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Business Financing – Tax Problems Caused By Intermingling Funds

Monday, August 21, 2023

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
  • ​Purchase

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
  • ​Wages
  • ​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.

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This content is for information purposes only and should not be considered legal, accounting, or tax advice, or a substitute for obtaining such advice specific to your business from a professional accountant. Additional information and exceptions may apply. Applicable laws may vary by state or locality. No assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a customer’s particular situation. J&S Accounting does not have any responsibility for updating or revising any information presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent research. J&S Accounting does not warrant that the material contained herein will continue to be accurate, nor that it is completely free of errors when published. Readers and viewers should verify statements before relying on them.

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Disclaimer

This content is for information purposes only and should not be considered legal, accounting, or tax advice, or a substitute for obtaining such advice specific to your business from a professional accountant. Additional information and exceptions may apply. Applicable laws may vary by state or locality. No assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a customer’s particular situation. J&S Accounting does not have any responsibility for updating or revising any information presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent research. J&S Accounting does not warrant that the material contained herein will continue to be accurate, nor that it is completely free of errors when published. Readers and viewers should verify statements before relying on them.