If you own an LLC, an S or C-corp, or some other formal business structure, stop mixing your business and personal expenses.
I’m asked all the time “what’s the best category to put personal expenses in?” My answer is none. Pay yourself a wage, and then pay personal expenses out of your personal checking account. Easy-peasy.
I have a few reasons for saying this. First, it’s difficult for your bookkeeper and accountant to sort between the two. Heck, at times, it may be hard for you to differentiate between the two.
My second reason has a little more substance: legal protection.
Why did you form a partnership or corporation? One of the reasons they exist is to separate individual shareholders from business liability. What does that mean? If an LLC goes bankrupt or is sued, the obligations of the company are not transferred to the owners. The liability stays with the company. While these things hurt shareholder value, they don’t exceed the boundaries of their investment.
UNLESS the company looks like a sham. In that case, lawyers can “pierce the veil” or come after individual shareholders. One standard for crossing the boundary is comingling assets: mixing personal and business expenses. Pay your personal mortgage with a company check? Buy personal groceries with a company card? You’re mixing expenses. You’re putting yourself at risk.
There are other reasons that a judge will “pierce the veil,” including criminal fraud. To be clear, in court, comingling assets are lumped together with fraud. Sounds worse when you put it that way, doesn’t it?
This discussion usually leads to a discussion about what we can deduct from our taxes. Put simply, deduct legitimate business expenses. Not your personal living expenses. These will differ a little depending on the details of your business, but most of them can tell what a personal expense is. Compare it to having a job in town. Ranch work has some additional perks, but if you start by thinking about what items you’d have to pay for if you drew a wage at the local lumber mill or the bank, you’d be off to a good start. There are some grey areas where it’s a good idea to get some advice. But there’s a lot of black and white.
When you are setting up your business structure, you should think about protecting the owner’s assets. Conversely, you should also consider protecting the business's assets from the owners. It’s fascinating how many times a divorce or addiction can ruin a small business. A well-thought-out program is a two-way street.