3 Tax Problems That Arise When Mixing Business and Personal Finances (and One Easy Fix)
While some professionals, such as attorneys, are subject to strict laws and ethical guidelines requiring them to keep their business and personal accounts separate, merging funds is not an outright crime for most business owners. For nearly all of them, however, mixing money is a recipe for tax headaches that can become a nightmare in April.
Sloppy bookkeeping is the bane of businesses, and entrepreneurs and employers who reserve separate credit cards and maintain deposit and checking accounts exclusively for their business operations ensure a smoother ride in tax season while retaining the legal protections that come with forming an LLC or corporation.
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MoneyLion spoke with a seasoned tax professional who outlined the potential pitfalls of keeping business and corporate funds in the same bucket — and an easy fix to avoid them and sail through any encounters with the IRS.
1. ‘Clean Proof’: When the IRS Comes Calling for Receipts
Katherine Johnson, CPA and CTRS of Next Level Tax Resolution, specializes in accounting, tax planning and tax resolution. She has spent 30 years helping individuals and businesses navigate complex IRS and state tax challenges.
In her opinion, commingling business and personal funds is most likely to create unnecessary and preventable tax nightmares when the IRS or state tax agencies request what she calls “clean proof.”
“Mixed money turns a normal tax question into a documentation fight,” Johnson said.
2. Tracing Mixed Money After the Fact Is Always Messier Than Separating It Up-Front
One of the costliest, most consequential and time-consuming efforts is untangling what Johnson calls “mystery deposits” during tax season.
“If business and personal funds flow into the same account, the IRS may ask whether deposits are taxable income, owner contributions, loan proceeds, reimbursements or transfers,” she said.
Another common problem is unlabeled — or unclearly labeled — business owner payments.
“I’ve seen cases where money pulled from the business had to be untangled as wages, draws, distributions, loans or personal reimbursements before we could even negotiate with the IRS,” Johnson said.
3. Combining Funds Lifts the All-Important Corporate Veil
Cornell Law School outlines the concept of the so-called corporate veil — a legal shield that separates business owners and shareholders from their LLCs and corporations, limiting their liability for debts, lawsuits and financial failure. LLC, after all, stands for limited liability company.
The corporate veil prevents creditors and other stakeholders from coming for a business owner’s house, car or bank accounts if things go south — but mixing funds lifts the corporate veil and eliminates those crucial safeguards.
“The practical fix is one business bank account, one business credit card and notes on every owner transfer,” Johnson said. “Label it when it happens as ‘owner draw,’ ‘capital contribution,’ ‘loan repayment’ or ‘expense reimbursement,’ because recreating intent months later is expensive and painful.”
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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