it could also have serious consequences.
Mixing your personal and business assets could complicate matters when it's time to file taxes and may even have legal repercussions.
Every small business owner should understand the risks of commingling and why it should be avoided.
What Is Commingling?
Commingling refers to failing to differentiate between your business and personal expenses. It can take various forms. Here are some examples:
- You use the money that you receive from a customer to meet your personal expenses.
- The same bank account is used for your business as well as your personal funds.
- You follow the practice of transferring money between your business bank account and your personal bank account without keeping a record of these transactions.
- You use a personal credit card for your business expenses. Conversely, you could use your business credit card for your personal needs.
- You use business funds to buy personal assets.
What Is A Commingled Fund?
A commingled fund is a portfolio consisting of assets from several accounts (usually business and personal) that are blended together.
While this practice can reduce the costs of managing and maintaining the accounts separately, it involves serious risks.
When you are starting your business, it can seem quite natural to treat your company’s funds and your own money in the same manner. This is especially true if your venture is structured as a sole proprietorship.
After all, why should you differentiate between the two?
However, commingling can have several adverse outcomes. Let’s understand what the risks of commingling are.
Why Is Commingling Bad?
When new business owners follow the practice of commingling funds, they often fail to anticipate the negative implications. Here are some of the problems you may face if you commingle your funds:
Keeping track of your business performance may be difficult
Consider a situation where you use the same bank account for your company’s and your personal expenses. How will you know which entries to consider when you are compiling your accounts?
Company owners who have commingled their money may not know if their business is making a profit or a loss.
It can be a painstaking task to manually check every line of your bank statement and separate the business and personal expenses. You may also have to incur an additional cost to get this work done.
You may face a problem when claiming tax deductions
Company owners can save a significant amount in taxes by deducting business expenses allowed by the IRS.
However, if you use the same bank account for both your business and personal expenses, you could face difficulties when it’s time to file your tax returns.
Remember that you have to be able to prove to the IRS that the expenditure you are claiming as a deduction was incurred for business purposes. If your records are disorganized, how will you do that?
Increased scrutiny at the time of an IRS audit
There is a relatively small probability that your business will be chosen for an IRS audit. The Internal Revenue Service selects small businesses for an audit on a random basis.
Your company could also be chosen to be audited if you have entered into transactions with another firm whose returns were picked out for an audit.
But what if the IRS does decide to audit your accounts and finds that you have commingled your funds? This could lead to complications and increased scrutiny.
It is likely that you will have to face additional questions regarding your accounting records.
You may face obstacles when raising a loan
When you approach a bank or a financial institution for a small business loan, you will be asked to produce your financial records and your bank statements.
If you have followed the practice of commingling, how will the lender ascertain which entries pertain to your business and make a credit decision?
Possibility of legal problems
If your business is structured as an LLC or a corporation, and you have commingled funds, you could lose liability protection. Creditors may be able to make a claim against your personal assets.
They could argue that your LLC or corporation isn’t a separate legal entity.
Is Commingling Illegal?
While it is legal (but not advisable) for married couples or business partners to commingle funds, it is illegal for lawyers and attorneys to do so, and is grounds for disbarment.
Those in the legal practice are responsible for setting up trust funds to keep clients' assets separate from their own. Sames goes in real estate.
Why Is Commingling Illegal In Real Estate?
Like in the legal profession, licensed real estate brokers, agents and other professionals who hold deposits for clients are strictly prohibited from commingling their clients' funds with their own.
This is because it may involve embezzlement and it’s difficult to detect.
How to Avoid Commingling
If you are starting a new business, it’s advisable to keep your company’s money and personal funds separate.
However, if you have an existing business and are already commingling and you want to correct this problem, it’s never too late to start.
Here are some of the other steps that you could take:
Open a business bank account
It’s best to start with a small business checking account. You can use this to pay for the expenses that you incur for buying inventory, paying your employees, purchasing fixed assets, and for every other type of business expenditure.
Just make sure that you don’t pay any personal expenses from your business bank account.
Get a business credit card
It’s a good idea to stop using your personal credit card for your business expenses. A business credit card can simplify your accounting and help you build your credit score.
Consider getting professional help
Hiring an accountant could give you more time to concentrate on your business. An accountant could also help you with your cash flow management and provide guidance on filing taxes.
The Bottom Line
Remember that the negative effects of commingling your funds won’t show up immediately.
New business owners often fall into the trap of thinking that it’s perfectly alright to follow this practice. But at year-end, or when it's time to file your taxes, you could find yourself in trouble.
It could take weeks of effort to separate your business and personal expenses.
It’s far better to discipline yourself and ensure that you refrain from commingling funds. If you do this, you’ll have more time to focus on what matters most - running a successful and profitable business.
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