Profitable Painter Podcast
Profitable Painter Podcast is a rich resource for anyone interested in starting, running, and scaling a professional painting business, offering valuable insights, strategies, and interviews with industry leaders. Through case studies and in-depth discussions, we deliver a vivid picture of the painting industry, with a disclaimer that any financial or tax information is general and not a substitute for professional advice.
Profitable Painter Podcast
Business and Personal: Why Separation Matters
Proper separation between business and personal finances is critical for protecting your painting business, minimizing tax liabilities, and ensuring legal protection through your LLC or corporation.
• Five key reasons to avoid co-mingling finances: legal protection, reduced audit risk, maximizing deductions, maintaining loan eligibility, and proper owner compensation
• Mixing personal and business finances breaks down your "corporate veil," potentially exposing personal assets to business lawsuits
• The IRS views co-mingled finances as red flags that increase audit probability and scrutiny of all deductions
• Paying for business expenses with personal funds can result in missed tax deductions unless properly documented
• Banks and lenders are more likely to approve business loans when they see clean, separated financial records
• Owner's compensation should be formalized - either as owner's draws for LLCs or as reasonable salary plus distributions for S-Corps
• S-Corporation owners must pay themselves a defensible "reasonable salary" that balances tax efficiency with IRS requirements
• Establishing good financial habits from the start is much easier than fixing problems after an audit begins
Join our Facebook group "Grow your Painting Business" with your questions about financial separation or accountable plans, and either Daniel or Richard would be happy to help you further.
This is Daniel, the founder of Bookkeeping for Painters. I'm a CPA that works exclusively with painting businesses to help them know their numbers and what they mean and stay big in tax. And today I'm here with Richard Dunton, enrolled agent. How's it going, richard? It's going really well, daniel. How are you? I'm doing well. I'm excited to talk about today's topic, which is mixing personal and business together. This is like a big topic A lot of folks when they initially come on board with us. We kind of have to give them this spill on why you want to keep these two things separate business and personal. There's at least five things, probably more, five reasons why you want to keep these two things separate to protect yourself and keep your financials clean. So I'm excited to jump into today's topic.
Speaker 2:Yeah, it is a very common thing that we see and it's so easy to do. Right, we're running out to the job site and we go to grab lunch and we swipe the business credit card. Or maybe we're at Sherwin-Williams and we just pay cash out of our own pocket and we got that. They call it co-mingling in the accounting industry and it's so easy to do, but it really can be something that damages our business. We want to make sure we don't co-mingle because it's important to protect our business. Our money and even our personal assets could be at risk if we had a bad habit of co-mingling. So I'm not going to sugarcoat it, I've done it myself plenty of times. I think every business owner has. But we're trying to break bad habits today. Let's do it All right. So you mentioned there's about five reasons why we want to avoid co-mingling and I think number one is probably one of the most important and also one of the least well understood, and that is the loss of legal protection when you co-mingle your finances. Most everybody listening who has a business probably has some kind of a legal entity. 90% of you are probably LLC, maybe a few of you have a corporation, and that's a really great thing because those legal entities give you separation between your personal life and your business life and it provides a certain amount of protection. We call that the corporate veil. Think of like an invisible wall that prevents people who are suing your company from coming after your personal bank accounts and your personal assets. It's very valuable to have. It's really the primary reason to have an LLC or a corporation. But if we are co-mingling our personal and our business expenses, then we are like taking a sledgehammer to that wall. We're just tearing down that corporate veil and we might think, well, you know, that's all very metaphorical, that's all on paper, but when it comes to a lawsuit, everything is on paper and a judge is going to look at your business records and they're going to say, hey, I don't see a separation between you and your company, right, I see you know Netflix and McDonald's and all this other stuff coming out of your business account. It doesn't look like you are actually operating a separate entity. And so I think I'm going to grant the plaintiff's motion to pierce the corporate veil and come after you personally, and that would be really really tragic because then all of our assets would be at risk. So it sounds like a small thing and really it doesn't take a whole lot of effort on our part, but it's super, super important if we should ever be unfortunate enough to be in a lawsuit, you know.
Speaker 2:So you might think about. Just as an example, let's say you know you have an accident on the job site. Maybe one of your guys spills a gallon of paint on a $10,000 Persian rug and that homeowner sues you. Maybe they can collect a judgment against your business account. But we want to protect our personal account, our 401k, things like that. So how do we do that?
Speaker 2:Well, we want to have a business checking account, not a personal checking account, that we pay for all of our business expenses out of. And while we're at it, let's also get a business credit card in the name of the business. We might co-sign or be a secondary on there, but the primary should be the name of our entity and we're only going to use that business card for business related purchases and we're never going to pay our personal bills from our business account. If we need money from the business, we're going to take that in the form of owner's pay and we'll talk more about how we do that later on but those pays are going to be deliberate and intentional. It's not going to be, you know, paying for personal expenses with a company. Check, yeah.
Speaker 1:I was going to say one quick note on setting up those business checking accounts and business credit cards, like you said in the business name, under the EIN of that business. So if you have an LLC or a corporation set up, you should have an employer identification number, which is basically like a social security number for a business, and make sure that the accounts are opened up under that EIN of that business so that you have that separation.
