Many small business owners have heard of it. A majority of small business owners unknowingly do it. And it is something that can cause serious and adverse results, all without the offending party knowing they did anything wrong. What am I referring to? It is called commingling of funds.
What exactly is the commingling of funds? At its very base, it is the act of mixing the funds belonging to one party with those of another party. Why is this so confusing to small business owners? It comes down to one simple thing. Separation between self and business.
Small business owners build the business. Many times the small business has one owner or principal. With this ownership comes a sense of entitlement to what the business has. This is where the problem manifests.
You see, when you form an LLC, as many small business owners do (in the United States), you are actually forming another entity. It is actually, legally, like giving birth to another person. The LLC has its own birth certificate called Articles of Organization as well as its own identity called an EIN or employment identification number.
The analogy is sound. However, although a parent is legally entitled to all things belonging to a minor in the United States, a business owner is not entitled to everything belonging to the LLC or other incorporated entity.
When you are a small business owner, you must treat your business like a completely separate person. Imagine that this person is an employee or representative of yours. You would not, hopefully, just reach into an employee’s account and withdraw their funds for your usage. The same mentality has to be considered with your own company.
If you do not treat your company as a separate entity, neither will the IRS or any judge if you face a lawsuit. They will see how you operate and quickly come to the conclusion that “you do not treat your company as a separate entity so neither shall we.” This is referred to as piercing the corporate veil. This is one significant level of security that business owners put in place in order to insulate them from exposure. What I am saying, in plain language, is that you form a company as a separate entity, in part, to protect your personal assets form jeopardy. If the corporate veil is pierced, your home, your car, your personal saving, EVERYTHING is up for grabs in a law suit!
How can you avoid this scenario? The first and easiest thing to do is always make sure you are advertising your business by your business’s lawfully registered name and sign every agreement as an authorized agent or officer of the business. The second thing to do is completely avoid commingling of funds.
How do you avoid commingling of funds? The process is simple yet the practice can be difficult to train yourself to do. Here are a few simple guidelines.
- All payment to your business needs to be deposited into your business account.
- Any expenses paid by your business account or corporate credit cards needs to be specifically for a justifiable business use. Do not buy home groceries with a corporate credit card.
- When you personally need monies from the business, either transfer the funds from your corporate account to your personal account and register it as an owner’s draw or write yourself a paycheck and register it as earned income.
Treat your business bank account like it belongs to another person. You need to document and have justifiable proof to all deposits into that account as well as any payments or withdrawals from that account.
If you follow our few simple guidelines as it pertains to commingling, you will avoid a tremendous amount of exposure and potential headache.