Comingling Expenses and Why You Should Avoid ItPosted on March 6th, 2018
For small business owners, it can be all too easy to intertwine business and personal finances. This is referred to as “comingling” and should be avoided for a few key reasons:
- Audits – Personal expenses are not tax deductible for your business. The IRS states that for business expenses to be deductible, they should be ordinary and necessary for your trade or business. Making personal purchases with company funds and deducting the expenses could get you in trouble during an audit.
- Loss of liability protection – Depending on the type of business entity you have, comingling expenses might cause you to lose the liability protection that a corporation provides, meaning that you as an individual could be held responsible if the company owes money.
- Misleading analytics – Comingling is a slippery slope—a few purchases every other week can add up to a surprisingly significant amount by the end of the year. As the level of comingling increases, it becomes more difficult to understand how your business is performing. Your business expenses become overstated, which skews trends and makes analysis less meaningful and accurate.
To avoid comingling expenses, a business should have its own bank and credit card accounts, and owners should avoid using the business accounts for personal use. This is a good idea for sole proprietors as well, since it simplifies the accounting process, allows for better reporting, and makes tax preparation a breeze!
While reading this article so far, you probably thought to yourself: “This sounds great! No more comingling for my business going forward!” But what about the following situations?
- When you forget your business checkbook or credit card and have to use your personal card
- When you accidentally use your business card for a personal expense
- When both you and your business use an item or service (such as your cell phone)
There are very simple solutions for these situations! Here are the best practices to account for them:
When you personally pay for a business expense:
Submit an expense reimbursement form with supporting documentation to the business for reimbursement. The company can either process a payment or leave the liability on the Balance Sheet in a “Reimbursements Payable” account. This is a good way to record these types of transactions when your business is short on cash and you don’t mind being reimbursed later.
When you charge a personal item on a company card:
Record the transaction as a receivable/asset for the company. You can create an “Employee Advance” account that shows a balance to be reimbursed by an employee. Recording the transaction in this manner will keep the personal expense from appearing on the Income Statement. Its presence on the Balance Sheet will remind you that the company needs to be reimbursed. The advanced amount can be paid back or applied against the Reimbursements Payable balance, if available.
When you share the cost of an item or service with your business:
You need to determine the proportion of business to personal use for the item or service. Accounting for this may depend on the type of business you have and to whom the item/service belongs (you or the company). Here are two different examples and how to account for them:
- Any type of company – If you’re using your personal cell phone to make business calls, it is reasonable to be compensated for that use by your business. If 50% of your cell phone use is for your business, then the business should reimburse you for 50% of your bill. Submit an expense reimbursement form with your bill as supporting documentation.
- Sole proprietors and partnerships – If you’re using your company cell phone for personal calls, split the expense between an expense account (such as “Telephone” or “Utilities”) and an equity account (usually “Owner’s Draw”). By doing this, you’re honestly reporting your personal use of something your business pays for (and deducts).
- Corporations – Stop right here! Items or services paid for by your business are off-limits for personal use.
If you use Balance Sheet accounts to record these transactions, don’t forget to reconcile those accounts! Refer to our blog on Reconciliation Best Practices to learn more about why this is so important.
Thanks for reading, and we hope you found this blog helpful. If you have any questions, feel free to leave a comment below!