Some business checking and savings accounts pay interest on the balance maintained in the account. When that happens, the business may have income that did not come from a customer, sale, or service.
For a sole proprietor, interest earned on funds held in an interest-bearing business account is generally business income. For example, the IRS includes income from an interest-bearing checking account as an example of other business income reported on Schedule C.
This is another reason keeping business and personal money in separate accounts can make the financial record much clearer.
How Does a Business Earn Interest?
Banks may offer interest on certain business checking accounts, savings accounts, money market accounts, or other deposit accounts.
A business might maintain cash in these accounts for many reasons, including normal operating needs, future expenses, tax savings, or business reserves.
While the money remains in the account, the bank may pay interest based on the account balance and its interest rate.
That interest increases the amount of money the business has, even though it was not earned through the business's normal sales or services.
Interest Is Income, but It Is Not Customer Revenue
Suppose a consulting business earns $75,000 during the year from providing services and also receives $200 of interest from its business savings account.
The $200 does not represent another consulting service provided to a customer.
It came from a different source.
For that reason, the business records should distinguish the interest from the revenue generated through normal operations.
The business may have:
Service revenue: $75,000
Interest income: $200
Both amounts are income, but understanding where each came from gives a clearer picture of how the business earned its money.
Where Is Business Bank Interest Reported?
For a sole proprietor, interest earned on an interest-bearing business account may generally be reported as other business income on Schedule C, Part I, line 6.
The IRS identifies income from an interest-bearing checking account as an example of income from a source other than the regular operations of the business that is included as other business income.
That keeps the interest separate from the gross receipts or sales reported from the business's normal products or services.
For bookkeeping purposes, the interest can also be recorded separately in an interest income or other income account rather than being combined with normal sales or service revenue.
Commingling Can Make Interest Harder to Identify
The distinction becomes less clear when a business owner uses a personal bank account for both business and personal activity.
This is common with very small businesses, particularly when the owner begins accepting payments or paying expenses before establishing separate business accounts.
The account may contain:
Personal income
Business income
Personal savings
Money being held for the business
Personal expenses
Business expenses
If the bank pays interest on that account, the account has earned interest on money that has been mixed together.
Now there is an additional question to answer: Does the interest belong to the business or to the owner personally?
That question is much easier to answer when the money was separated from the beginning.
A Personal Interest Statement Does Not Automatically Identify Business Interest
Banks generally report taxable interest to the account holder on Form 1099-INT when the applicable reporting requirements are met. The form identifies the interest paid on the account; it does not determine how every dollar in a commingled account was being used. Taxable interest must also be reported even when no Form 1099-INT is issued.
If a sole proprietor uses a personal interest-bearing account for both personal and business money, a Form 1099-INT issued to the individual does not automatically tell the tax preparer how much, if any, should be associated with the business.
The account itself was not kept exclusively for business purposes.
Determining the appropriate treatment may therefore require looking beyond the tax form and understanding how the account was actually being used.
A Separate Business Account Creates a Clearer Record
Now consider the same owner using two accounts.
The personal account contains personal income, savings, and spending.
The business account contains the financial activity of the business.
If the business savings account earns $200 of interest, there is much less uncertainty about why that interest exists. It was earned on money being held in the business account.
If the owner's personal savings account also earns $300, that interest can be identified separately as personal interest.
Instead of trying to sort through a mixed account later, the separation already provides context for the income.
The Interest Form Is Only Part of the Record
Form 1099-INT is useful tax documentation, but it should be considered along with the accounts that generated the interest.
For a business owner with several accounts, the year-end tax documents might include interest from:
A personal savings account
A personal certificate of deposit
A business checking account
A business savings account
All of those amounts may ultimately appear on various interest statements, but they do not necessarily belong in the same place on the tax return.
Knowing which account generated the interest helps determine whether it was personal interest or income associated with the business.
Small Amounts Can Still Matter
Business bank interest may only be a few dollars, particularly when account balances or interest rates are low.
The amount being small does not change what it represents.
Interest credited to an account is generally taxable even when a Form 1099-INT is not issued.
Recording the interest when it appears in the business account also helps keep the bookkeeping complete and makes the amount easier to identify when the tax return is prepared.
Separate Accounts Make the Answer Easier
Separating business and personal money is often discussed in terms of keeping expenses organized, but income can become commingled too.
Interest is a good example.
When personal and business funds are held together, determining what belongs to the business may require additional review.
When the business maintains its own accounts, interest earned on those accounts can be identified along with the other financial activity of the business.
That separation creates a clearer record during the year and a clearer starting point when it is time to prepare the tax return.
