The Top Mistakes of Small Businesses – Co-mingling
In the world of small business, time is the most critical asset. Most small business owners are strapped for time and therefore when it comes to doing all the activities that they need to do to properly manage their business sometime they take short cuts, it the effort to save time, but sometimes these short cuts can really put the business at risk. One of these is falling into the comingling trap. This might save the time strapped owner sometime in the short run but in the long run threaten the business and open it up for unnecessary risks.
Co-mingling is not a cocktail mixer but the mixing of business and personal funds together. Co-mingling is one of the most prevalent mistakes small business owners make in their accounting systems and it is one that most fundamentally know that they should not do. Setting up your systems to separate your personal and business funds will in the long run save you time and money. When you Co-mingle, you fail to differentiate business and personal expenses, this can take many forms. Let’s explore some examples where this happens.
- You receive money from a customer and use that money to pay for a personal expense.
- You use the same bank account for personal as well as business funds
- You regularly transfer monies between business and personal accounts without keeping records of these transactions
- You use a personal credit card for business expenses or use a business card for personal ones
- You use funds from the business to buy personal assets.
- Paying for a business meal with a personal card; and
- Grocery shopping and using your business card because you forgot your personal card.
Why is Co-mingling Bad?
So, you might be saying, Ok, I get it, but Why is Co-mingling bad? First and foremost is it makes keeping track of your business performance difficult. For example, if you are using the same bank account, how will you know which entries belong to business expenses when accounting for your performance. When you comingle, you might not know if your business is making a profit or loss, too many owners make that decision by the bank balance and not the facts of the business. It is a painstaking process to check every line of a bank statement and separate personal and business expenses, this comes at the expense of the limited time you must do work driving your business.
Additionally, companies may face problems when claiming tax deductions, this can be a costly mistake.
Company owners potentially can save a great deal of money when deducting allowable business expenses. This, however, can be difficult when it comes time to file your tax returns, if you use the same bank account for both your business and personal expenses. Why, because you must be able to prove to the IRS that the expenditure you are claiming as a deduction was incurred for business purposes. Disorganized or missing records are the number one reason that such expenses are Disallowed.
Increased scrutiny at the time of 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.
If the IRS audits you and your accounts and transactions are co-mingled, then this could create complications and increased scrutiny. That means that you likely will have to face additional questions and scrutiny regarding your accounting records.
- You may face obstacles when raising a loan
- Lenders might call into question your business practices and the businesses viability and your ability to control the operations if your records are sloppy and disorganized.
- Possibility of legal problems
Losing your liability protection is possible If your business is structured as an LLC or a corporation, and you have co-mingled funds. Creditors may be able to make a claim against your personal assets arguing that your LLC or corporation isn’t a separate legal entity.
Co-mingling Funds as a Sole Proprietor
If you are operating as a sole proprietor, co-mingling funds becomes less of an issue. This is mainly since you won’t have an entity’s integrity to protect.
Creating separation between your personal and business transactions will, however, make your life much easier come tax time. Your business bank account can literally act as your accounting platform. As you grow, you’ll want to investigate more robust accounting platforms. But in the beginning, a business bank account can be your “books.”
Operating without an entity makes everything very simple. And having a separate bank account makes it much easier to track your business transactions.
Co-mingling Funds as an LLC Member
Operating out of an entity brings the co-mingling issue front and center. Co-mingling funds should be 100% avoided when using this type of entity.
The good news is that LLC’s have some flexibility regarding co-mingling funds. If a mistake occurs, you can generally retroactively fix it. This is good news for new investors and business owners who are still figuring out how to effectively operate their businesses, but just because it can be fixed doesn’t mean you should take co-mingling funds less seriously.
The problem arises when you consistently use your personal credit cards for business expenses. You are establishing a pattern of co-mingling funds. This hurts the integrity of your entity and exposes you to risk.
When you establish a pattern of bad business practices such as co-mingling personal and business funds, the integrity of the entity deteriorates. While you can certainly correct some of these mistakes, you can’t do much where there is a deliberate pattern emerging. Given this, attorneys will attempt to “pierce the corporate veil” and they will most certainly use your co-mingling patterns as reasoning to do so, putting your business at unnecessary risk.
Co-mingling Funds as a C or S Corporation Owner
C and S Corporation owners need to take co-mingling funds seriously. This is true from a tax, accounting, and legal perspective. If co-mingling exists and is not dealt with properly and promptly, the IRS could disallow many of the deductions.
It is imperative that a shareholder/employee of a corporation build good habits of separating out personal and business expenses. However, swiping the personal card for a business expense is still okay – provided an accountable reimbursement plan exists.
An accountable reimbursement plan resolves co-mingling issues for corporations. Basically, it allows the owner to use a personal card for business expenses and still receive a business write-off for the expense.
Such a reimbursement plan outlines how employees of a corporation are reimbursed for expenses. Without an accountable reimbursement plan, some business expenses will no longer be deductible by the business. Bottom line, if you are a corporation, make sure you absolutely have a reimbursement plan and abide by it.
How to avoid co-mingling
The best way to avoid this problem is to start off on the right foot and have the plan and discipline in place so you don’t co-mingle. 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 co-mingling and you will want to correct this problem ASAP, it’s never too late to start.
Additionally, the following steps are important to avoid co-mingling
- Open a business bank account.
Find a bank that offers a free business checking account. Use this account for business transactions only. 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. Don’t pay any personal expenses from your business account, pay yourself from the business account, put it into a personal account and then use the personal account for business.
- Get a business credit card.
It is best to STOP using your personal credit card for your business expenses. Using a business credit card can simplify this. If you must use a personal credit card, keep the receipts, and expense it to the business on a monthly basis and reimburse yourself. Take the time to do it right the first time.
Consider getting professional help
One of the best ways to save time and money is to hire an accountant from the beginning. This gives you the expertise and saves you time to focus on the sales and operations of the business. Additionally, a CPA can also help you with things like cash flow management, financial reporting, KPI’s and guidance on tax advice.
The negative connotations of co-mingling might not show up immediately, and often new business owners find out the pain and problems it causes at the end of the year when it is time to file taxes causing weeks of extra work and cost to untangle the mess. If you are co-mingling now STOP and follow a system, if you are a new business, do it right the first time.