If you are like every other business owner I’ve worked with, you hate paying income taxes. It’s understandable. You worked for every dime of your money and you’d like to keep it. Who wouldn’t? While there are plenty of legal ways to try to reduce your income tax liability, many business owners I have worked with make the mistake of running personal transactions through their business bank accounts in order to reduce their tax liability. Here are the three biggest reasons mixing personal affairs with business affairs is a bad idea.
While many business owners are focusing on cutting their income tax liability down to nothing, they forget that they are simultaneously destroying the value of their company. By flooding your business account with personal transactions and showing little to no profit every year, your company quickly starts to look like a hot pile of garbage to any potential investors. If you purchased a house, you wouldn’t actively start dismantling it so it looked less valuable. You take care of it, invest money into it when necessary, and hope that the value increases over time. This is exactly how you should treat your company. Showing profits and paying taxes is like putting money into your house to make it more valuable.
While today you may just be focusing on making a living, it’s important to realize that your business is an asset that can be sold in the future. You have equipment, customers, and business connections that someone may be willing to pay money for if the numbers look good. This is a huge opportunity for most self-employed people, and especially for ones that have little to no retirement savings. I have seen clients with clean books and consistent profits sell their companies for more than they would have ever imagined they were worth. It’s a fantastic way to transition into retirement.
There is a term that most business owners have heard at one point or another called “piercing the corporate veil.” A big part of forming a separate legal entity (e.g. corporation, LLC) is to shield yourself from potential liabilities. This is how business owners protect their personal assets. Commingling of business funds and personal funds is something that can pierce the corporate veil, opening up the shareholders to personal liability in lawsuits.
Some business owners are shocked when you explain this to them. Disguising your personal transactions as business transactions is fraud. Plain and simple. IRS auditors can figure out pretty quickly which transactions don’t belong in your business account. When they see that you’ve been categorizing all of your weekly Wal-Mart purchases to “office expense,” you can bet that they’re going to ask for receipts to see if these were just groceries. When you can’t provide the receipt, they’ll probably disallow the expenses and assess additional taxes, penalties, and interest. Also, don’t make the mistake of giving the transactions to your accountant and trying to blame him or her when they are categorized as business expenses. Accountants work with what you give them. If you are trying to deceive them, you will be held liable. Not them.
It is crucial to keep your bookkeeping clean and free of any personal transactions. The benefits of doing so certainly outweigh the amount of tax savings. Try to take pride in paying taxes. It means you’re making money! That’s the whole reason you started a business in the first place, right?
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