Transcription
You've probably heard someone say, "Just use your business credit card for everything or your accountant will sort it out at tax time." Don't worry, that's wrong. And believing it can cost you thousands in an IRS audit, thousands more with your accountant, destroy your legal protections, and even trigger catastrophic tax consequences that are nearly impossible to reverse.
The truth is, mixing your personal and business expenses is one of the biggest mistakes that I see business owners make. So today, I'll explain how you should separate your business and personal expenses the right way so you can maximize deductions, lower your accounting costs, and legally keep more money out of the IRS's hands. And I'm Jasmine Duchi. I'm practicing tax attorney, CPA, and agent. I got my first tax license in high school. And in today's video, we're going through the real legal and tax consequences of mixing your personal and business accounts. The kind of problems you only realize when the IRS or your accountant hands you the bill.
Let's start with the pain you feel immediately. Your wallet. Okay. When you mix personal and business spending, you're basically hiring your accountant to play detective. Except instead of solving crimes, they're solving the mystery of why you spent $47 at Target on a Tuesday. And believe it or not, your accountant is not going to charge you the same or less for doing more work combing through a million personal expenses. They will charge you more. So what happens? Your accountant sends you a list of transactions that no one on earth could classify without your input. Right? Suddenly, you're spending your free time as if that even exists for business owners trying to remember why on earth did I go to Home Depot 3 weeks ago. And oh shoot, my accountant now knows about my personal obsession going to Larry's Hot Yoga. And here's the kicker. Even after all that back and forth, some charges still end up mclassified because you can't remember why did you go to Home Depot. Or maybe you just don't have the guts to tell your accountant that the $10,000 you spent on a fancy hotel and dinner was personal since your wife was out of town that weekend. If you'd kept only business expenses in the business account, your accountant could confidently categorize almost every expense based on vendor information. Instead, they're forced to know way more about your personal life than either of you ever wanted while still having to bother you every month for additional information.
And if higher accounting bills weren't bad enough, mixing accounts sets you up for something far worse. a higher tax bill and a nightmare with the IRS. Here's what actually happens. You lose real deductions because your accountant pushes anything questionable into the personal bucket. You accidentally create taxable events, especially in S corps and CC corps, when personal charges get reclassified as dividends. Capital gains from exceeding basis or compensation with payroll tax. And worst of all, you make an IRS audit substantially harder, more expensive, and more likely to end up with you paying the IRS more. Let's talk about why. Remember that third point, the Iris audit nightmare.
Picture it. You're at Larry's Hot Yoga, relaxed, sweating out the stress from running a business. You head home feeling great until you open up the mailbox. Inside is that dreaded letter. We selected your return for examination. Your first thought, and just like that, your inner piece is gone. The audit begins. But you think, no problem. I'll call Jasmine. She's an attorney. This will be easy peasy. Except here's the problem. Even though you've watched my channel, even though you're sitting here listening to this very video, you still co-mingled your business and personal accounts. Why? Because cousin Bob swears he's been doing it for 20 years and never had a problem. But I can tell you instead, one of two things usually happens. You actually managed to track down receipts. Congratulations. But it doesn't save you. Now the burden is higher because you have to prove those business expenses were really business while they're sitting in between clearly personal charges like Larry's hot yoga. or what I see way more often, you mixed personal and business because let's be honest, you're pretty damn disorganized. So, when I ask for receipts, you shrug and you say, "Yeah, I don't have most of them. The IRS can't possibly expect me to keep the receipts, right? Don't bank and credit card statements work?" And the legal answer is no. Statements alone are not enough. They only prove that you paid for something, not that it was an ordinary necessary business expense.
But in practice, had you kept personal and business clearly separate, we would have a better argument for something we call the Cohen rule to prove your expenses were for business. The Cohen rule comes from a famous court case where the judge allowed a taxpayer to estimate expenses based on facts and circumstances, even without receipts. Okay? It is basically the Hail Mary of tax law. You can sometimes reconstruct the story after the fact. It's an argument that we only rely on when it's all we've got and it's not a sword that you can use against the IRS. Instead, it's a fairness argument that the IRS and tax court often permit in the right situations. Now, let me ask you, do I have a stronger or weaker argument based on facts and circumstances that your Target and Home Depot charges were 100% business when they're sitting on the same statement with the Dallas Zoo and Larry's Hot Yoga? It's weaker because the natural conclusion is if you can't even separate what belongs in the business account in real time, why should the IRS trust your opinion about what's business at a later date?
Moral of the story, keep personal expenses on personal accounts. Your bookkeeper doesn't need to see them. Your tax preper doesn't want to see them, and the IRS definitely shouldn't see them. Okay? Best case, co-mingling costs you thousands more in accounting fees. Worst case, it blows up into an IRS nightmare. Either way, it's one of the most expensive shortcuts you'll ever take.
Finally, as if the tax consequences weren't enough, comingling also creates legal exposure. I'll keep this one short and simple. If you treat your business and personal as one in the same, the court will too. Okay? The whole point of creating an LLC or a corporation was to separate yourself from the business. But if you treat it like your personal piggy bank, you're telling the court you never respected that separation, so why should they?
So, here's your action plan to avoid these problems. Okay. Keep personal expenses on personal accounts. This includes expenses like tax payments to the IRS, which are personal expenses unless your business is a Ccorporation. Okay. Keep business expenses on the business accounts so proof of payment is clear and easy to access. For mixed expenses like home office or cell phone, stay consistent. Okay? I usually recommend expensing these mixeduse expenses on your personal account and then reimbursing them through an accountable or reimbursement plan with the business. This is as simple as a one-page piece of paper outlining your reimbursement policy. And make sure to cut that check to show the reimbursement actually happened. And finally, maximize business deductions on your business accounts by knowing what is a legal deduction. And if you're like, "Wait, I want to know more about how to understand if something is a legal business deduction," then click the next video.