June Walker, an unenrolled tax preparer, writes a blog subtitled Tax & Financial Advisor to the self-employed since 1979.
In a recent post she advises her business clients to commingle their business funds with their personal funds.
You read that write right: She advises the commingling of funds.
Listen:
You need only one checking account. Do not open a separate checking account for your business.
Yes, that’s the exact opposite of what Sammy Segar, CPA, told you. And it’s not just Sammy who tells you that. In an IRS publication, you are urged to open a business checking account and “although a bank may charge you an extra fee for a business account, the new account will more than pay for itself in accounting efficiency.”
Most accountants disagree strongly with my position – because they don’t know you like I know you. My system will save you money and time; their advice will cost you money and time.
First, Ms. Walker may be the most brilliant, competent, well-meaning person on the face of the planet, but she is not a lawyer. In giving this advice she is engaging in the unlicensed practice of law and it is dangerous.
Second, and more importantly important, Ms. Walker is giving business owners horribly bad advice.
(And it’s not just bad advice for tax reasons, although those reasons alone would suffice.)
The Corporate Veil
Lawyers advise their clients to incorporate for a variety of reasons, but by far the most important one is to insulate shareholders from personal liability for corporate debts. The tax reasons for incorporation are legion, but subordinate to this overarching reason.
Law students learn at law school orientation that merely incorporating a business is not enough for a shareholder to avoid personal liability for corporate debt. The corporation must respect the formalities of its form of business.
Generally, when a business operates in a corporate or limited liability form a corporate veil is created between the business and it’s shareholders.
Shareholders, directors and officers have a duty to ensure that the corporate veil is kept intact at all times.
To prevent a creditor from piercing the corporate veil shareholders must do more than merely file articles of incorporation with the state. There are a number of ongoing governance requirements and formalities that incorporated business owners must comply with in order to keep the corporate veil intact.
In order to avoid personal liability in a lawsuit or IRS audit, shareholders must be able to prove that the corporation is a bona fide business entity – a real business and not just a shell created to avoid personal liability.
Piercing the Corporate Veil
Creditors of a corporation will do everything in their power to collect a corporate debt or judgment, including the filing of a lawsuit against the shareholders of a corporation.
In order to make the shareholders’ liable for the corporate debts, however, the creditor must “pierce the corporate veil.”
Here are 6 factors that greatly increase the likelihood that a creditor will be able to pierce the corporate veil and pursue collection from shareholders:
- corporate debt is intentionally and knowingly incurred when the company is insolvent;
- annual shareholders’ or board of directors’ meetings are not held and/or other corporate formalities are ignored;
- corporate records are not maintained;
- shareholders use corporate funds for personal reasons thereby endangering the corporation’s financial stability;
- there is a general commingling of corporate activity and/or funds and those of the person or persons who control the corporation;
- there is a failure to maintain separate offices, the company has little or no other business and is only a facade for the activities of the dominant shareholder who is in fact, the corporate “alter ego.”
Legal Advice
Never – I mean never – use your personal bank account to operate your incorporated business or LLC.
And never – I mean never – take legal advice from a non-lawyer.
(Hat Tip: Robert Flach, The Wandering Tax Pro)
15 responses so far ↓
1 Judy // Aug 15, 2009 at 6:37 pm
My employer hasn’t paid pr taxes since Nov 07. Employer has tax attny handling the case.
The business checking acct funds were frozen, to be taken by the IRS in late Aug.
Employer went in for a 4180 interview and had a 4180 form she filled out and faxed back to the IRS.
Employer basically threw me under the bus and pointed to me as making financial policies for the company and naming me as the Business Manager. I was never offered the position of Bus Mgr nor did I ever accept such an offer, never got promoted, was never paid as a Bus Mgr nor was I educated as such. I have emails proving Employer has hands in every aspect of the business, makes all decisions, I take orders from and carry out as best I can. I’ve worked for the company for 9 1/2 years. Employer assures me the IRS will only go after the officers of the Corp. Even said the tax attny said they only go after the officers of the corp. I truly doubt that any attny would state that. I’ll ask the tax attny on Monday if he did infact state that . At that point I expect he’ll tell me he can’t advise me and I’ll have to get my own counsel at my own expense at that time. As of today I’ve notice that the bank accts have been released. My employer wants to go with me to the 4180 meeting. Yeah right. Several of my friends don’t think the IRS will hold me responsible for the unpaid PR taxes. I have a very bad feeling about this.
2 Peter // Aug 16, 2009 at 10:11 am
Judy,
Thanks for visiting.
Officers (and shareholders) are not automatically responsible persons for purposes of the assessment of the trust fund penalty.
Here is the standard:
If you didn’t have signature authority on the company’s bank accounts and didn’t sign checks or otherwise bind the company to debt, you should not be held responsibile.
You might want to take counsel with you to the 4180 interview.
