Know Someone Who Runs Personal Expenses Through Their Small Business?

Gene Marks and Ben Gran

[This article has been updated to reflect the new tax law that went into effect on January 1, 2018]

Tax Strategist or Tax Evader?

C’mon…admit it. You know someone who’s done it. Maybe they:

  • Took some petty cash and used it to pay for a couple of cases of beer, some food at the store, and lunch with friends.
  • Shared a company car with a teenage daughter on the weekends.
  • Charged that expensive dinner with the missus on the corporate card.
  • Bought a bunch of clothes and other household stuff, and charged it to the business.
  • Wrote off an entire resort vacation with the family because they made a single, one-hour sales call to a customer while in town.
  • Had the contractor who upgraded a home kitchen send an invoice to the company.

Yeah, you know someone who’s done this stuff. Or at least some of it. Right?

The truth is, many small business owners have, at one time or another, blurred the lines between “business” and “personal” expenses to try to save money on taxes. No one’s perfect. No one talks about it, or likes to admit it.

But it’s too tempting.

Charging a personal expense through the business means taking a deduction for it against income. And if our state and federal tax rates are somewhere between 20-30% combined, then effectively that could be like getting a 20-30% discount on those things purchased. It’s a perk of being a business owner, right?

What harm is there?

And really, who’s going to know? Chances are someone probably won’t even get audited. And besides, even if a small business owner fudges the numbers a bit on their tax deductions, it’s such a small amount, relatively — the IRS has much bigger fish to fry, right?

Is charging personal expenses through the business legal? Of course not. It is fraudulent. But the legality is not the issue. There’s another bigger issue at stake here …

Tax Minimizer or Tax Evader?

My dad used to tell me there are two types of taxpayers in this world: tax minimizers and tax evaders.

Smart business people are tax minimizers. These business owners do everything they can, within the law, to minimize their taxes. They plan. They defer income where they can, and increase expenses when they’re able. They take advantage of credits and deductions. They may take an aggressive position here or there, but always with good, documented reasons. Considering that taxes are the number one highest expense for any business person, smart business people are always good at (legally, prudently) minimizing their tax obligations.

But dumb business people are tax evaders. These are the people who seek to reduce their taxes by any means, legal or not. These are the people who cut corners and cook the books. This is not a good practice.

Running personal expenses through a business may not seem significant. It may only represent a small amount of your overall expenses. But it represents something much more significant: Someone who willfully runs personal expenses through the company without any explanation, justification, or reason, has officially categorized themselves as a tax evader. And, if they one day are unfortunate enough to be the subject of an IRS audit, an IRS auditor will judge them on this behavior.

Going through an IRS audit is a stressful and risky endeavor for tax evaders, because it opens up their entire business finances to stricter scrutiny. A $500 fraudulent deduction for personal expenses could be, in the eyes of an IRS agent, a clue to something much, much bigger. If there is distrust or lack of credibility with the business owner, then the agent may dig further, create more havoc, and spend more time disrupting the business — whether there’s good reason or not. That stupid $500 personal dinner bill that was run through the company could cost countless unproductive hours responding to IRS requests. That’s painful — and the tax penalties, business disruptions, and other potential consequences are not even remotely worth it.

So, the next time you see someone charging a personal expense to their business, do them a favor and share this article with them. It’ll make you a better friend, and help them become better business owners.

New Tax Law

Also, under the new tax law that took effect Jan. 1, 2018, there are significant tax breaks for small business owners. For example, business owners who operate their businesses as pass-through entities (LLCs, partnerships, S corporations, or sole proprietorships) can now take a special 20% deduction on their business income (with certain limitations). Taxes are never fun, but why bother trying to cheat on your business expenses when the government is giving you this new deduction?

Talk to your tax adviser about what the new tax law means for you — and keep on being a smart tax minimizer, not a dumb tax evader.

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20 Responses to "Know Someone Who Runs Personal Expenses Through Their Small Business?"

    • Dawn Weaver | April 4, 2018 at 8:32 am

      I’m a sole proprietors and there never seems to be enough to be Able to make an income if you will. Where I can split it out.

    • Larry jones jr | April 4, 2018 at 2:38 pm

      I have the same question on how do you split if small business is a bit shy of pay myself or do I just pay my self the bare minimum and hope for the best..

    • Gene Marks | April 4, 2018 at 7:05 pm

      I don’t think, as a sole proprietor or very small business you have to get yourself all hung up on paying yourself a salary…yet.

      You have revenues and expenses. Whatever is left over is your income. You can keep doing that.

      However, as you grow your company hopefully that leftover income goes up and up. So much so that you can eventually allocate a portion of that as ‘salary” and the remainder goes to savings.

    • David Frederick | July 3, 2019 at 8:50 am

      Also a small business owner, I think it is important to pay yourself something, even if it is small at first. If you rely on “what is left over” you are setting yourself up for “failure” because the justification of the need to buy this or that is easy. There is a fresh take on the “pay yourself first” idea in the book by Mike Michalowicz, “Profit First” that has revolutionized they way I run my business the last two year.