Speaker 2:Absolutely. It's just a matter of dotting the I's and crossing the T's and making sure that the paperwork lines up. So, yeah, try to have everything under that business account. The second reason we don't want to combine our personal and business finances is that we would increase our audit risk by doing so.
Speaker 2:When you have a lot of personal expenses inside your business account, it's like waving red flags, asking the IRS to look into your situation more closely. This is something that they are looking for, especially if you have a corporation and maybe you have multiple shareholders. If you're an S corporation, those shareholders need to take distributions according to their percentage of ownership or pro rata share. So if your distributions get lopsided like you're 50-50 partners but you're spending a lot more of the company money on personal expenses than your partner is now, we're just really shooting a flare, saying, hey, something's wrong here, and we're inviting the IRS and they said well, we see that you've got, like you know, $5,000 of automobile repairs and $10,000 of materials this month. But we also see Netflix and groceries, and then Amazon. What's Amazon? Well, that's business. Can you prove it? Do you have the receipts? Can you show me the business purposes?
Speaker 2:If not, they're going to be inclined to disallow it because they've already got evidence that personal expenses are going on here. So now they're going to hold your feet to the fire and really force you to prove all of your business expenses. They have the right to deny those deductions and then the ball is in your court to prove otherwise. That's going to increase your taxable income. It's going to add penalties and interest. It's not going to be a good day. So let's not tempt the IRS by paying personal bills from our business account. You know we'll pay ourselves properly and again, we'll talk about that as we go on.
Speaker 1:Yeah, and I think some folks with the IRS audits folks think that, oh, that's not going to happen to me, it's never happened to me before, so it's not going to happen to me in the future. But if you I think that I think the stat is somewhere around one percent of businesses or something like that you have a one percent chance of getting audited. I think is the number that's thrown around, which you know we obviously work with uh, we've worked with hundreds of painting painting businesses and it does seem to be about a handful of folks at any point in time are going through some kind of audit, and so it kind of approximately, I would say, line up with that rule of thumb of 1% chance. And if you're in business for any length of time or if you plan on being in business for the extent of your career, it's not really a question of if you're going to get audited, it's a question of when you're going to get audited.
Speaker 1:So definitely take this seriously. It's getting in the good habits. Once you have these good habits established, it's too easy to do. The problem is if you get into these bad habits and then you're going to have to deal with all this pain of an audit and denied deductions and all this stuff. So it's good to just establish those bad habits from the beginning, or from starting now, so you don't have to worry as much moving forward.
Speaker 2:Yeah, absolutely. I have helped a few clients through audits and it's not pretty. I have helped a few clients through audits and it's not pretty. The IRS is demanding bank statements and if you don't provide them, they will get your bank to send them through a subpoena and they will scrutinize every line. And it's not like innocent until proven guilty with the IRS. If they think that you're commingling, they're going to assume the worst about everything and then they're going to make you prove that these were actually business expenses. Unless you've got the receipts, it's going to be very, very difficult to do so.
Speaker 2:Yeah, so the third reason we don't want to commingle is we don't want to lose out on potential deductions by using personal money for business expenses. So you know, you imagine you walk into Sherwin-Williams, you buy some roller covers, you buy some tape because they've got a great sale going on, and maybe you pay for it with a $100 bill out of your pocket. You don't think much about it, but how are you going to make sure that those supplies are properly deducted from your business income? Now, there are ways to do it. You know we can do owner's contributions, things like that, but by default you're going to miss out on that deduction unless we've got a good record of it in your business account. So you know, one thing that we do with our tax planning clients is every quarter we're doing what's called an accountable plan expense report and this is set up for those personal expenses so that we're documenting them and that we are reimbursing the business owner from the corporation for those personal expenses. It's also a great way to capture things that aren't necessarily like cash transactions. So maybe you have a home office that you're running your company out of or you're using a personally owned vehicle for business. We're going to capture the value of those assets and we're going to make sure that you get reimbursed. Now, if you don't do an accountable plan reimbursement, you're probably going to miss out. Or if you don't do them on time and you don't do them according to the rules, the IRS has the right to reclassify those reimbursements as like draws or distributions and then they're going to disallow that deduction. So the best course of action make sure you pay for everything from the business account and if there is an occasional personal use of money, you record that in your accountable plan and you go through the right steps to be properly reimbursed so that you get your money tax-free out of the company and the company gets the deduction when they file the corporate taxes.
