What's Difference Between a Law Firm Expenses and Personal Expenses?

What's the Difference Between a Law Firm's Bank Account and Their Wallet? This is a  post around the differences between law firm finances and personal finances and how to book those personal finances into the accounting records.

A law firm is a business. It's important to remember that, but it's also important to note that your law firm is also not a personal bank account. That's why it's always important to keep your personal finances separate from professional expenses.

Let's start with the credit card used for law firm expenses.  It is imperative to keep personal and professional expenses are kept in different accounts. If you have a personal account, you'll need to make sure that you don't commingle business and personal expenses in it.

That means your personal account should only be used to cover legitimate personal expenses. That includes things like meals and entertainment, and costs related to your children. If you have a business account, you'll need to make sure that you don't commingle personal and business expenses in it. Your business account should only be used to cover legitimate business expenses. This includes things like office supplies, client expenses, and other related expenses.

As a professional accountant combing through the records, we sometimes see personal expenses booked into the business account.

While I am thrilled that you bought beautiful Gucci shoes because you've earned enough money to pay for them,  you cannot write them off on your business books. There is no place on the books for the shoes except for me to book them in as distributions.

So, what if you're using one credit card that's under your personal name for both the business and your personal expenses? How do I book them into your records as the law firm's bookkeeper?

When lawyers comingle using one credit card for business and personal expenses, it creates a bit of a tangled mess. We have to sort through the myriad of line items on the credit card statement to figure out what is personal and business-related. And this is how they are booked:

"Owners or partner distribution"

These transactions will be taxable personally. It's considered an income event to the owner of the business.

The IRS Take

The biggest issue with this type of scenario is how the IRS will see it during an audit. The IRS does not like commingling. I sat through an audit many years ago where a client had done just that. They had one personal credit card that they booked many truck repairs. The auditor meticulously examined the personal Netflix and Macy's transactions and dug out the business expenses.

Even though these truck repairs were, in fact, performed on the truck for the business, the auditor discluded them. There was too much detangling necessary to separate business from personal. Additionally, the auditor dug even deeper into the records. This comingling was not an inexpensive mistake on behalf of my client as the auditor removed them as expenses for the business. It cost the firm over $20,000 in legitimate expenses that were disallowed. 

I share the story to prevent you from having the same terrible results. Even though the client had the receipts to prove that these expenses were business expenses, the auditor discounted them from the records because they were paid on a personal credit card.

How do you prevent commingling?

 What if your business is new and you cannot get a business credit card yet?

It's as simple as getting a second credit card attached to you personally, but you use it only for your business. I even suggest getting a label maker and creating a label on the credit card so that you don't make a mistake and use the wrong one.

What if you have employees that purchase on your business's behalf? That's simple there are several options:

You can designate a specific amount that the employee can use with all of the above. It's like an expense card. You track your expenses, and you can cap the amount of money spent, so you have control.

Conclusion

If I don't have you quite convinced yet of the need to separate, I'll give you an even better explanation.

Did you know how much work it is for the accountant or bookkeeper to troll through all the expenses on a personal credit card to determine which ones are business? For example, meals. Are they personal meals? Are they business meals? There's a chance you will miss essential business expenses that will lower your income and lower your taxes.

As you can see, it is imperative to maintain good, clean accounting records. We don't want to pay more in taxes than we already do. Finding that good accounting professional is Your key to success.

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