3 Jeff Day // Aug 16, 2009 at 7:12 pm
You stated: “Lawyers advise their clients to incorporate for a variety of reasons, but by far the most important one is to insulate shareholders from personal liability for corporate debts.”
“Jeff you need to incorporate, and that will only be $800 please”
I am an enrolled agent in Southern Indiana. It is my opinion most lawyers and many if not most CPA’s advise to incorporate for the biggest reason: “FEES”!
I agree that co-mingling of funds is dangerous territory and if nothing else gives an appearance of inappropriateness. But to claim that a small new company should incorporate for liability protection is greatly over-stated. Would you sell a new automobile to a new company that had no assets or would you require a personal guarantee? Would you rent a new warehouse to a new company that had not track record and no assets or would you require personal guarantees?
It is not unusual for a CPA to increase fees $1000 a year for a “S-Corp” more than a schedule C on personal return.
Jeff Day EA
Evansville, IN
4 Peter // Aug 17, 2009 at 8:25 am
Jeff,
You can tell a lot about a person by what he is critical of in others.
The fact that you are so ready to accuse others of intentionally giving bad advise to their clients just to make more money for themselves tells me that you are inclined to do the same.
Projection ain’t just a river in Egypt!
I advise my clients to have Last Will and Testaments.
Do I do that just for the fees?
I also advise my clients never to go to Tax Court without a lawyer.
Just for the fees?
Oh, and I always tell my clients not to do handshake deals and instead get the terms in writing.
Do I do that just to get more fees?
If you have a serious business, it’s unwise to operate as a sole proprietorship and probably malpractice for a lawyer not to point that out to his clients.
By the way, Jeff, I hereby advise you to incorporate your tax preparation practice. I am quite sure I will not get a single penny for that advice.
Life is too short to be so cynical.
Here’s a little advice for you:
5 Judy // Aug 17, 2009 at 2:46 pm
Peter, Yes, I am a signer on the bank accounts and yes I did with the bookkeeper decide who was to get paid. But the owner of the company assured me repeatedly that the IRS only puts liens on officers of the corporation. Does it sound like she’s setting me up to you?
6 Peter // Aug 17, 2009 at 8:37 pm
Judy,
I don’t know if you’ve been set up, but I do think you could be assessed a trust fund penalty.
The fact that you were not an officer is not enough to insulate you from liability.
If you end up having to pay, you may have a claim against the owner.
But the IRS doesn’t apportion responsibility among responsible persons (there can be more than one responsible person) and will pursue collection from whomever has the ability to pay.
I suggest you talk to a tax lawyer before you speak to the IRS or your former employer.
Good luck and if you want to talk more about this feel free to email me.
7 Commingling of Funds is Still a Horribly Bad Idea // Aug 19, 2009 at 12:15 am
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10 steve // Mar 25, 2010 at 4:06 pm
Hello,
An elderly friend of mine formed an LLC and started a deli in 2008 in South Florida. He never colleced or reported sales tax. The FL Dept of Revenue is now after him to pay sales tax on the minimal sales he had since starting up.
Can the FL-DOR come after him personally if he just closes down the LLC and closes up the shop?
What if he opens up the deli again in a new LLC in his wife’s name after closing the first LLC?
I am just trying to help this old guy out, without getting paid. Any advice would be appreciated.
Thanks,
Steve
11 Peter // Mar 25, 2010 at 9:39 pm
Steve,
Assuming the company was formed and operated properly, the DOR cannot go after your friend personally for the debts of his LLC unless he actually collected and failed to remit sales tax.
This is general information. I suggest you have your friend hire an attorney before doing anything.
12 Jill // Feb 8, 2011 at 12:55 pm
Peter,
I am self employed, not Inc., nor LLC. I file my taxes yearly with my husband jointly. Am I legally obligated to pay quarterly taxes, or is this just a convenience so I do not have a large payment in April?
13 Peter // Feb 9, 2011 at 12:13 pm
Jill,
Generally, you are required to make estimated tax payments. Calculating the proper amount of estimated payments can be tricky, however.
14 Barbara Saunders // Oct 22, 2011 at 6:02 pm
There is no “corporate veil” in a sole proprietorship, is there?
Opening a business account prematurely made it more difficult, not less, to separate business and personal expenses for me. When you’re freelancing and new, you end up switching money back and forth: $150 “draw” to pay the personal phone bill. $25 from the personal account to the business account to buy some postage, etc.
This quickly becomes an accounting nightmare.
Much cleaner to have one account and a ledger of business income and expenses until it gets to the point of actually having the business cover its own overhead and expenses. (Unless a separate job initially covers all personal expenses so that only “investments” into the business are necessary and no withdrawals.)
15 Peter // Oct 31, 2011 at 6:39 am
Barbara,
No corporation, no corporate veil.
I disagree. It can never be cleaner from an accounting standpoint to commingle your personal and business funds.
Never.
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