Speaker 2:All right, number four this is one that we don't think about too much, but it certainly could be a problem, and that is business credit and loans could be denied. Now why would that be the case? Well, the bank is going to want to look at your business records to see if your company is profitable enough so that they can feel confident in loaning money. And if they can't get a clear idea of what your profit is, because there's so many personal transactions in there, they're not going to feel comfortable underwriting that loan or that line of credit. Imagine how embarrassing it would be to be showing your bank records to the banker and you're saying, well, you got to take this out and you got to take that out, and that doesn't really count. And if you move this over here, it all looks good. You're just kind of eroding away their confidence in you. How much better would you feel and more confident would you feel if you walked in with a clean P&L, a clean balance sheet, no co-mingling, and now the bank feels very confident about giving you that line of credit that you need. This does happen from time to time. Banks don't really need a reason to deny a loan other than they don't feel good about it, so we don't want to give them anything that might accidentally spook them. The way that we can build a good relationship with the bank and build that good will is to have a business checking account and a business credit card with that bank. They can see that you have a history of paying your credit card on time, you're not overdrawing, you're not having bad checks, and they can see all of your business expenses coming out of those business accounts. Having those, you know, nice, clean, separated financials is going to be important to them, be important to them. So those are kind of the four reasons why we do not want to mix business and personal.
Speaker 2:But now how do we properly pay ourselves out of our company? Because obviously we're working hard so that we can provide for ourselves and our families. So if we're not going to pay for personal expenses directly out of the business, how do we take proper owner's pay? Well, it's going to depend on whether you have a LLC that is disregarded, so also known as like a sole proprietorship, or if you have corporate taxation. If you are a disregarded LLC, aka sole proprietor, then you are going to take owner's draws and this is going to be a formal writing of a check from the business account to yourself with owner's draw in the memo. It's going to happen on a somewhat regular basis. It doesn't have to be super formal but it shouldn't be sloppy or haphazard.
Speaker 2:Right, a $4.50 owner's draw to buy McDonald's well, mcdonald's is way more than $4.50 now, isn't it? I'm thinking back in the 90s is way more than four and a half bucks now, isn't it? I'm thinking back in the 90s. But you know I'm getting that. You know 10 bucks here and there to buy McDonald's is not a good way of doing owner's draws. Much better to have like a set monthly amount and then you can give yourself additional amounts based on if you have extra profit that month.
Speaker 2:Now, if you are an S-Corp, you're going to do something similar, but you are also and foremost going to pay yourself a reasonable salary.
Speaker 2:That is a formal salary ran through payroll, with payroll taxes and withholding taken out, filing 941s with the IRS, taxes and withholding taken out, filing 941s with the IRS, filing paperwork with the state, and it's going to be an amount that is commiserate to what you do in your business, and this is a very formal salary and it's required for people who have S-Corps.
Speaker 2:It is something that you don't want to take lightly, because if you do not pay yourself a reasonable salary, the IRS is not getting any payroll taxes and that makes them very, very cranky and it makes them want to look into your situation to see what else you might not be paying.
Speaker 2:So I encourage my clients to be aggressive with their salaries, and by aggressive I mean trying to keep it very modest so that you are only paying the minimum amount of payroll taxes, but having it at a level that is defensible and reasonable based on what you do, and that's going to be different depending on where you live, how many hours you work in your business, what your role is in the business. So we do very comprehensive salary recommendations at our firm, helping people know exactly what they can pay themselves to minimize payroll tax, but also have a very rock-solid, defensible recommendation that would stand up to scrutiny. Now, once you've paid your salary, then you would be entitled to distributions. We call them owner's draws and a sole prop. We're going to call them distributions in an S-Corp, but it's the same concept a regular distribution that's paid on a monthly or a quarterly basis, preferably like a percentage of the profits, and those would come to you free of any kind of payroll tax.
Speaker 1:Yeah, and going back to the reasonable officer salary, it's super important to get that salary dialed in. We just onboard a new client today actually and looking through what he was paying himself via salary for his S-Corp officer salary and he paid himself $163,000 for the year, which is very high, especially considering his business is a good size business a little over a million, but nothing too crazy. But he had a very high salary and he was just doing basic business owner stuff, so he could have probably had a salary about $100,000 lower and saved himself about $15,000. So make sure you're getting those reasonable officer salaries dialed in for what you actually would have to pay someone else, like the market rate, and getting those items because you don't want to pay yourself too high of a salary, but you also don't want to pay yourself too low of a salary to make the IRS upset. So that's an easy way you can save big in tax there.
Speaker 2:Yeah, that's a great point. I think the social security office should send him like a fruit basket or something, because he's probably been single-handedly keeping his area funded. Yeah, High payroll taxes is great for the social security and the Medicare. It's not so great for you as a business owner. So pay your fair share, but no more than that is is the way to do it.
Speaker 1:Yeah, especially with all those 190 year olds that are out there drawing security.
Speaker 2:Yeah, so 90-year-olds that are out there drawing Social Security. Yeah, so just kind of the key takeaways from this episode. You know it seems like a simple thing, but why do you not want to mix business and personal? Well, you lose your legal protection, you put yourself at an increased IRS audit risk, you could be missing out on some very valuable tax deductions and you could be making it very difficult for your company to get a loan or a line of credit in the future. The way you fix this is to pay yourself correctly and then to only spend your personal money on personal expenses. So if anyone has any questions about how to do that or how an accountable plan works, where they need help getting their salaries dialed in, we would love to hear from you. You can go to our Facebook group Grow your Painting Business, jot down your question there in the comments and either Daniel or I would be happy to talk to you further about that. If you found this podcast helpful, we hope that you subscribe and we hope that you join us on the next episode.