    • Robert | July 3, 2019 at 12:08 pm

      There’s more: by using business income to pay for personal expenses, you also violate the “corporate veil” that protects you from the liabilities of the company. If proof is had that you used business assets for personal, you are basically “outted” that there is no difference between the personal you and your business entity. Therefore, if your company is sued, it can go right to your personal assets. Now, especially for professional LLC’s, etc., that’s a very big deal.

      • Hannah Stacy | July 9, 2019 at 2:18 pm

        Thanks for the comment Robert!

    • Reed Ashwill | July 3, 2019 at 3:27 pm

      Pre-fund your salary by accumulating funds in your business. If the business has an additional $25,000 at the end of the year you can give yourself a $2,000 per month raise for the next year — because you have “pre-funded” your salary increase. This is over-and-above your normal business reserves that you keep.
      If you haven’t pre-funded for it, you can’t take any more out next year than you did this year. Never bet on the come thinking the increase in revenues you have had for the last few months will constantly continue.

      • Hannah Stacy | July 9, 2019 at 2:17 pm

        Thanks for your comment Reed!

    • charles porter | July 4, 2019 at 11:50 am

      I LIKE IT

    • Andrea Marquez | July 8, 2019 at 5:16 pm

      My husband and I Co own two companies and we have lunch out everyday and it’s always a working lunch because that’s the only time we can discuss “the business financials and strategy” without interruption … we have even tried to not discuss business (even on our 20th wedding anniversary) but we still did … are those lunches deductible? They should be because small business owners are literally always working in some way shape or form.

    • Gene Marks | July 9, 2019 at 9:48 am

      Andrea –

      Are the companies related? Do the companies do business with each other? Was business discussed at the lunch? Are you both involved in the business transactions? If so, the expense is likely deductible but remember there’s a 50% limitation. Hope that helps!

    • S K Hand | July 9, 2019 at 11:19 pm

      One should also consider that to claim inappropriate expenses/deductions is to devalue the company; it will appear that the business costs more to operate than it legitimately does. An otherwise sound exit strategy could be undermined by tax-evasion practices.

      • Hannah Stacy | July 12, 2019 at 8:36 am

        Thank you for sharing!

    • Rosie M | July 15, 2019 at 11:14 pm

      Is there a formula or percentage to base the salary or take home money for me as a business owner?
      I usually take just what I need to pay for my personal and home expenses.
      I appreciate any information or recommendations.

    • T | July 22, 2019 at 11:50 am

      What if you know someone who writes off family vacations and gives everyone money to spend and 1099 each one for the spending money? The tax person knows it and let’s it happen.

    • Gene Marks | July 23, 2019 at 5:00 pm

      T,

      Who’s “the tax person” you’re referring to? This doesn’t seem kosher, sorry.

      T | July 22, 2019 at 11:50 am
      What if you know someone who writes off family vacations and gives everyone money to spend and 1099 each one for the spending money? The tax person knows it and let’s it happen.

    • Ken | August 11, 2019 at 4:48 pm

      I have a question about this… I recently found out by my HR person that my 2 bosses are taking a large salary for themselves since the company started and also have both their wife’s on payroll who do not work at all for the company in any way shape or form. They also bought 2 range rovers and the company makes the monthly payments for them along with the gas,tolls, and parking fees. They can take the bus to work since all they do is drive to work to sit at there office and that’s it. They are not traveling sales men. They also charge there large lunches and bar bills to the company every day. The business is now suffering due to a tough time in our business sector and they are laying people off and looking to slash people’s salaries but I can’t help and feel that we would have been ok had they not done these things as well as other things that are legal but severely stupid…. what can I do if I lost my job because they say money is tight but the sales for the company are higher then last year and I can prove they mismanaged company funds?

    • Gene Marks | August 12, 2019 at 10:50 am

      Hi Ken,

      Assuming this is a privately held company your bosses are free to mismanage and drive their firm into ground as they please. You’re just an employee and it’s not your perogative to question what they do, sorry. If you believe that they are breaking laws then you can report to them to the police. The IRS and SEC also has whistlewblower programs for things like this, although it’s generally used by employees at large public companies.

      I wouldn’t want to keep working for people like this. You can obviously see the writing on the wall. If you can, you should look for employment elsewhere and spend time with people that you enjoy and for owners that you respect…and respect you.

      Ken | August 11, 2019 at 4:48 pm
      I have a question about this… I recently found out by my HR person that my 2 bosses are taking a large salary for themselves since the company started and also have both their wife’s on payroll who do not work at all for the company in any way shape or form. They also bought 2 range rovers and the company makes the monthly payments for them along with the gas,tolls, and parking fees. They can take the bus to work since all they do is drive to work to sit at there office and that’s it. They are not traveling sales men. They also charge there large lunches and bar bills to the company every day. The business is now suffering due to a tough time in our business sector and they are laying people off and looking to slash people’s salaries but I can’t help and feel that we would have been ok had they not done these things as well as other things that are legal but severely stupid…. what can I do if I lost my job because they say money is tight but the sales for the company are higher then last year and I can prove they mismanaged company funds?

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