A common problem with single-owner and other closely held corporations is intermingling of funds. This occurs when a corporate shareholder uses his or her personal checking account for corporate deposits or payment of corporate expenses.
Separation of funds can be a key in preserving the liability protection of the corporate veil. Courts can pierce the corporate veil by finding that the corporation is an “alter ego” of the shareholder, essentially stating that the corporation is not separate and distinct from the individual as evidenced by the intermingling of finances.
Also, a shareholder who deposits personal funds or pays personal expenses from the corporate checking account is intermingling funds. For the same reasons as the reverse, courts can cite this as evidence that the corporation is not a separate and distinct entity from the individual.
Tax Problems Caused By Intermingling Funds
Unintended tax consequences can occur when personal and corporate funds are intermingled. When a shareholder provides funds to or on behalf of a corporation, there are several different types of tax treatment that may apply, depending on the circumstances. For example, when a shareholder provides funds to a corporation, it can be classified as one of the following transactions.
- Capital contribution
- Loan to the corporation
- Repayment of a loan from the corporation
- Expense reimbursement
When a shareholder purchases an item for the corporation from his or her personal funds, that shareholder is considered to have provided funds, or made a contribution, to the corporation. Classification is determined by how the transaction is structured and the circumstances surrounding the transaction. Providing funds to corporations without careful planning can cause unintended tax consequences.
If an individual takes funds from a corporation checking account, the transaction can be classified as:
- Taxable dividend.
- Nontaxable distribution.
- Nontaxable expense reimbursement.
- Loan to the shareholder.
- Repayment of a loan from the shareholder.
Failure to carefully structure transactions when taking disbursements from a corporation can result in otherwise nontaxable transactions becoming taxable, in addition to opening the corporation up for a court to pierce the corporate veil.
Personal Use Of Corporate Assets
A similar situation with intermingling funds occurs when personal assets are used by the corporation and vice versa. If corporate assets are used for personal purposes, the IRS can reclassify expenses reported on the corporation’s tax return as expenses attributable to the shareholder rather than the corporation. On the other hand, if a corporation uses personal assets owned by the shareholder, this could indicate a lack of separation of the shareholder and corporation, opening up the possibility of having the corporate veil pierced.
About J&S Accounting
J&S Accounting is a full-service bookkeeping, payroll, and consulting services. Our team understands that well-organized financial records help your business run more efficiently. We are a woman and minority-owned accounting practice improving the fiscal management of small businesses and nonprofits in Savannah, GA, and nationwide.
> Learn More