The Dangers of Intermingling Company and Personal Funds

When you own your own business or run a small business, it is easy to intermingle funds.

Intermingling happens when you don’t separate your business and personal accounts or when you do not keep proper records documenting transactions between personal and business accounts. The simple act of using your personal checking account to receive business deposits or pay business expenses can lead to many unintended consequences.

These consequences can be legal in that you can lose some of the liability protections afforded to corporations. There can also be financial consequences since the reclassification of your income and expenses can lead to unexpected back taxes that you will have to repay.

Fortunately, a bit of planning, forethought, and recordkeeping can help you keep your records straight and ensure you avoid surprises.

Below, I go through the record-keeping and liability issues, tax consequences and give some advice on how to keep your records separate.

Record-keeping and liability issues

The first problem with intermingling is recordkeeping: when all of your expenses and deposits mix together, it can be impossible to sort through what belongs where. From just an ease-of-compliance, filing, and knowing how your business is doing perspective, separating funds is essential.

However, intermingling can create more significant liability issues.

One reason you may establish an LLC, or a Corporation is for liability protection. Creating an entity separate from yourself establishes a “corporate veil” that protects you personally from liabilities the corporation incurs.

If you intermingle funds, you risk the courts “piercing the corporate veil” and determining that the corporate entity is, in reality, not a separate entity. In this case, even if you have created an LLC or a corporation, you lose that liability protection.  

If you use your personal accounts for business purposes, you are definitely intermingling. However, intermingling can happen even if you have separate accounts.

A shareholder/owner who deposits personal funds into or pays personal expenses from a business checking account can also be intermingling funds. For this reason, it is crucial to establish separate corporate and personal identities and formally track transactions between the two.

Court Case Example, Reginald Jarret, et al. (T.C. Summary 2008-94)

A taxpayer operated a tax preparation business as a sole proprietor. The taxpayer later incorporated but continued to have clients make checks out to him personally and treated the funds received by the business as his own.

He also failed to create an employment agreement between himself and the corporation.

The court ruled that the taxpayer operated his business as a sole proprietor and removed all liability and legal protections that the corporation would have provided.

The court also found that the individual, rather than the corporation, earned the income. As a result, the taxpayer was subject to self-employment tax (that he owed for many past years).

Tax problems caused by intermingling funds

Like in the case above, intermingling can easily lead to unintended tax consequences. Corporate income is not subject to self-employment tax, while personal income is. So, like in the case above, if the court determines that the income accrues to the individual, not the corporation, you may end up paying back taxes.  

Additionally, as a shareholder/owner, when you provide funds to or on behalf of a corporation, several tax treatments may apply, depending on the circumstances.

For example, providing funds to a corporation can be classified as one of the following transactions:

  • A capital contribution
  • A loan to the corporation
  • Repayment of a loan from the corporation
  • Expense reimbursement
  • Purchase   

These classifications can have different tax treatments and consequences. To ensure that your contribution is classified the way you want and expect for tax purposes, you must record the transactions correctly.

When you, as a shareholder, purchase an item for the corporation from your personal funds, in theory, you contribute to the corporation. But, a reviewer or auditor will classify the transaction based on the circumstances surrounding it and how you structure it. So, without planning, your contributions may end up reclassified, which can lead to different tax treatment.

(By structure, I mean how the transaction takes place. One way to structure a transaction is to pay for a personal expense using a corporate credit card or write a check drawn on a corporate account. Another way to structure the same transaction is to first make a distribution to yourself and then pay for the expense from your personal account.)

Withdrawals present the same issue. If you take money from a corporation, you may classify the transaction as:

  • Taxable dividend
  • Nontaxable distribution
  • Nontaxable expense reimbursement
  • Wages
  • Shareholder loan
  • Repayment of a loan from the shareholder

Just as with the deposits, if you fail to structure transactions carefully and intermingle funds, you can run into tax consequences. A reviewer may reclassify your transactions based on their interpretation of the situation, leading to nontaxable transactions suddenly becoming taxable.

Court Case Example: Pappas, T.C. Memo 2002-127

In this case, the taxpayer managed several business activities, including real estate, entertainment services, and interior design. She incorporated her business in New York under the name Real Services, Inc.

She did not keep good corporate books and frequently used the corporate checking account to intermingle funds. Business deposits went into the account, but she made payments out of the account for personal reasons. Some of the examples cited in the case include birthday presents for family, tuition payments for her daughter, end contact lenses for her friend.

The IRS audited the individual and determined that she owed taxes on personal expenses. She argued that the corporation should be liable, not her, because the corporation received the funds and made the payments.

The court determined that the corporation was a sham and removed all protections. In the decision, the court specifically cited “the intermingling of corporate funds” and “failure to observe corporate formalities such as maintaining books and records, failure to pay dividends, and siphoning off funds by the dominant shareholder.”

How to avoid intermingling of funds

Fortunately, the solution to intermingling is simple.

First, you will need to create separate corporate and personal accounts. Use your personal accounts for all personal activities and payments. Use the corporate accounts for all business activities and payments.

The next step is to ensure that you keep a record of all of your corporate financial activities. The best way to do this is to use software like QuickBooks to track and categorize every transaction. Every transaction includes payments to you or contributions from you. Through this bookkeeping, you establish a record of formality that a reviewer can read and use to verify that the business is a separate entity.

Finally, maintain a record of business decisions and create contracts, even with yourself as an owner. If you have multiple LLC members or shareholders in a corporation, be sure to have regular meetings where you take notes and keep the notes for the record. You should also have an operating agreement in place (even if you are the sole shareholder). This again helps establish that the owners are separate from the business and will protect you from liability. These records do not need to be long or complicated; they just need to exist.  

Additionally, be sure to retain records for at least the statute of limitations. You will want to be able to substantiate your claims if you are ever questioned.

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Jeff Coyle, CPA

Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.

He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.

His business experience includes:

Creating and preparing financial reporting, budgeting and forecasting.
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Providing insight on financial results and providing advice based on those results.

Jeff also has a long history of helping individuals manage their taxes and plan their finances including:

Income tax planning and strategy.
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Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.

Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.

Jody H. Chesnov, CPA

Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004.  After a career of public accounting and general management, Jody knows the value of good financials.  Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.

He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles.  His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.

He has a particular expertise in early-stage growth companies.  His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.

Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller.  He has experience across industries, which gives him a deep understanding of business.

Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.

In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.  

He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.

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