Commingling Funds – Why you should NEVER do it

    By Ted Sutton, Esq.

Ryan was always ambitious and hard working. As a teen, he would regularly work on house flips with his dad. But when Ryan turned 18, he decided to start his own house flipping business.

After listening to his dad’s advice, Ryan formed an LLC for his house flipping business. A service helped him form an LLC with the Secretary of State, provide a registered agent address, and draft an operating agreement for his business. Once he began flipping houses, Ryan held himself out as the manager of the LLC.

But he skipped the step of forming a separate bank account. His dad never used one, so he didn’t feel the need to set one up. Any business funds were deposited and paid out from Ryan’s personal bank account. This was the same account Ryan used to pay his rent and other personal expenses.

After Ryan had been flipping homes for one year, one of his home buyers tripped and fell on a broken staircase. The buyer then filed suit against the LLC. After a lengthy trial, the court found that the LLC was liable for the buyer’s injuries. But because the LLC did not have a separate bank account, the buyer was able to reach Ryan’s personal bank account.

Because Ryan commingled business and personal funds, he was personally on the hook. He could not use the corporate veil to shield himself from personal liability.

What is Commingling Funds?

When you form a business, you can NEVER commingle funds. But what exactly does it mean to commingle funds?

A person commingles funds when they mix business and personal funds into a single bank account. But if you do this as a business owner, you can run into a lot of trouble.

When someone sues your business, a plaintiff may try to pierce the corporate veil to hold you personally liable. The corporate veil itself symbolizes that you are keeping your business property separate from your personal property.

But if you follow the list of corporate formalities, you can stop someone from piercing the corporate veil. The list varies by state, but it may include the following:

1. 1. Properly formed under the Secretary of State
   2. Maintaining separate bank accounts
   3. Maintaining separate records
   4. Having an operating agreement or bylaws
   5. Having bank accounts that are adequately capitalized
   6. Holding company out as a separate business
   7. Holding yourself out as manager of that business
   8. Conducting regular meetings
   9. Having minutes of those meetings
   10. Following other rules and regulations
   11. Legal entity separate from its owners
   12. No commingling of funds
   13. No personal obligations from business bank account
   14. No evidence of fraud or injustice
   15. Maintain annual filings, annual report, fees, good standing
   16. Having a registered agent
   17. Paying taxes for corporation
   18. Filing separate tax returns
   19. Making proper distributions
   20. Selling interests with proper approval
   21. Issuance of stock or membership certificates

If you follow most of these formalities, there will be a sufficient separation between you and your business. If this separation exists, you will not be held personally liable. But if there is no separation, then you are individually on the hook for any judgment entered against you. For more information on the corporate formalities, please check out my dad’s most recent book, Veil Not Fail.

In many states, the first formality that courts look at in veil piercing cases is whether the business owner commingled personal and business assets. You do not want this to work against you. If you don’t follow this first formality, it is very easy for the court to pierce the veil. But if you form a separate bank account that keeps your business assets separate from your personal ones, the veil will be much more difficult to pierce.

After you get an EIN number from the IRS, opening a business bank account at the beginning is very easy. In fact, many banks have low minimum balance requirements for business bank accounts. Having this separate account will protect you in the long run because it may shield you from personal liability.

Is it commingling or not?

It is also worth mentioning what constitutes commingling funds and what does not. Knowing these differences will help you properly operate your business.

One thing that does not constitute commingling is having bank statements mailed to your personal residence or a P.O. Box. This is especially true if your business is a passive holding company. If your business does not have a physical address, your personal residence may be the only address where banks can send bank statements. Another thing that does not constitute commingling is using your business bank account for all business income and expenses.

However, there are some things that do constitute commingling. Clearly, one of them is using one bank account for both business and personal expenses. Another is using your business bank account for any personal expenses, and vice versa. But if you keep these things separate, you will not be commingling funds.

Conclusion

Had Ryan set up a separate business bank account at the start, he would have stopped the buyer from piercing the corporate veil. After all, he followed many of the other corporate formalities. But because he didn’t have a business bank account, he was personally liable to the buyer.

Do not make the same mistake Ryan made. Have two separate bank accounts and use them as such.