Keeping Business and Personal Separate

Avoiding a mess

Any experienced small business accountant will tell you: When a business owner commingles business and personal transactions in the same bank account or credit card account, the complications can be significant and serious. It leads to reduced precision in the company accounting, which drives accountants crazy and exposes the business owner to risk in the event of an IRS audit or some other kind of investigation into the accounting by a financially literate 3rd party. Commingling creates a high risk of “piercing the corporate veil”, which exposes you personally to legal liability.

It is a fundamental requirement in running a business to set up a separate bank account and credit card that you’ll use exclusively for business transactions. It doesn’t matter if the accounts actually happen to be in your personal name, especially for a business credit card, because you’re not going to get a credit card based solely on business credit early. The important point is to use separate bank and credit card accounts for business transactions only, and to keep all your personal transactions out of these accounts.

This rule applies whether your business is a sole proprietorship or a separate legal entity. The important part isn’t about whether all of your accounts are opened in the name of your business (though if you have a separate legal entity, your bank accounts should be in the business name and tax ID). This is about keeping your business transactions entirely separate from your personal transactions. Commingling transactions between business and personal in the same bank or credit card account leads to a bookkeeping nightmare quickly, and in the unlikely scenario of an IRS audit, demonstrates a lack of bookkeeping and financial discipline that can work against you.

In the infrequent occurrence that a transaction that is entirely personal, which should not appear on the business tax return as a business expense, does come through a company bank account or credit card, the bookkeeper should treat that transaction as a receivable that the owner needs to pay back or in some cases can be classified as a distribution of profits to the owner. Note that with some entity types or business situations a company cannot make distributions of profits to the owner or if they do it is a taxable transaction.

Here’s a great rule to follow

It’s always best for a business owner to pay for business expenses out of the business account and personal expenses out of the personal account. That should be a standard operating procedure at every company. If the owner needs to transfer funds from the business to their personal account to cover the cash need, that’s strongly preferable to just paying for the personal cost directly out of the business account - even if the transaction were to be recorded in the accounting as a receivable that the owner needs to pay back.

In reality, it certainly can happen that a personal charge might hit the business account. Sometimes the cardholder uses the wrong card. Sometimes the business owner initially thinks a transaction might be business-related but ultimately the final decision ends up leaving it out of the business expenses. Here are how transactions should be recorded in those situations.

If a transaction is truly a business expense by definition of the IRS and expected to be tax-deductible, of course, that gets recorded to the expenses section of the P&L.

If a transaction is definitely personal, it is recorded to a receivable from the owner or, if you’re sure that this the appropriate treatment for your company, it could be recorded to distributions.

Sometimes a transaction is kind of in-between - it’s going to be tax deductible for the IRS, but it’s really more personal than business in nature so it wouldn’t really be appropriate to see business operating expenses go higher in a given month just because of this. For example, if the owner of the company has a meeting in Europe but gets in a day or two early and stays a day or two later and charges those costs to the company, or the owner went on a trip with a friend who also is a customer or potential customer (so it should be expensed, because they discussed business topics on the trip) but the primary reason of the trip really was pleasure. In these situations, the transaction should be coded in Other Expense - down below the Net Operating Income of the income statement. This way the tax accountant will pick it up for the tax return, but the net operating income and the selling, general & administrative (SG&A) expense of the company won’t be impacted by it.

If you’re looking for advice or recommendations, contact us at Care@PrecisionF.com.