In the world of small business lending, there is a line between what is a personal expense and what is a business expense. At the same time, many small business owners operate their company as if it is an extension of their personal life. In most cases, a small business really is an extension of the owner. So, can you use a business line of credit for personal use? Can the line of credit be used to pay expenses that are unrelated to the business? No, you cannot. Let’s talk about why.
Some business owners make the mistake of using cash from a business line of credit to pay for personal expenses. If the line of credit is personal, then it is not tax-deductible. If the Internal Revenue Service (IRS) discovers that a personal expense is paid for with even a small amount of a business line of credit, the agency could reclassify it as a personal line of credit and disallow all interest charges. So, be careful and adhere to the rules. It’s important to be aware of these risks, keep your accounts separate, and keep detailed records of all business expenditures made with the line of credit.
In reality, lenders do not monitor every transaction to see if it is for personal use. It is difficult to know if a transaction is for business or personal use without supplemental information. For a small business line of credit provider, it would be especially impractical to screen every usage. In addition to adhering to government tax policy, it’s ethical to adhere to the stipulations of the agreement when establishing a small business line of credit. If a lender finds out about a business owner using a business line of credit for personal use, they will call in the balance of the note. Furthermore, financial penalty may be taken against the offending party.
Why can’t I use my business line of credit for personal finances?
As we briefly discussed earlier, one of the main reasons not to use your business line of credit for personal use is taxes. The government doesn’t react favorably to individuals who dodge tax payments, whether it be intentional or not. Regardless of the intent of the business owner, the violation is unfortunately seen as the same in the eyes of the IRS. Furthermore, a small business, or the owners of that business, may create more tax liability by using a small business line of credit for personal use. The bottom line is that we now have two reasons not to mix business with personal; bad practice and tax liability.
Now we arrive at the legality of the matter. Like with taxes, it’s best to consult an attorney with specifics. Mixing personal use of a business asset or debt instrument can have legal consequences. For example, infractions like this could be used in lawsuits of any type, opening the business owner to personal liability through a legal concept called, piercing the veil. If a business owner is using the business as an extension of their personal life, the business owner can potentially be held personally responsible for any legal liabilities of the business. This being the case, it’s easy to see that owning a business can come with even more responsibility than one might expect. Legal responsibility is just one of several legal consequences of using a small business line of credit for personal uses.
Future Funding Opportunity
The next reason is relating to future funding. If the small business owner shows a history of engaging in violation of the covenants of an existing loan agreement, the chances of being approved for funding reduce dramatically. Most underwriters will want to review bank statements, and these statements might show certain payments and large withdrawals. These are all red flags for underwriters. It’s not worth it to put the business at risk due to the co-mingling of finances. So, if you engage in this cross-use of funding, lenders will be less inclined to approve you and your business for funding in the future.
Can I use my personal line of credit to finance my business?
What about the opposite case? You might be wondering if you can use a personal line of credit for your small business. We know that starting and growing a business is very difficult, and sometimes capital is hard to find, especially early on. Unsurprisingly, a good portion of business owners utilize their personal for business expenses. Unfortunately, doing so puts your personal credit at risk and comes with high-interest rates. Using a personal line of credit for a corporation also mixes personal and business assets. Doing this could void your corporate status. In short, it is ideal to just keep your personal line of credit, and most of your other personal finances, out of your business.
The Bottom Line
So, based on what we’ve previously covered, it is important to separate personal uses from business uses. The company itself was established as a separate, free-standing entity. For that entity to thrive and grow, it can not be associated with the expenses of another entity (human or corporate). A small business line of credit is designed for the financial health of the company. Financial health includes limiting expenses and working to achieve growth. The use of a small business line of credit for personal use negates both objectives. The business is bringing on more expenses and decreasing the funds available for legitimate business costs, emergencies, and growth.
We’ve discussed some negatives in this article related to the misuse of business lines of credit, but there are benefits to using this funding option properly. You can find out how to obtain one here. It’s a powerful tool for any small business. It is only detrimental when used improperly. You have probably put a lot of effort in to ethically creating and growing your business, and you deserve the rewards for doing so; however, the keyword is ethically. Always treat the small business as a separate entity. If you use the business’ credit for your own personal gain, then you will likely be penalized.