You have to do extra work to separate personal expenses from business expenses. You can’t just download the bank account transaction history to QuickBooks, Xero or Zoho Books, and know that all expenses are business related.
Instead, someone has to carefully comb payday loans Rhode Island through and re-categorize expenses. It’s an unnecessary manual step that saps business productivity. Besides, memory fades and makes it all the harder to re-categorize if you don’t get to it right away.
The founder of WeWork discovered this the hard way. The high-flying company, once valued at $47 billion, filed for an IPO in the summer of 2019. The filing disclosures revealed the founder’s self-dealing, including personal loans he got from the company at below-market rates.
The company’s biggest investor forced him out as CEO. In the end, he had to resign from the company he founded!
WeWork is a high profile example. Remember, though, even in a small business with no plans for an initial public offering, stakeholders could sue for misappropriation of funds, fraud or breach of fiduciary duty. So if there are other owners or investors, paying personal expenses from a business account will eventually catch up with you.
6. Could negate part of the Subchapter S benefit
A Subchapter S is an election you make with the IRS to treat taxes as a pass-through and avoid double taxation of both the corporation and the owner.
Another advantage of a Subchapter S is that it can reduce employment taxes (Medicare and Social Security taxes) for the owner. Here is how it works. The owner becomes an employee of the company. As long as he takes a reasonable salary, the owner doesn’t have to pay employment taxes on corporate distributions over and above the salary.
However, if the owner takes non-salary distributions without keeping good track of how much he is spending, he could run afoul of the IRS. How? By taking distributions that far outstrip his salary. Tax law requires that the owner’s salary not be unreasonably low compared to profit distributions.
What can happen is that the owner loses track of how much he is taking out of the company for personal purposes. This is easy to do when you mix personal and business expenses and don’t have good accounting controls.
As Nolo states, “If the IRS concludes that an S corporation owner has attempted to evade payroll taxes by disguising employee salary as corporate distributions, it can recharacterize the distributions as salary and require payment of employment taxes and penalties which can include payroll tax penalties of up to 100% plus negligence penalties.”
7. Makes it harder to profit and grow
The more disciplined a business is about finances, the greater the likelihood of success. If you are loosey-goosey handling bank accounts, it can cause your business to lack fiscal discipline in other ways. And that puts an unnecessary impediment in front of you.
Any financial reports may show an inaccurate picture of the business, because they may include personal expenses. How in the world can you generate a useful Profit and Loss statement (P&L) without clean data?
At the very least you will have to stop to clean up your data first. This robs you of real-time reporting capability.
Overall, by mixing personal and business funds and not maintaining discipline, it becomes harder to manage the business toward profits and success.
Best Practices for Business and Personal Expenses
Most small businesses start out with the owner using her personal funds to start the business. So, from the owner’s standpoint it may seem perfectly fine to keep mixing personal and business. In fact, according to one survey, 27% of business owners admitted using the same account for business and personal.